This Selected Economic Issues paper for Bosnia and Herzegovina reports that output, exports, and incomes have increased and inflation has stabilized. New modern banking laws have been passed in both entities, and the banking sector has been almost completely privatized, with the majority of assets now under foreign ownership. The reforms to the central bank and to the banking system have been aimed to secure stability and to build an efficient financial system.


This Selected Economic Issues paper for Bosnia and Herzegovina reports that output, exports, and incomes have increased and inflation has stabilized. New modern banking laws have been passed in both entities, and the banking sector has been almost completely privatized, with the majority of assets now under foreign ownership. The reforms to the central bank and to the banking system have been aimed to secure stability and to build an efficient financial system.

IV. The Corporate Sector 1

A. Introduction

1. The corporate sector is in severe difficulties. It appears to be characterized by wide-spread loss making, a heavy debt burden, and excess labor. And a poor business environment compounds the challenges. All this impedes investment, including FDI, and job creation. These problems have multiple roots: former Yugoslav worker-manager structures; disruptions of civil war; voucher privatization; lack of bankruptcy procedures; restrictive labor legislation; corruption; and neglect by the Bosnian authorities and the international community.

2. But there are bright spots. A number of privatizations have occurred recently, including to foreign investors, and restructuring is taking place in these companies.

3. This chapter focuses on four questions. How bad is the overall situation in corporates? How did it get that way? What has blocked attempts to remedy the situation in the past? And, in the cases where restructuring has occurred, how and why did that work? This analysis provides a backdrop to work being conducted by the IBRD to develop a program of restructuring going forward from here.

B. How Weak is the Corporate Sector?2

4. The analysis in this section uses data from the APIF and AFIP databases of industrial company balance sheet and P&L data. The findings covers the 1,000 largest companies in both the RS and Federation in 2002, cleansed for SoEs that will not be privatized (e.g. hospitals) and for SoEs that have been privatized. The enterprises included in the sample represent about one third of total employment.

5. These data are of uncertain quality. Balance sheets and income statements are not subject to independent auditing, compliance with local audit requirements is weak, and most companies do not make their audited statements publicly available. The application of accounting rules varies across companies and there is liberal use of off-balance sheet accounts.3 4 This state of affairs qualifies all assessments of firm level data.


6. The corporate sector is dominated by loss making and marginally profitable enterprises. Profitability is low in both entities with the average gross profit margin (before tax) negative in RS and at breakeven in the Federation (Text Table 1). SoEs are considerably less profitable than private enterprises— 70 percent of SoEs and 25 of percent of private enterprises are loss making. And only one in five private enterprises and one in twenty SoEs report profit margins above 5 percent, though profits may be incompletely recorded.

Text Table 1.

Profitability, 2002

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7. Profits have not increased in recent years. Increases in industrial production in the RS and Federation over the past two years have not yielded larger profit shares for corporates. Instead, increased output has been matched by wage and employment growth (Text Table 2). Profits consequently declined by 10 percent in the Federation between 2002 and 2004. And while profits increased somewhat for RS enterprises in 2003 (helped by the appreciation of the Serbian Dinar) they stagnated in 2004.

Text Table 2:

Unit Labor Cost Components 2002=100 1/

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Costs and sales revenue

8. Reduced labor costs are not sufficient to restore profitability. In the SoE sector labor costs as a share of revenues are typically four times higher than in private enterprises. And shedding up to half the labor force, and assuming no consequential loss of output, would leave 40 percent of SoEs continuing to generate losses (Text Table 3). High non-labor related costs likely stem from outdated plant and machinery, poor management, weak corporate governance, low sales volume (see below), and corruption. Administrative and transportation costs associated with a heavy reliance on imported raw materials could also be inflating non-labor related costs.

Text Table 3.

Federation: Profitability after Labor Shedding, 2002

% reduction in labor costs

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9. Low sales revenue to assets suggests inadequate organization of production. SoEs generate considerably less revenue from their assets than private enterprises in both entities and across a range of industries (Text Tables 4 and 5). It is uncertain, however, if assets are realistically valued in the companies books.

Text Table 4:

Sales Revenue/Assets, 2002

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Text Table 5:

Sales Revenue/Assets, 2002

(by Sectors)

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Liquidity and solvency

10. A large proportion of enterprises are illiquid. On the available data, half of the SoEs and 40 percent of private enterprises are unable to repay their current (less than 1 year) liabilities from their current assets (Text Table 6). And with the vast majority of companies also unable to repay current liabilities from current income (even over a 10 year horizon), the implication is that they are liquidating fixed assets or securing outside financing to repay their current obligations, and/or simply accumulating arrears, and thereby reducing solvency.

Text Table 6:

Liquidity, 2002

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11. Enterprise debts, as reported in the RS, are dominated by intercompany arrears. Over one third of enterprise debts are owed to suppliers (Text Table 7). A further quarter of their debts are in the form of loans. Wage arrears reportedly account for only 5 percent of total enterprise debts, and tax and contribution arrears a further 10 percent. Loss making SoEs have accumulated proportionately more arrears to suppliers than loss making enterprises in the private sector, while the latter have accumulated proportionately more wage and tax arrears than loss-making SoEs. It is unclear, however, if total labor debts are correctly recorded. Under the labor law, wage arrears accumulate even for “fictitious” workers who have long since stopped appearing for work if they have not been given their work books. These debts may be incompletely recorded.

Text Table 7:

Debt Structure, 2002

(in Percent)

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12. With this proviso, clearance of tax and labor debts would have a limited effect on the corporate debt burden. Writing off tax and labor debts would return only 15 percent of companies to a position of being able to pay current liabilities from current assets, leaving some 40 percent of enterprises illiquid, and effectively insolvent (Text Table 6). And loss-making private enterprises would benefit disproportionately from across the board clearance of tax and labor debts because of the concentration of these debts in these companies.

C. How Did The Corporate Sector Get to This Point?

13. Initial conditions in 1995 were not favorable. Disruptions of civil war left plant and machinery severely outdated if not destroyed. Know-how was lost through large scale emigration and internal displacement of the labor force. And those enterprises previously part of Bosnia and Herzegovina’s vertically integrated industries, found themselves isolated and without traditional local markets.5 And with the break-up of Yugoslavia, access to the markets in the Former Yugoslav Republics was disrupted. All this left Bosnia and Herzegovina’s GDP at a fraction of its prewar level. Manufacturing output was crippled, and at end-2004 had recovered less than half of its pre-war contribution to GDP (see Table 1).

Table 1:

Growth of Value Added 1/

(in percent, in real terms)

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Source: Bosnian authorities and staff estimates

Based o the 1993 System of National Accounts starting from 1996. The 1989 figures are based on the former system and therefore not directly comparable to to subsequent ones.

14. But subsequent policy choices aggravated these difficulties.

  • SoEs were treated as a social safety net. In the context of demobilization of military personal, SoEs were pressed into hiring large numbers of veterans, inflating their payroll. Alongside, labor regulations afforded generous wage and benefit packages for SoE workers, beyond the means of SoEs to pay. And by requiring the clearance of all unpaid wage and contribution arrears prior to dismissal, labor regulations effectively prevented SoEs from shedding labor.

  • Alongside, voucher privatization failed to transform SoEs into profit seeking enterprises.

  • With government mandates lasting only 2 years, there was little political will to tackle this difficult agenda.

  • Bankruptcies were rare. Prior to the introduction of modern bankruptcy laws in 2003, bankruptcy procedures were protracted and ineffective for securing creditor rights in the Federation, and non-existent in the RS. This led to a build-up of interenterprise arrears, a barter system of trading among enterprises, and bilateral negotiation between creditor and enterprises.

  • And unconditional debt write-offs and reschedulings in the RS prolonged the life expectancy of unprofitable enterprises and reduced the profitability of others.

15. And price stability provided enterprises with no relief from their debt burden. Anchored by the currency board, prices remained low and stable, so enterprises’ real debt burden was not significantly reduced.

D. Why Has Revitalization Proved So Difficult?

16. Profit seeking for shareholders is not a core motive for enterprises. Under the current incentive structures, many enterprises do not seek to maximize profits for shareholders or pay workers wages or contributions for pensions and health insurance in full. Hard budget constraints are not enforced because of a reluctance of creditors (including workers) to file bankruptcy proceedings. And voucher privatized enterprise are not under the effective control of private shareholders (see below). Enterprise managers and workers also tend to view the problems they face through the former Yugoslav lens of “government should solve everything” including by boosting aggregate demand and sheltering them from foreign competition. All this renders firms resistant to change.

17. The current labor legislation is a further impediment. Tripartite collective bargaining sets contracted wage rates above the ability of firms to pay. With contracted wage rates at least 20 percent higher than paid wage rates, wage, pension, health, and unemployment benefit contributions have gone unpaid. And by requiring the clearance of all wage, benefit, and contribution arrears before a worker can be released, which corporatessimply cannot afford, the labor laws prevent shedding of “excess” and “fictitious” workers.6 Wage and benefit rates are also inflexible downward because of the fixed system of coefficients for determining wage and benefit rates and, in the Federation, indexation of the minimum price of labor to the average price of labor.

18. The business environment discourages firm entry. According to the European Bank for Reconstruction and Development (EBRD) Transition Report 2004, out of 27 transition countries, Bosnia and Herzegovina belongs to the lowest-performing five in the area of small and large scale privatization. While it costs 16 per cent of per capita income on average to start a business in the region, it costs more than double this (46 percent) in Bosnia and Herzegovina. Bosnia and Herzegovina also has one of the highest tax burdens in the region. All of these factors discourage investment and push entrepreneurs into the already large informal sector.7 And corruption levels, ranked among the top five obstacles to doing business by firms operating in Bosnia and Herzegovina, show no sign of abating.8 Apart from discouraging new capital to enter Bosnia and Herzegovina, these trends risk existing investors relocating their operations outside of Bosnia and Herzegovina.9 And political considerations feature prominently in decisions on allowing foreign investors to participate in tenders for SoEs. Nevertheless, high world steel and aluminum prices have made Bosnia and Herzegovina’s mining and steel industries increasingly attractive to foreign investors.

19. Bankruptcy procedures are new and largely untested. There is growing acceptance that bankruptcies are a natural and necessary part of a healthy corporate sector, but this is not yet matched by a willingness to file bankruptcy proceedings, especially on the part of the governments who remain disposed to unconditional debt write-offs for enterprises. The legal administration to enforce the 2003 bankruptcy laws is being developed with the assistance of USAID, and initial indications are that bankruptcy cases are moving through the courts without major delay up to point of sale of assets. Sale of assets is impeded by poor land registry records. Moreover, the potentially large volume of bankruptcy cases needed to revitalize the corporate sector may overwhelm the limited capacity of the courts and trustees, undermining efforts to impose credible hard budget constraints on enterprises.

20. Corporate restructuring presents social challenges. Revitalizing the corporate sector will often initially result in job losses, in some instances in single company towns. Alongside there are limited resources available to ameliorate the social effects—a balance needs to be struck between addressing wage arrears and gaps in pension contributions for workers, and fiscal solvency.

21. Faced with these realities, corporate restructuring has been neglected by the Bosnian authorities and the international community. And the ratcheting-up of worker expectations has exacerbated the challenges.

E. Lessons From Earlier Revitalization Initiatives

Voucher privatization

22. The program of voucher privatization launched in 2000 intended to promote company restructuring by transferring public companies to private ownership (see Box 1). While this transformed the ownership structure for many SoEs, the hoped-for revitalization did not materialize. Private share holdings in Voucher Privatized Enterprises (VPEs) were pooled and managed by Privatization Investment Funds (PIFs), which received a fixed management fee based on the book value of company assets in their portfolio. PIFs therefore had no incentive to demand increased profitability from VPEs, or to force management change. PIFs were further hampered by regulations limiting their holdings to 30 percent of VPE capital. Even in the absence of these restrictions it is not clear that PIFs were (and are) equipped to oversee corporate restructurings. Alongside, governments retained effective control over VPEs through direct shareholdings and shareholdings of the pension and restitution funds.

23. The lesson here is that private ownership has to secure control by a competent and financed owner, who is endowed with effective control over the enterprise and the ability to remove management if necessary.

Debt rescheduling

24. Following voucher privatization, the RS government engaged in rescheduling of company debts to provide “breathing space” for them to restructure (Box 1). After a 2 year grace period on tax and contribution arrears, only 20 percent of participating VPEs began repaying rescheduled liabilities. Companies did not restructure their operations because they did not have to. Because the authorities failed to file bankruptcy proceedings against VPEs that did not pay their current tax and contribution obligations (as required under the terms of the rescheduling) the incentives for companies to restructure was undermined from the outset.10

Voucher Privatization and Debt Rescheduling in Bosnia and Herzegovina

In an attempt to revitalize the corporate sector, Bosnia and Herzegovina undertook a voucher privatization scheme between 2000 and 2001. About 1000 enterprises in the Federation and 600 enterprises in the RS were privatized under the program, covering around a quarter of SOE assets.

All citizens of BiH were eligible to receive vouchers. These could be used to “purchase” share capital in companies included under the program, residential property (in combination with a partial cash payment), or could be traded for cash. Frozen foreign currency account holders had the opportunity to convert all or part of their savings into vouchers, and military veterans received additional vouchers. In all, vouchers equivalent to some KM 15 billion (150 percent of 2000 GDP) were issued.

Voucher holders could acquire shareholdings in SOEs directly, but most opted to exchange their vouchers for shares in Privatization Investment Funds (PIFs), which pooled the vouchers to acquire shareholdings in Voucher Privatized Enterprise (VPEs). Key strategic enterprise (56 in the RS and 72 in the Federation) were excluded from the voucher scheme.

Following voucher privatization, some 500 VPEs in RS were granted a rescheduling of liabilities (as of end-2001) owed to the RS government, totaling some KM 430 million (14% of 2001 RS GDP). The intention was to give these recently privatized companies some relief on debt servicing to allow them time to restructure their operations along profitable lines.

As an indictor of the ability of VPEs to stay current on their current tax and contribution arrears during the period of the rescheduling, participating enterprises had to demonstrate that all liabilities were fully paid for the first quarter of 2002. In the event, only a fraction of participating VPEs stayed current on their current obligations to government, without consequence.

When the grace period expired in mid-2004, 80 percent of participating VPEs did not make payments on their rescheduled liabilities. The bank accounts of these companies were initially blocked and later unblocked pending review of their business plans with a view to additional rescheduling for those companies deemed to have sound plans.

25. The lesson here is that without a tight link between debt write-offs and restructuring (including through bankruptcy), debt write-offs and rescheduling simply delays the needed structural adjustments and encourages firms to expect further reschedulings from government in future.

Strategic privatization

26. Following the Voucher Privatization scheme, privatization based on international competitive tenders has been slow. Out of a total of number of 108 strategic companies, only 18 had been sold by end-2003 (mostly from the Federation portfolio). In large part this is because the privatization agencies do not have control over SoE assets (as is the case in Croatia, for example), and the tender process is subject to interference from line ministries. Alongside, when tenders failed, a common practice in the RS has been to revert to one-on-one negotiations between investors and the government. Knowing in advance that this would occur, investors tended to wait until the tenders failed, and then entered covert negotiations with the authorities. This both undermined the tender process and encouraged corruption. And with cantons responsible for privatizing companies located in their jurisdiction and the central government responsible for privatizing corporates located in more than one canton, the Federation privatization program was fragmented and uncoordinated.

27. The lesson here is that privatization processes must be transparent, time bound, free from political interference and under the effective control of the single agency in each entity.

Sale to private owners

28. If the new executives of recently restructured large companies are to be believed, rapid restructuring will yield high returns. These executives expect their exports, which were 13 percent of BiH exports in 2003, to exceed all 2003 BiH exports within two years (Text Table 8). All of these companies had attracted foreign investors either as owners, advisors, or partners, with some investors, having been “the first-in” in other transition economies now turning to Bosnia and Herzegovina. And even companies that were sold for a minimal price after several failed tenders have made a significant contribution to the local economy, employment, and exports. A distinctive feature of these companies is that many had been pro-active, prior to sale, in developing business plans for their revival, and in some cases had successfully secured foreign bank financing on the basis of those plans. As a result of these restructurings, industrial output increased strongly in both entities in 2004. This demonstrates that with effective management and fresh capital, enterprises can be turned around relatively quickly, and that the authorities can be effective in attracting quality foreign investors to Bosnia and Herzegovina.

Text Table 8:

Large Company Restructurings

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29. The lesson here is that company restructuring, if deep and decisive, can yield results quickly.

30. Nevertheless, the optimism of managers of restructured companies is tempered by the business environment. An aging work force and a lack of skilled engineers and mid-level managers, combined with restrictive labor legislation, are cited as constraints on company growth. A lack of rail capacity, unreliable electricity supply, and government bureaucracy are also seen as key impediments to expanding production. On the latter, one telling example is that long delays in having import documents signed by the relevant line ministry results in repeated loss of competitively priced raw materials, leading one large company to consider relocating its business operations outside of Bosnia and Herzegovina.

F. Conclusions

31. Bosnian enterprises had a bad start after the war, but policy and neglect since has made matters worse. A broad program of corporate restructuring is needed to tackle the estimated 60 percent of enterprises in Bosnia and Herzegovina that have debts which they cannot repay.

32. Quick fixes are unlikely to help. While enterprises are unlikely to be sold with large debts on their books, indiscriminate write-offs of tax arrears will not deliver a rejuvenated corporate sector. Rather, a comprehensive restructuring program, including reform of the labor market and better corporate governance, are needed to establish profit seeking as the core motive of the corporate sector. This is a complex and challenging task and the authorities are drawing on World Bank expertise in these areas.

33. The core elements of a remedy, suggested by Bosnia and Herzegovina’s own experience with alternatives, are clear:

  • Debt write-offs and reschedulings must be made conditional on restructuring and management change.

  • Shareholders must have effective control over the enterprise, including the ability to remove management.

  • Governments must demonstrate commitment to bankruptcy proceedings to establish a credible threat to enterprises that do not restructure. This includes addressing capacity and administrative constraints in the bankruptcy procedures.

  • The process of privatization must be free from political interference, transparent, and strictly timebound.

  • The social aspects of corporate restructuring need to be addressed in the context of limited fiscal resources.11

  • Labor legislation must be reformed to prevent future accumulation of wage and contribution arrears and to alleviate frictional unemployment during corporate restructuring.

34. This presents a challenging administrative, social, and political agenda. But further inaction simply exacerbates these challenges. While there is emerging consensus on the need for broad based corporate restructuring, it is as yet unclear if the political will has emerged to implement it decisively.


Prepared by Graham Slack.


This section builds on and extends work undertaken by Mr. Bob Etherington and colleagues at the World Bank.


See World Bank, Report on Observance of Standards and Codes, Accounting and Auditing, October 2004.


The notable exception is the financial industry.


Key industries in Bosnia and Herzegovina were organized under a vertically integrated business model managed by holding companies. SIPAD, UPI, and UNIS for instance managed the entire production of timber, agriculture, and metal-related products, from raw material through to finished product.


Fictitious workers continue to accrue wages and benefits despite not turning up to work for long periods of time.


See Chapter 5.


World Bank, Anti-Corruption in Transition 2, Corruption in Enterprise-State Interactions in Europe and Central Asia 1999–2004, 2004.


During IMF Staff interviews with executives of a number of recently privatized enterprises, most responded negatively when asked if, with their current knowledge, they would invest again in Bosnia and Herzegovina. Most saw neighboring countries as more attractive business locations and some acknowledged plans to relocate unless the business environment improved.


By contrast, the 1998 restructuring program for Polish coal mines forgave liabilities incurred to government only when, inter alia, restructuring plans were implemented, and timely payments were made on obligations to government agencies.


See Chapter 6.