Bosnia and Herzegovina
2007 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Bosnia and Herzegovina

This 2007 Article IV Consultation highlights that the economy of Bosnia and Herzegovina is enjoying its fourth consecutive year of stable growth underpinned by the currency board. Export growth of 29 percent on the back of productivity gains, export price increases, and improvements in reporting following the introduction of the VAT, combined with robust domestic demand, pushed real GDP up 6 percent in 2006. Fiscal policy has thus far been prudent. This good overall picture reflects a benign external environment and the effects of past economic reforms.


This 2007 Article IV Consultation highlights that the economy of Bosnia and Herzegovina is enjoying its fourth consecutive year of stable growth underpinned by the currency board. Export growth of 29 percent on the back of productivity gains, export price increases, and improvements in reporting following the introduction of the VAT, combined with robust domestic demand, pushed real GDP up 6 percent in 2006. Fiscal policy has thus far been prudent. This good overall picture reflects a benign external environment and the effects of past economic reforms.

I. Recent Developments and Outlook

1. Bosnia & Herzegovina labors under a complex and fragmented political system. The Dayton Peace Agreement that ended the war in 1995 created two largely autonomous Entities (the Republika Srpska (RS) and the Croat-Bosniak Federation of Bosnia & Herzegovina (Federation), itself divided into ten largely ethnic cantons), which exercise most economic power; and a State government with a very limited mandate. This structure has entrenched ethnic divisions, as highlighted by last October’s elections; causes fragmentation and duplication of many domestic policy functions; and weakens incentives to cooperate. The Office of the UN High Representative (HR), with extensive powers to impose or overrule legislation and dismiss elected officials, has so far held the system together and gradually expanded the mandate of the State. Recognizing the need for greater local ownership, the HR has recently curbed the use of these powers, and his office is to be closed in 2008. But a modest first attempt at constitutional reform failed in 2006; key measures, like police reform—a condition for signing the Stabilization & Association Agreement with the EU—are stalled; and policy coordination between Entities and State is weak.

2. The economy is nevertheless enjoying its fourth consecutive year of stable growth underpinned by the currency board. Export growth of 29 percent on the back of productivity gains, export price increases, and improvements in reporting following the introduction of the VAT, combined with robust domestic demand, pushed real GDP up 6 percent last year (Figure 1). The export expansion slowed this year (the improvement in reporting was one-off) but was still 24 percent in the first four months compared to the same period last year. The currency board anchored prices: headline inflation, reflecting the VAT effect and administered price hikes, averaged 7 percent last year but declined to 1½ percent in early 2007. The recorded current account deficit was almost halved last year to 11.5 percent of GDP reflecting the improvement in the trade gap; the “true” deficit was probably 5-7 percent of GDP as official statistics underestimate current inflows. Unit labor cost trends and other standard indicators suggest that competitiveness is favorable, while the recent gains in export market shares were broadly based and focused in key markets, as well as in sectors of growing global importance (Figure 2). Bank borrowing and other unidentified inflows pushed official reserves to €2.9 billion (5¼ months of imports) at end-April 2007.

Figure 1.
Figure 1.

Bosnia and Herzegovina: Recent Economic Developments

Citation: IMF Staff Country Reports 2007, 268; 10.5089/9781451804935.002.A001

Sources: Bosnian authorities; and Fund staff calculations.
Figure 2.
Figure 2.

Bosnia and Herzegovina: Competitiveness Indicators, 2000-07

Citation: IMF Staff Country Reports 2007, 268; 10.5089/9781451804935.002.A001

Sources: Bosnian authorities; Direction of Trade Statistics;; Comtrade; and Fund staff. calculations.

3. The pace of financial deepening, a key contributor to growth, is consistent with regional trends, although supervision has weaknesses. After an initial surge, steady private sector credit growth of about 25 percent annually has contributed to a gradual increase in the credit-to-GDP ratio. The pace of financial deepening is in line with trends in Central and Southeastern Europe (Figure 3). On the supply side, credit expansion is stimulated by competition and consolidation in the banking sector, which is dominated by foreign banks, and financed largely by lending from these banks to their local affiliates (Figure 4; for an in-depth analysis, see accompanying Selected Issues paper, Chapter VI). Although bank soundness indicators are good and improving, last year’s FSAP identified a number of weaknesses in supervision, notably its fragmentation into two Entity-based agencies. While this has not been addressed, the inclusion of individuals in the credit registry in 2007—also an FSAP recommendation—was a key step toward better risk management.1

Figure 3.
Figure 3.

Bosnia and Herzegovina: Credit Developments, 2000-07

Citation: IMF Staff Country Reports 2007, 268; 10.5089/9781451804935.002.A001

Sources: Bosnian authorities; and IMF staff calculations.
Figure 4.
Figure 4.

Financial System Indicators

Citation: IMF Staff Country Reports 2007, 268; 10.5089/9781451804935.002.A001

Sources: CBBH; FBiH Banking Agency; RS Banking Agency; IMF; and IMF staff estimates.

4. Fiscal policy has thus far been prudent and public debt low, though the size of the government is large. Since 2004, the general government has been close to balance or in surplus. The VAT introduced on January 1, 2006 generated a surge of revenue, partly due to one-off factors (estimated at 1½ percent of GDP), while the share of expenditures was kept at its 2005 level. The general government thus recorded a surplus of 3 percent of GDP. At about 50 percent of GDP, the size of the government is large, reflecting inefficiencies and duplication of functions. At the same time, at 23 percent of GDP at end-2006, public debt is low. Even after the planned bond issuance to cover outstanding domestic claims against the government—which staff assumes will raise the debt-to-GDP ratio by some 25 percentage points over the next three years the debt will still be low in net present value terms, as most of it is concessional. The introduction of statutory borrowing limits for all levels of government was a major step toward fiscal discipline: though not yet binding, these ceilings could be helpful in limiting fiscal deficits in the future (Box 1).

Government Debt Laws

Law on government borrowing, debt, and guarantees were adopted by the State in 2005 and the RS in 2007, and a similar draft law is pending approval in the Federation.

Borrowing limits. The state and RS laws limit borrowing by imposing ceilings on projected debt service (including amortization) at 18 percentage of previous year’s revenue. In the RS, the limit also applies to municipalities, whose foreign borrowing requires a separate approval from the Finance ministry if projected debt service exceeds 10 percent of municipal revenue. The State limit will be subject to annual reviews after the first three years. The Federation draft law imposes the same debt service ceiling. Within this envelope, the cap for cantons is 5 percentage, and that for municipalities gradually rises from 3 to 10 percent.

Institutional framework. The State Finance ministry prepares a five-year State Debt Management Strategy in cooperation with a Debt Committee (an advisory body composed of representatives of the State and Entities, including Finance Ministers). A separate Debt committee in the Federation, composed of the Federal and cantonal Finance Ministers, coordinates borrowing and debt management in the Entity.

5. This good overall picture reflects a benign external environment and the effects of past economic reforms. Growth in Bosnia & Herzegovina’s trading partners was strong. World prices of metals—a key export—have risen 55 percent over 2005-06. Low world interest rates facilitated the financing of the current account deficit. Although Bosnia & Herzegovina generally lags behind the region in terms of structural reforms (Figures 5 and 6), certain reforms in specific sectors have had a sizeable impact: industrial production and exports of key products, such as steel and aluminium, benefited from foreign investment; the successful introduction and administration of the VAT led to the good fiscal outcome in 2006; last but not least, the process of financial deepening was spurred by the privatization and opening of domestic banks to foreign participation.

Figure 5.
Figure 5.

Bosnia and Herzegovina: Progress in Structural Reforms, 2003–06

Citation: IMF Staff Country Reports 2007, 268; 10.5089/9781451804935.002.A001

Sources: EBRD Transition Reports, 2003 and 2005; and IMF staff estimates of unweighted regional and category averages. Indicators range from 1 (no reform) to 4+ (standards of an industrialized market economy).1/ The nine areas are large-scale privatization; small-scale privatization; governance & enterprise restructuring; price liberalization; trade & foreign exchange system; competition policy; banking reform & interest rate liberalization; securities markets & nonbank financial institutions; and infrastructure reform.
Figure 6.
Figure 6.

Indicators of Institutional Quality and Reform, 2006

(Rank, unless otherwise specified)

Citation: IMF Staff Country Reports 2007, 268; 10.5089/9781451804935.002.A001

Sources: Transparency International; World Bank, Doing Business Database; World Economic Forum.1/ Lower ranking means better environment. The corruption perception index relates to perceptions of the degree of corruption as seen by business people and country analysts. The global competitiveness index covers 125 countries. The World Bank indices cover 175 countries.2. The EBRD maximum score is 4.33, with maximum being best.

6. The outlook for the rest of 2007 is fair, but the effects of long-standing weaknesses will start becoming evident. The momentum of growth is projected to continue, the international economic environment to remain favorable, and inflation to remain contained. In contrast to these positive trends:

  • The governments’ failure to resist spending pressures in the runup to last October’s elections will, in the absence of corrective action, cause a sharp deterioration of the government balance. The one-off effects of the VAT will disappear while the bill for pre-election spending increases—most notably in the Federation—will come due this year. As a result, the general government could register a deficit of up to 1½ percent of GDP in 2007.

  • This fiscal impulse, combined with higher private demand, will boost imports, as data for the first four months already show. As a result, the current account deficit is likely to widen somewhat in 2007. Large privatization receipts, however, will provide sufficient non debt-creating financing.

7. The medium-term baseline outlook is relatively stable but, under current policies, the risks would gradually increase. These risks are explored further in Chapters II-IV of the accompanying Selected Issues paper.

  • Net exports will continue to provide stimulus reflecting strong partner demand and recent trends in market penetration, but growing export volumes would be partly offset by falling world metal prices (WEO) in the outer years. On the assumption of continued structural policy drift, the staff’s baseline scenario (Table 9) assumes that growth would slowly lose steam, the private savings-investment gap would narrow only marginally, and the current account deficit would stay high. Although net foreign liabilities now are low, persistent current account deficits would eventually bring them to very high levels.

  • Economic growth would not make a significant dent in unemployment unless the Entity governments—under whose purview these policies fall—implement corporate restructuring and tax and labor market reforms. Moreover, because labor mobility is limited, unemployment in depressed areas would stay high and the creation of a single labor market—and thus a single economic space—prove elusive.

  • Government revenues are projected to decline slowly, reflecting the loss of trade taxes as EU integration advances while, absent new measures, expenditures would remain high, leading to a gradual deterioration in the general government balance. Toward the end of the decade, when the statutory borrowing limits become binding, the adjustments required to comply would be significant. Absent a comprehensive medium-term fiscal strategy and effective policy coordination, however, it is not clear how these adjustments would be made.

  • Financial sector indicators were reassuring and some steps have been made in response to the FSAP recommendations last year. However, remaining vulnerabilities in the system could, if left unaddressed, amplify the impact of other shocks.


General government balance, staff baseline (% GDP)

Citation: IMF Staff Country Reports 2007, 268; 10.5089/9781451804935.002.A001

II. Report on the Discussions

8. There was consensus on the broad strategic economic objectives… The programs of the new governments emphasized private sector development; strengthening competitiveness to reduce the current account deficit and safeguard the currency board; creating jobs in the formal economy to make a dent in high unemployment; building a single economic space through tax harmonization; and preparing for EU membership.

9. …but the authorities took a different view of the medium-term outlook than staff. They considered that the recent improvement in the external position alleviated the concerns about external sustainability expressed by staff in last year’s consultation and validated their more optimistic assessment. They stressed that the unchanged-policies assumption of the staff’s baseline was unduly pessimistic: the new governments would accelerate the pace of reform, leading to more broad-based and sustainable growth. And they expected export performance to continue strengthening.

10. Staff acknowledged that there was significant upside potential to its baseline outlook if reforms accelerated, but pointed out that Bosnia & Herzegovina’s reform record was poor. Staff agreed that recent export trends were reassuring: if they persisted, the current account would continue to improve and net foreign liabilities could stabilize within a decade (see accompanying Selected Issues paper, Chapter II). But staff cautioned that first, these trends were recent; second, that this assessment was subject to larger-than-usual uncertainties due to data deficiencies; and, third, that it was conditional on prudent fiscal policies and an acceleration of structural reforms going forward. In this connection, the authorities’ record in implementing the Fund’s past policy advice was poor (Box 2), reflecting weak ownership, fragmented institutions, low administrative capacity and—last year—preoccupation with the elections. Staff noted that, with the exception of the latter, these factors were still present.

Implementation of Fund Policy Recommendations

Since the last Fund arrangement expired, there have been three Article IV consultations (in 2004, 2005, and 2006) with broadly similar recommendations.

Fiscal policy. The general government generated surpluses in 2005 and 2006. However, the projected policy easing in 2007 would be inappropriate. Untargeted social transfers increased further in 2006 and there has been little progress in rationalizing government spending and reducing the tax burden on labor.

Fiscal coordination. The draft law on the Fiscal Council is yet to be adopted.

Financial sector. The authorities have responded positively to the 2006 FSAP. A financial sector surveillance unit has been established within the Central Bank of Bosnia & Herzegovina (CBBH), but the decision on unifying banking supervision remains hostage to domestic politics.

Structural reform. Progress in macro-critical reforms—corporate restructuring, private sector development, improving the business climate, labor market liberalization—has been patchy and unequal: progress has been made in the RS but very little in the Federation.

11. Against this background, discussions focused on (i) policies to ensure macroeconomic and financial stability; and (ii) steps to improve coordination and create a single economic space. Staff argued that the combination of a benign external economic environment, strong growth momentum, and a fresh mandate from the electorate to the new governments provided a good opportunity to address these challenges. The authorities agreed, and stressed their intention to focus their energies on the economy. They also agreed that past Fund advice on corporate restructuring and private sector development was still relevant, although these topics were not a major focus of this year’s consultation discussions. There is a high probability, however, that fundamental constitutional and political issues will continue to dominate the debate in the near term.

12. Staff stressed the need to improve the quality of statistics, which was not adequate for effective surveillance. Improvements in national accounts and price statistics, under preparation with Fund assistance, needed to be implemented as soon as possible.2 Major problems remained in the timeliness and coverage of general government statistics and in the quality of balance of payments estimates, particularly for remittances, due mainly to lack of capacity. The recent data ROSC (see accompanying paper) provides a blueprint for needed technical and institutional improvements.

A. Fiscal Policy

13. The authorities acknowledged the risk of a general government deficit emerging in 2007 but saw little scope for adjusting policies.

General Government: Overall Balance

(in percent of GDP)

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Source: Staff estimates and projections.
  • The RS budget was based on conservative assumptions and targeted a broad balance (including municipalities and extrabudgetary funds but excluding foreign-financed projects) and its implementation was on track. The RS government, however, did not rule out a supplementary budget later in the year.

  • The public finances in the Federation, both at Entity and cantonal levels, would come under pressure this year as a result of unfunded pre-electoral hikes in demobilized soldiers’ benefits. The Entity government did not intend to roll back these hikes, but was confident that its present budget had sufficient margin to cover the additional spending. Instead, it intended to focus on consolidating the legal framework and administration of the multitude of veteran benefits. As regards cantons, since the additional spending would be financed by a drawdown of deposits from accumulated surpluses from 2006, it was not subject to any top-down constraint. The consolidated Federation budget (including all levels of government and extrabudgetary funds but excluding foreign-financed projects) would thus likely record a sizeable deficit.

  • The State budget was fully funded and broadly balanced. The State government saw no need for action on its part to offset deficits in other parts of the general government

14. Staff expressed concern about the prospect of a large deterioration in the general government position in 2007. A swing estimated at 4½ percentage points of GDP in the general government balance would reverse the prudent fiscal management of recent years and have repercussions for aggregate demand. To limit this swing, staff urged the RS to stick to the spending levels in its original budget and save any higher-than-projected revenue, and the Federation government to take measures to offset the likely deficits in cantonal budgets. Staff supported the Federation government’s plan to consolidate the various laws dealing with demobilized soldiers’ benefits but cautioned that this would be insufficient to generate the required savings.

15. The governments’ ambitious infrastructure investment plans, coupled with the availability of substantial privatization receipts, raised questions about the authorities’ medium-term fiscal policy intentions. Staff noted that both Entity governments’ programs envisaged large road-building projects (in the Federation alone, these amounted to 17 percent of 2006 GDP over the coming four years). At the same time, the proceeds from large privatizations would provide a ready source of cash: the RS government would receive 7½ percent of GDP this year from the sale of RS Telekom and oil refineries, and the Federation could expect 2-4 percent of GDP over the next two years if it launched privatization in earnest. How would these investment projects be managed and financed? How would the privatization receipts be used? And how did both fit into the governments’ medium-term fiscal plans?

16. The authorities did not have a comprehensive medium-term strategy for the entire general government sector. All governments underscored their commitment to a responsible fiscal policy, aware that this was the only macroeconomic management tool in a currency board. This meant aiming their individual budgets at a balance or small surplus over the medium term while gradually lowering their expenditure-to-GDP ratios. But these targets did not cover all parts of the government, such as projects financed by foreign sources or privatization receipts. And no authority was in a position to articulate clear medium-term fiscal policy objectives for Bosnia & Herzegovina as a whole.

  • Both Entity governments stressed that they did not intend to use privatization receipts to finance current spending. The RS government had a well-developed—but not yet fully-approved—plan that envisaged setting aside about 15 percent of these receipts to fund pension reform (on which it had started preparatory work with World Bank assistance) and using the rest to (i) finance public investment projects and (ii) support strategic sectors through the banking system. It emphasized that the allocation decisions for the latter would be done by commercial banks on business grounds. The Federation also envisaged using future privatization receipts for investment and support of key sectors but did not have concrete plans at the time of the discussions.

  • As regards the financing of infrastructure investment, notably road construction, the 2007 Entity budgets already included several small projects. For larger projects, Entity governments envisaged using a combination of concessions and public-private partnerships. A number of feasibility studies were completed or underway, but no comprehensive plan existed so far for the country as a whole. Staff expressed reservations about the current institutional capacity to handle public-private partnerships, especially for large projects, but the authorities were confident that they could manage these arrangements.

17. The authorities were aware of the risks arising from some unsettled categories of claims against the government. Significant progress had been made (reported in last year’s consultation) in determining fiscally responsible settlement terms for frozen foreign currency deposits (FFCDs), war damage, and other claims. However, proposed amendments to the law on FFCDs and pending lawsuits could undermine these arrangements, while the size and settlement terms for restitution claims were still undecided. The State government agreed that the potential cost of the FFCD amendments could be significant. While not ruling out minor revisions in the settlement terms, it intended to stick as close as possible to the original law. It also planned to finalize a restitution law that would cap financial compensation and set terms consistent with fiscal sustainability.

18. Staff advocated aiming at a general government balance over the medium term. The currency board arrangement, uncertainties regarding the size and settlement terms of some government liabilities, and the declining concessionality of government debt justified a conservative target. A balanced budget would reduce the public debt-to-GDP ratio (including debt assumptions to cover domestic claims) to about 40 percent of GDP by 2012 and provide sufficient cushion for plausible shocks (Appendix I). It would also be a simple anchor for policymakers and the public. Achieving an overall balance while reducing the tax burden and making room for priority investments will require cuts in current spending, where there is ample scope for savings identified in the recent World Bank Public Expenditure Review.

B. Improving Policy Coordination and Creating a Single Economic Space

19. The discussion of fiscal policy highlighted the insidious effect of lack of policy coordination. The fragmentation of fiscal authority and complexity of inter-governmental fiscal relations is a by-product of Bosnia & Herzegovina’s constitutional setup and could thus best be addressed in the context of fundamental constitutional reform. But the problem is aggravated by lack of cooperation between the various governments in setting and pursuing their fiscal policy objectives.

20. The authorities were taking steps to improve fiscal policy coordination. They intended to strengthen the legal basis for the Fiscal Council that would set targets and coordinate fiscal policy for the country as a whole. The Council, including the Prime Ministers and Finance Ministers of the Entities and the State, was already operating in a rudimentary fashion. The authorities had prepared a draft law that would provide a firm legal basis, formalize procedures, and define the scope of coordination of budgetary policy. Moreover, they argued that the statutory borrowing limits were an important additional coordinating and disciplining device.

21. Staff welcomed these steps despite some reservations, but argued that they would not be sufficient to ensure effective coordination. The draft Fiscal Council law provided appropriate voting and deadlock-breaking rules, but the definition of the consolidated budget balance excluded most capital spending and the penalties envisaged for noncompliance were weak. Staff urged the Federation to approve as soon as possible the law on borrowing limits, and all governments to improve public financial management so that the limits could be effective. It cautioned, however, that fiscal rules and institutions alone were not sufficient to guarantee effective coordination and sound policies: political will to cooperate was paramount. Absent that, the borrowing limits, even if effective, may force piecemeal and suboptimal expenditure adjustments on various levels of government and might not prove politically sustainable.

22. The creation of a single economic space in Bosnia & Herzegovina was still unfinished business. Staff noted that the last few years had seen significant economic convergence between the two Entities, as the economy of the RS caught up with the Federation, but few signs of economic integration between them and even among cantons in the Federation (see accompanying Selected Issues paper, Chapter V). Labor and business mobility was impeded by a myriad of regulatory and tax barriers. The authorities outlined plans to reform corporate and personal income taxes, simplify the process for obtaining business permits, reduce regulations, and simplify inspections. In these areas, the RS had already made significant progress, and action was now needed by the Federation. Staff welcomed this but noted that creating a single economic space would require farther-reaching reforms, notably (i) harmonizing the laws on securities and companies; (ii) amending labor legislation to stop the accumulation of wage claims in cases where workers were not effectively employed by the company, thus allowing workers to switch employers without first having to settle existing claims; (iii) harmonizing the base for employers’ contributions on wages; and (iv) ensuring the portability of pension and health benefits across cantonal and Entity borders. The authorities were non-committal. The RS government, in particular, was concerned that emphasizing harmonization with the Federation might imply slowing down the pace of their own reforms.

C. Ensuring Financial Stability

23. Authorities and staff agreed that the pace of financial deepening per se was not a concern, but financial stability required close attention. The CBBH stressed that the recent extension of the credit registry to individuals in 2007 would help improve banks’ risk management. In addition, given its mandate in the area of financial stability, the CBBH with assistance from the Eurosystem central banks and the Fund was upgrading its monitoring and analysis of the financial sector and had started preparing regular Financial Stability Reports.

24. Staff welcomed these steps but felt that more could be done to safeguard system soundness and weaken the link between credit expansion and foreign borrowing. In particular, it noted that under competitive pressures, some banks may be assuming higher credit risk; that some large banks were repeatedly fined for violations of prudential rules, which suggested that fines were low; and that current regulations created a bias in favor of bank borrowing from abroad to finance credit. To address these concerns, the two Entity supervisory agencies should:

  • Tighten loan classification by moving loans with payments overdue more than 30 days to category C gradually over the next 12-18 months.

  • Raise the fines for noncompliance with prudential regulations.

  • Relax the maturity matching requirement between banks’ assets and liabilities in order to reduce the need for foreign borrowing to finance credit. This should be done gradually and with appropriate prudential safeguards to ensure adequate bank liquidity.

25. Staff reiterated the recommendation to unify bank supervision either at the CBBH or in a new, independent agency. A single supervisor was necessary for financial sector stability, as well as for establishing cooperation with key foreign supervisors, some of whom were hesitating to conclude Memoranda of Understanding with the Entity agencies. Staff also recommended strengthening the legal and supervisory framework for insurance and leasing. While accepting the economic rationale of these recommendations, the governments—particularly in the RS—noted that they would imply a transfer of competencies from Entities to a State-level agency. They could therefore not be decided separately from the broader constitutional debate. Against this background, staff advised the authorities at least to improve cooperation between the domestic supervisors and the CBBH.

III. Staff Appraisal

26. Bosnia & Herzegovina is in its fourth year of strong and stable growth. This largely reflects the benign international environment and the effects of past reforms in key sectors and the financial system, as well as the benefits of the currency board.

27. The authorities should take advantage of this opportunity to address longstanding distortions. Many of these distortions, such as the large and inefficient public sector, segmented labor market, and overregulated business environment, are to some extent a reflection of the more fundamental constitutional problems and ethnic divisions facing the country. But even within this fragmented governance framework, much can be done to improve macroeconomic management, strengthen financial stability, and facilitate private sector development. Achieving this requires a deeper sense of ownership of and commitment to economic reforms, and stronger political will to cooperate, than currently apparent.

28. Urgent action is needed to limit the deterioration in the fiscal position this year and set the basis for prudent fiscal policies in the medium term. To minimize the incipient fiscal relaxation in 2007, the RS government should stick to the expenditure plans in its original budget and the Federation government should act to offset the deficits likely to arise in cantons. To ensure fiscal sustainability, borrowing limits alone will not be sufficient: a comprehensive medium-term fiscal framework for the general government is needed. This framework should aim at maintaining a general government balance, in light of the exigencies of the currency board and uncertainties regarding the size of government liabilities. Fiscal sustainability also requires rejecting proposed amendments to the FFCD law and ensuring that financial restitution is capped at a fiscally responsible level. Private sector involvement in infrastructure is appropriate but poses risks: public-private partnerships can result in significant future public liabilities and should not be used unless a strong institutional framework is in place.

29. Privatization receipts are both an opportunity and a challenge. In the absence of nonconcessional public debt that could be repaid, genuine one-off expenses that boost growth would not jeopardize debt dynamics if financed by privatization, even if they temporarily raise the recorded deficit. Plans to use part of privatization receipts for pension reform are appropriate. But using them to finance private business development in “strategic sectors” is not a good option: if the business environment is improved, the private sector should be able to accomplish this without government support; if not, government support will make little difference and the money may be wasted. In addition, sizeable privatization revenue may complicate liquidity management in the financial system and jeopardize macroeconomic stability. To avoid this, the Entity governments should deposit these receipts abroad or with the CBBH until it is time to spend them, and spread out their use over time.

30. Improvements in fiscal policy coordination are urgently needed. The statutory borrowing limits are a good first step. The authorities’ intention to establish a firm legal basis for the Fiscal Council is welcome, but the current draft law should expand the definition of the general government to cover all public investment and strengthen penalties for noncompliance. Ultimately, however, these institutional improvements will not be sufficient to ensure effective coordination and good fiscal outcomes without the political will to cooperate.

31. Although the real exchange rate does not appear misaligned, structural reforms are important for safeguarding competitiveness, as well as for creating a single economic space. Recent balance of payments trends assuage earlier concerns about the viability of the currency board and, notwithstanding serious data weaknesses that complicate an accurate assessment, the level of the exchange rate appears appropriate. But going forward, reforms to restructure the corporate sector, improve the business environment, make the country more attractive for foreign investment, and deregulate the labor market are key for sustaining competitiveness. Harmonizing corporate income taxes, employers’ contributions, and capital market legislation, ensuring the portability of pension and health benefits, and facilitating labor mobility are also critical for internal economic integration.

32. Maintaining financial stability requires improving credit risk management further, closing gaps in nonbank oversight, and unifying bank supervision. Staff welcomes the extension of the credit registry to individuals and the initiatives of the CBBH in monitoring financial stability and coordinating supervision. Tightening loan loss classification, raising penalties for noncompliance, and relaxing maturity matching requirements would boost system soundness and weaken the link between credit expansion and foreign borrowing. While necessary, these steps would not be sufficient to ensure an appropriate framework: strengthening the regulatory framework for insurance and leasing and ultimately unifying bank supervision are also necessary.

33. Statistics are not adequate for effective surveillance. Recent improvements notwithstanding, major problems remain in the timeliness and coverage of general government statistics and in the quality of balance of payments estimates. The authorities should persevere with the improvements currently underway and follow up on the recommendations of the recent data ROSC.

34. Bosnia & Herzegovina has not accepted the obligations under Article VIII, Sections 2, 3 and 4 but maintains restrictions on the transferability of balances and interest accrued on frozen foreign currency deposits. Staff does not recommend approval of these restrictions.

35. It is proposed that the next consultation with Bosnia & Herzegovina take place on the standard 12-month cycle.

Table 1.

Bosnia and Herzegovina: Selected Economic Indicators, 2003–07

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Sources: Bosnian authorities; and IMF staff estimates and projections.

National accounts estimates are preliminary. They are being revised with the help of Fund technical assistance.

Based on weighted averages for the Federation and Republika Srpska.

Increase in 2007 reflects recognition of domestic claims.

Table 2.

Bosnia and Herzegovina: Balance of Payments, 2003–12

(In millions of euros, unless otherwise indicated)

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Sources: Bosnian authorities; and IMF staff estimates and projections.

Errors and omissions are explicitly projected to capture unrecorded capital inflows.

Table 3.

Bosnia and Herzegovina: Vulnerability Indicators, 2004–07

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Sources: Bosnian authorities; and IMF staff estimates and projections.

Includes repayment of IMF loans.

Table 4.

Bosnia and Herzegovina: General Government, 2003–07

(In percent of GDP)

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Sources: Ministries of Finance; and IMF staff estimates and projections.

Corrected for temporary effects of VAT refunds.

Table 5.

Bosnia and Herzegovina: Elements of General Government, 2003–07

(In percent of GDP)

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Sources: Ministries of Finance; and IMF staff estimates and projections.
Table 6

Bosnia and Herzegovina: Monetary Survey, 2003–07 1/

(In millions of KM)

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

Data for March 2005 onward are based on the upgraded classification of general government, so there is a structural break in March 2005.

The jump in broad money growth in 2004 reflects banks’ efforts to mobilize foreign currency deposits, following a tightening of end-month forex exposure limits. Further regulatory changes in late 2004 dampened these efforts.

Table 7.

Bosnia and Herzegovina: Monetary Authorities’ Balance Sheet 2003–07

(In millions of KM)

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Sources: Provided by the monetary authorities; and IMF staff estimates.
Table 8

Bosnia and Herzegovina: Survey of Domestic Money Banks, 2003–07 1/

(In millions of KM)

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Sources: BiH monetary authorities; and IMF staff estimates.

Data for March 2005 onward are based on an upgraded classification of general government, so there is a structural break in March 2005

2003 data are adjusted to correct for the structural break due to the RS gov’t takeover of KM 463 of old bank claims on RS enterprises in June 2004.

Table 9.

Bosnia and Herzegovina: Staff Illustrative Medium-Term Framework, 2004–12


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Sources: Bosnian authorities; and IMF staff estimates and projections.

National accounts estimates are preliminary. They are being revised with the help of Fund technical assistance.

Data from 2006 onwards include an estimate of debt assumptions to settle domestic claims on government.