This Selected Issues paper for Bosnia and Herzegovina (BiH) reports that GDP per capita in BiH is similar to that in neighboring Balkan countries. BiH risks are falling behind rather than catching up with other transition economies in terms of its economic development. This could delay the process of convergence to and integration with the European Union, including its ambitions to eventually adopt the euro. Accelerated structural reforms and macroeconomic stability remain key to achieving higher and sustained growth rates.

Abstract

This Selected Issues paper for Bosnia and Herzegovina (BiH) reports that GDP per capita in BiH is similar to that in neighboring Balkan countries. BiH risks are falling behind rather than catching up with other transition economies in terms of its economic development. This could delay the process of convergence to and integration with the European Union, including its ambitions to eventually adopt the euro. Accelerated structural reforms and macroeconomic stability remain key to achieving higher and sustained growth rates.

III. Assessing Bosnia and Herzegovina’s External Stability and Competitiveness10

Core Questions and Findings

  • How do different methodologies assess the level of Bosnia and Herzegovina (BiH)’s equilibrium current account balance and the level of the real effective exchange rate? The estimates of equilibrium current account deficit—taking into account capital transfers—range from 7½ to 13½ percent of GDP. Based on staff’s baseline macroeconomic scenario over 2008-13, the underlying current account deficit—at around 12-14 percent of GDP—hovers at the upper end of the equilibrium range. A number of assessment methodologies suggest that there is no strong evidence of a significantly overvalued real exchange rate that could result in future external instability although uncertainty surrounding the estimates is large. Recent movement of the real effective exchange rate and robust export performance suggest that external competitiveness is currently broadly adequate.

  • How have exports evolved? Export growth has been strong, and both real export growth and market share gain over 2003-07 are above the average regional performance. Constant market share analysis suggests that most of the export growth can be attributed to competitiveness effect. However, exports continue to have a narrow base, and, over the years, have become more concentrated in resource-intensive products that are exposed to large swings in global prices.

  • Does the external balance sheet suggest near-term risks? At about 50 percent of GDP, external debt is not low. However, with less than 10 percent of the external debt at short-term maturities, and these more than fully covered by international reserves, repayment risks are low.

  • What is the competitiveness outlook and what are the main risks to external stability? The projected terms-of-trade shock in the next 2-3 years and the widening current account deficit in 2008 imply larger financing needs, which could expose BiH to a shift in investor sentiment. Stabilizing the external account and preserving external competitiveness will require tighter fiscal and public-sector wage policies, while addressing financial sector vulnerabilities. Moreover, enterprise reform and privatization are imminent to maintain external competitiveness, and boost productivity gains and export momentum.

A. Introduction

25. BiH’s external position has improved markedly in recent years. Among the Eastern European countries with double-digit current account deficits, BiH is the only country that has seen its current account (CA) position improve over the last five years: it narrowed from an average of 18 percent of GDP during 2002-05 to 8.4 percent of GDP in 2006. On account of a domestic demand boom, the deficit widened to 13 percent of GDP in 2007. The better overall external position can be attributed mainly to the improvement in the goods and services balance which moved from a deficit of 46 percent of GDP in 2003 to 33 percent of GDP in 2007. The financing of the CA deficits has been tilted towards long-term sources including FDI and long-term commercial bank borrowing. International reserves reached €3.4 billion or 5.4 months of imports at end-2007.

uA02fg001

Current Account Deficit Developments

(Percent of GDP)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: Central Bank of Bosnia & Herzegovina; and IMF, World Economic Outlook.
uA02fg002

Bosnia: Current Account Balance, Main Components and Financing

(Percent of GDP)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

26. During the same period, the real effective exchange rate (REER) has been stable, and export growth has been strong. The CPI-based REER depreciated slightly during 2000-02 and has been quite stable since. At the same time, ULC-based REER has not moved much from its level in 2000. Moreover, exports benefited from favorable price competitiveness as well as strong world demand, resulting in a large gain of market share in the world market, before plateauing in 2007.

uA02fg003

Real Effective Exchange Rate

(Index, 2000=100)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: BiH Statistics Agency; UN Comtrade; and IMF staff calculations.
uA02fg004

Bosnia’s Market Share

(Index, 2000=100)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

27. This paper examines BiH’s current account developments, external competitiveness, and risks to external stability. The recent widening of the current account deficit and the tapering-off of the gain in export market share have raised concerns about BiH’s external competitiveness and external stability risks. This paper, therefore, explores the following questions:

  • How do different methodologies assess the level of BiH’s equilibrium current account balance and equilibrium real exchange rate?

  • What have been the driving forces behind BiH’s export growth?

  • Does the external balance sheet suggest near-term risks?

B. Assessing the Level of the Equilibrium Current Account Balance

Underlying current account balance

28. By stripping off temporary factors, the underlying balance gives a more accurate picture of the underlying trend. Specifically, the underlying current account balance is the balance adjusted for temporary factors, the business cycle and lagged effects of real exchange rate movements. We follow the methodology in Isard and Faruqee (1998) in computing the underlying balance. The estimates are corrected for BiH’s business cycle11, the Euroarea’s business cycle, real exchange rate movements and one important temporary factor—the introduction of VAT at the beginning of 2006. Using the 2007 figure, the underlying balance is 11.5 percent of GDP (Table 1).

29. The underlying CA balance can also be estimated in a forward-looking calculation. This methodology uses the medium-term projection and removes any change in policy, given that the forward-looking projection assumes no output gap and no change in the real exchange rate. According to this methodology, the underlying CA deficit is 13.7 percent of GDPas projected for 2013. Given that we expect the fiscal policy stance will remain more or less the same in 2013 compared to the 2008 position, the adjustment for expected policy change is not necessary. However, given that BiH faces a large terms of trade shock in 2008, the projected CA deficit implicitly assumes some change in the real exchange rate. Therefore, the forward-looking estimate is not the same as the estimate based on the 2007 outturn. Although the underlying balance is between 12-14 percent of GDP, in the calculation of the next section, we use the upper-bound figure of 13.5 percent of GDP.

Table 1.

Underlying Current Account Balance Estimates, 2003-07

(In percent of GDP)

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Sources: CBBH and staff estimates.1/ Based on projected values.

VAT was introduced in January 2006. As a result, there was a temporary jump in imports in 2005, and a temporary drop in 2006.

Underreporting of exports became evident in 2006 with the introduction of the VAT. The underreported amount in 2006 is estimated at 2.7 percent of GDP. Assuming that the underreported exports are constant in percent of GDP, exports before 2006 are corrected by 2.7 percent of GDP.

Due to limited data, we only consider Euro area’s business cycle.

The RER series is corrected for inflation spike in 2006 due to VAT introduction.

Macroeconomic balance approach

30. The macroeconomic balance approach asks how far the underlying CA balance is from a benchmark level. It first estimates an equilibrium relationship between the current account balance and a set of fundamentals. The equilibrium CA balance (the benchmark level or CA norm) for a country is then computed from the relationship as a function of fundamentals. We first estimate BiH’s CA norm using the IMF Consultative Group on Exchange Rate Issues (CGER) methodology. The standard CGER methodology (Lee and others, 2008) is based on a pooled OLS regression using the data from 54 industrialized and emerging markets between 1973 and 200412. The independent variables—chosen based on economic theory and past empirical literature—include fiscal balance, demographics, lagged current account, oil balance, relative income and economic growth, and dummies for economic crises and financial center. Stronger fiscal balance raises national saving and thereby improving CA balance. Demographic variables include old-age dependency ratio and population growth to capture the economic effect of inactive dependent population. The lagged current account is included to reflect the persistence in the series. Oil balance allows the effect of oil prices on the CA balance, while relative income and economic growth capture the stage of development and the economy’s need for investment and borrowing. Finally, dummies for crises and financial center are included to reflect the sharp CA adjustments following past crises and the substantial CA surpluses observed in the financial centers, respectively.

31. On the basis of this approach BiH’s equilibrium current account deficit is 7 percent of GDP, although with large confidence intervals (Table 2). Given forecast errors of 2-3.5 percent of GDP with standard errors for emerging markets at the higher end of the range, the estimated equilibrium CA deficit can range between 3.5-10.4 percent.

Table 2.

CGER Macro Balance Coefficients and Equilibrium CA Balance Estimates

Sources: Lee and others (2008) and staff calculation.

Relative to weighted average of trading partners

Relative to the US.

32. Rapid financial deepening and integration—an important factor driving the convergence process in Europe—may affect these estimates. Abiad, Leigh and Mody (2007, ALM thereafter) have shown that including the financial integration effect in the list of standard independent variables yields different conclusions. Specifically, in a global sample, the financial integration variable is not statistically significant. However, in the sample of EU countries, the results differ: the standard determinants of CA balance become mostly insignificant, while financial integration has a strong and significant effect. Once financial integration effect is taken into account, BiH’s equilibrium CA deficit is estimated at 11.5 percent of GDP (Table 3).

Table 3.

ALM (2007) Macro Balance Coefficients and Equilibrium CA Balance Estimates

article image
Sources: Abiad, Leigh and Mody (2007) and staff calculation.

Real PPP GDP per capita

Financial integration is defined as the sum of foreign assets and foreign liabilities.

External sustainability approach

33. The external sustainability approach determines the real exchange rate equilibrium level that would be consistent with stabilizing the net foreign asset position at a given “benchmark” value. First, the CA balance that would stabilize the net foreign asset position is calculated, based on certain assumptions on growth, and rates of return on the foreign assets and liabilities. The difference between the equilibrium CA balance and the medium-term projection—the CA gapis then used to compute the RER adjustment required to close the CA gap. According to Jahjah (2007), the CA balance required to stabilize the NFA is around 5.5-5.7 percent of GDP, depending on the level of stabilized NFA and the assumed adjustment paths.

Summary

34. The range of estimates of BiH’s equilibrium CA deficit is wide and subject to large uncertainties and mitigating factors. The above approaches imply an equilibrium CA deficit of 6-12 percent of GDP. However, large uncertainty surrounds these estimates as the estimates have large margins of error. Moreover, capital transfers (1.8 percent of GDP projected in the medium term) are not taken into account. BiH has already signed a Stabilization and Association Agreement (SAA) with the EU, and is expected to benefit from significant capital grants, which would be of a permanent nature. Including those transfers would lead to an equilibrium CA deficit of between 7.5 and 13.5 percent of GDP (Table 4). In addition, the current account data have wide margins of error because the large size of workers’ remittances and the individual (resident) assets abroad make it difficult to estimate correctly the size of the current account. Although the Central Bank of Bosnia and Herzegovina (CBBH) has increased its estimates of private transfers from around 14 percent of GDP to an average of about 18 percent of GDP13, uncertainty still remains as the data on remittances are largely based on model calculations that in turn heavily rely on assumptions rather than actual data.

Table 4.

Adjusted Equilibrium CA Balance

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Source: Staff estimates.

C. Assessing the Level of the Real Exchange Rate

Purchasing power parity approach

35. The purchasing power parity (PPP) approach relies on the concept that, over time, a country’s nominal exchange rate will tend to converge to its PPP-determined level. Convergence occurs as a country’s per capita income moving toward the reference country’s per capita income. However, many factors may keep it from converging to the PPP-determined level. The most common factor is the Balassa-Samuelson effect. The PPP GDP per capita is generally used as a proxy for the relative productivity differential. Real exchange rate undervaluation (overvaluation) is observed if the country’s price level is too low (high) compared with the price level implied by its relative income level.

36. PPP estimates are sensitive to the choice of the country sample and the estimation period. Using the 2001–06 average income and price data for all IMF member countries, we estimate that BiH’s RER is undervalued by 43 percent. Using the estimated equation from Coudert and Couharde (2005) and Courdert and Couharde (2002) which use cross country data from 2003 and 2000, respectively (in a sample without very poor countries), BiH’s RER is undervalued by 31-34 percent.

uA02fg005

Relative price and income compared to EU-15, average, 2001-06

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: WEO; and Fund staff calculations.

Equilibrium real exchange rate approach (ERER)

37. The ERER approach evaluates the relationship between the real exchange rate and a set of fundamentals. Our estimate is based on the CGER methodology which estimates a panel regression of CPI-based REER on the following fundamentals: net foreign assets (NFA), productivity differential, commodity terms of trade, government consumption, trade restriction index, and price controls. A country with smaller NFA (or larger debt) needs larger CA surplus (or more depreciated real exchange rate) to service. Productivity differential is included to account for the Balassa-Samuleson effect. Through real income or wealth effects, higher commodity terms of trade lead to an appreciation of the RER. Higher government consumption is likely to appreciate the RER as such consumption generally falls more on nontradables than tradables. Trade restriction is included as it may lead to higher domestic prices and more appreciated real exchange rates. Finally, a lower number of administered price categories are expected to be associated with a more appreciated real exchange rate in transition economies as prices rise towards market levels.14 For Central and Eastern European (CEE) countries15, the regression specifications allow for a stronger Balassa-Samuleson effect, compared to the global sample. BiH’s experience is likely to be similar to the CEE sample than the global sample. We therefore estimate BiH’s equilibrium RER using the CEE-specific regression coefficients.

38. Regression results point to a prediction of a more appreciated RER than the actual RER from 2004 to 2007.16 The main contribution to a more appreciated real exchange rate prediction is the rapid growth of productivity in the tradable sector. Relative to nontradables, average labor productivity growth17 of BiH tradables over 2004-06 is much higher than that of the main trading partners.

uA02fg006

Actual and Predicted Real Exchange Rate

(Index, 2000=100)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

article image
Sources: BiH Statistics Agency; Eurostat; and IMF staff estimations.

Croatia’s data is only available for 2003-04.2004

39. Medium-term estimates for the REER suggest an undervaluation of about 17 percent (Table 5). In line with CGER practice, we use the latest WEO projections (April 2008) for 2013 for the terms of trade and the most recent actual value (2006) for the productivity differential, trade restrictions and the number of administered price categories. The estimated value is 17.2 percent higher than the actual REER index in 2007. However, there are two caveats with the estimation. First, it is sensitive to the productivity differential between tradables and nontradables in the medium term. If the productivity differential relative to trading partners were to be reduced to half of the most recent actual value, the estimated undervaluation would be essentially eliminated. Second, the forecast error is quite large at about 12 percent.

Table 5.

CGER Equilibrium Real Exchange Rate Coefficients and Estimates

article image
Sources: IMF (2006) and subsequent refinements using CEE-specific coefficients.Note: Fixed effect regression for 48 industrialized and emerging market countries for the global sample.CEE are Czech Republic, Hungary, Poland, Slovakia, and Slovenia.

Relative to a trade-weighted average of top 4 trade partner countries.

Calculated such that the average prediction error (i.e. the average misalignment) for 1997-2004 is zero.

Real exchange rate assessment based on the current account gap

40. This method assumes that real exchange rate movements are the only factor in closing the CA gap. To calculate the required movements, the elasticities of imports and exports to the real exchange rate (0.92 and -0.71, respectively) are drawn from a cross country study (Isard and Faruqee, 1998). The estimates from the adjusted CA gap (from the previous section) show an overvaluation ranging from 1 to 29 percent (Table 6).

Table 6.

Current Account Balance Gap and Estimated Real Exchange Rate Overvaluation

(in percent of GDP, unless otherwise specified)

article image
Source: Staff estimates.

Overall assessment of the level of the real exchange rate

41. Estimates of BiH’s real exchange rate over- and undervaluation, and current account gaps vary widely and are subject to large uncertainties. The estimates range from 17 percent undervaluation to 29 percent overvaluation. Significant uncertainty surrounds these estimates due to the large forecast errors of regression-based estimates, the assumption regarding BiH’s business cycle, and the assumed import and export elasticities to real exchange rate movements.

D. Analysis of Export Performance

Export performance and structure

42. Export growth has been robust in recent years. The value of exports of goods rose from about 18 percent of GDP in 2003 to 29 percent of GDP in 2007. Export growth registered an average of 26 percent between 2004 and 200618, and slowed down to 15 percent in 2007. BiH’s export growth over the recent period has been better than the regional average. Real export growth from 2003 to 2007 registered 69 percent; this is higher than the average export growth of the new member states (NMS) at 61 percent and much higher than the average export growth of the non-NMS Southeastern European (SEE) countries (excluding BiH).

uA02fg007

Growth of Export Value (in KM) and Its Contribution

(Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: CBBH; and IMF staff estimates.

43. BiH’s recent experience with an export boom is similar to the one of the new member states starting in the mid 1990s. As BiH started its transition path only in the late 1990s, it is still going through a catch-up phase. Studying the dynamic of export structure in eight new member states, Fabrizio, Igan and Mody (2007) conclude that between 1994 and 2004, these countries went through a catch-up phase during which they put into good use their human capital in moving up the technology and quality ladder. These factors have allowed them to maintain the dynamism of their exports despite exchange rate appreciations.

uA02fg008

Real Export Growth, 2003-07

(Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: WEO; and IMF staff calculations.

44. BiH has also gained a significant share in world exports in the last few years. From 2003 to 2007, BiH’s market share in world exports rose by 42 percent, which exceeds the regional average of around 30 percent. It is however important to keep in mind that the large gain in market share may reflect BiH’s position as a newer entrant into the world market compared to the NMS. Newer entrants have a significant catch-up possibility and a country’s share saturates at some point.

uA02fg009

Change in World Market Share, 2003-07

(Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: Direction of Trade Statistics; and IMF staff calculations.

45. The gains in market share have been broad-based across sectors, especially in those with relatively faster growth in global trade. Market share gains are largest in iron-steel and wire products. All of BiH’s 15 top manufacturing products are in the sectors with relatively faster growth in global trade, and BiH has gained positive market shares in most of these sectors from 2003 to 2006.

uA02fg010

Bosnia’s Exports by Main Category, 2003-06

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: UN Comtrade; and IMF staff calculations.

46. Metal exports have benefited from strong global demand for commodities and past privatizations. Metal exports account for about ¼ of total exports, and their value has been buoyant, supported by increases in both volume and price. New investment in the iron and steel industry contributed to the increase in export volume. In fact, from 2003 to 2007, iron and steel has taken over aluminum as the most important metal exports of BiH. During the same period, due to strong demand in China and other emerging markets, the world price of metal nearly tripled. In line with this, the metal price, calculated based on BiH’s mix of metal exports, tripled over recent years.

uA02fg011

Metal Price Index

(2003=100)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: CBBH; and IMF staff estimates.
uA02fg012

Share in Metal Export Value

(Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

47. Non-metal export growth, however, has been mainly driven by growth in volume. Strong growth in machinery and mechanical appliances, mineral products and chemical products contributed to non-metal export growth. The mineral products are mostly electricity exports as demand for electricity in the region grew over the years.

uA02fg013

Contribution to Metal Export Growth

(Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: CBBH; and IMF staff calculations.
uA02fg014

Contribution to Non-Metal Export Growth

(Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

48. In terms of export structure, BiH’s exports have shifted away from light manufacturing towards metal products and machinery. The share of machinery and mechanical appliances exports improved from 8.2 to 12.9 percent. On the resource-intensive side, the share of metal exports has increased from 22.4 percent to 27.7 percent of total exports. Meanwhile, the share of light manufacturing goods—which include textile, footwear and miscellaneous furniture—shrank, and the share of wood and wood products fell sharply.

uA02fg015

Composition of Exports, 2003

(In Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Source: CBBH.
uA02fg016

Composition of Exports, 2007

(In Percent)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

49. There is further evidence that the composition of BiH exports shifted towards resource-intensive exports. The classification of manufacturing industries by factor inputs19 shows that the share of resource-intensive products increased from 48 percent in 2003 to 56 percent in 2006. At the same time, the share of medium- to high-tech exports fell from 31 percent to 25 percent, while the share of low-tech labor-intensive exports also fell slightly from 21 to 19 percent over the same period. This shift makes BiH more vulnerable to swings in commodity price at the global level.

50. The structure of exports based on labor-skill requirements20 has also shifted towards low-skill products as resource-intensive products generally require low skill. The share of low-skill exports rose from about half of merchandise exports in 2003 to about 56 percent in 2006, at the expense of medium-skill exports. The share of high-skill exports remain small around 4 percent, and fell slightly over the period.

uA02fg017

Exports by Labor Skills

(In percent of total exports)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: UN Comtrade and staff calculations.
uA02fg018

Exports by Technology Levels

(In percent of total exports)

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

51. This shift away from medium- and high-tech products towards resource-intensive products is unlike the experience of most NMS. The shift away from low-medium towards high tech products during the transition period among the NMS is well documented. For example, Fabrizio, Igan and Mody (2007) show that exports in CEE-8 have moved up the technology and quality ladder over the 1994-2004 period, with medium- to high-tech products accounting between about 25 percent (Latvia) to almost 80 percent (Hungary) by 2004. Regarding export markets, BiH’s main export destination has also shifted from the advanced European markets towards emerging European markets (Table 7). This shift represents a shift towards more dynamic and growing markets. Due to its historical and cultural ties, Croatia, Slovenia and Serbia have always been important export markets for BiH. Over the recent periods, the share of this group of “neighbors” has increased from 40 to about 44 percent with most gain in Slovenia and Serbia. The share of other emerging European markets also rose from 3 percent to 10 percent at the expense of the share of Germany and other advanced European countries.

Table 7.

Direction of Bosnian Merchandise Exports, 2003 and 2006

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Source: UN Comtrade.

Constant market share analysis

52. To assess export competitiveness more thoroughly, a constant market share analysis (CMSA) is conducted. CMSA provides a structure to analyze BiH’s export growth and assess to what extent growth was due to competitiveness gains or driven by demand in particular markets or for particular commodities (see Appendix for methodology). Due to limited data (no detailed export data for BiH before 2003), the CMSA was conducted using the UN Comtrade data between 2003 and 2006.21

53. The CMSA shows that BiH’s export growth over 2003-06 can be mainly explained by the competitiveness effect (Table 8). World trade development accounts for about 20 percent, while the residual—the competitiveness effect—contributes to about 72 percent of the increase in exports over the period. The contribution of the market distribution effect of about 6 percent reflects the increase in exports in growing markets such as Serbia, Slovenia and other emerging European countries.

Table 8.

Constant Market Share Analysis of BiH’s Export Growth

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Sources: UN Comtrade and staff calculation.

Based on commodity composition of exports in 2003

54. The competitiveness effect reflects changes in quality and composition of Bosnian exports as well as the effects of favorable export prices. Manufactured goods account for 33 percent of the residual from the CMSA (Table 9). About 80 percent of the overall growth of manufactured goods is from metal products, whose world price rose over the period.

Table 9.

Share in Competitiveness Effect by Commodity Group

(In percent of total competitiveness effect)

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Sources: UN Comtrade and staff calculation.

E. External Balance Sheet Analysis

55. BiH’s net international investment and external balance sheet are relatively benign. The net position worsened from -44 percent of GDP to -51 percent of GDP at end-2007, mainly reflecting the increase in FDI inflows as external debt has remained stable (Figure 1). The composition of external debt has shifted towards more commercial banks’ borrowing and less public sector borrowing. External assets have increased by more than 10 percentage points of GDP, reflecting stronger international reserve position and commercial banks’ foreign assets. Also, BiH’s external balance sheet does not suggest near-term risks. While, at 48.5 percent of GDP, BiH’s external debt is not low, the maturity structure points to low repayment risks. The CBBH’s foreign reserves can easily cover all the short-term external liabilities, which are estimated at 7 percent of GDP or about 14 percent of total external debt at end-2007.

F. Conclusions

56. The results of this chapter suggest that BiH’s balance of payments position is not likely to lead to significant external stability risks. The CA deficit currently exceeds sustainable levels. Compared to an underlying balance of 12-14 percent, estimates of BiH’s equilibrium CA deficit range from 6 to 12 percent of GDP. If capital transfers are taken into account, the equilibrium CA deficit is estimated to range from around 7.5 to 13.5 percent of GDP, implying that the CA gap could range between 0 and 6 percentage points of GDP. However, there is no strong evidence of a significantly overvalued real exchange rate at present that could result in future external instability, especially given robust performance in exports and stable movements in the RER. Estimates of BiH’s real exchange rate over- and undervaluation, and current account gaps vary widely from 17 percent undervaluation to 29 percent overvaluation and are subject to large uncertainties. External balance sheet analysis does not indicate serious vulnerability as the size of external liabilities are manageable, and the maturity structure favorable.

57. However, going forward competitiveness and export performance will depend on the set of adopted macroeconomic policies and the pace of restructuring. The projected terms-of-trade shock in the next 2-3 years and the widening current account deficit in 2008 imply larger financing needs, which could expose BiH to shifts in investor sentiment. Stabilizing the external account and preserving external competitiveness will require tight fiscal and public sector wage policies. Moreover, enterprise reform and privatization are necessary to maintain external competitiveness, and boost productivity gains and export momentum.

Figure 2.
Figure 2.

Bosnia and Herzegovina: External Position

Citation: IMF Staff Country Reports 2008, 326; 10.5089/9781451804966.002.A002

Sources: CBBH, IMF, BIS and Fund staff estimates.

Appendix I—Constant Market Share Analysis (CMSA)

CMSA decomposes change in exports(x1-x0)

X1-X0=rX0+Σi(ri-r)Xi0+Σij(rij-r)Xij0+Σij(ρij-ri)Xij0

Export growth = global market growth + commodity composition effect + market distribution effect + competitiveness

where

Xt ij = value of Bosnian exports of commodity i to country j during period t

r = growth rate of world exports

ri = growth rate of world exports of commodity i

rij = growth rate of world exports of commodity i to country j

ρ ij = growth rate of BiH exports of commodity i to country j

The global market growth effect (the first term) measures how much BiH exports grew to keep the export share in world trade unchanged. In other words, this term shows how much BiH exports would increase if the growth rate over the years is equal to the growth of world trade.

The commodity composition effect (the second term) calculates how much export growth has benefited from the concentration of exports on commodities that demand has been rising rapidly relative to overall world exports.

The market distribution effect (the third term) measures how much export growth has benefited from increased demand in particular export markets.

The last term, the competitiveness effect, is a residual. This captures the change in export market share after adjusting for the impact of other effects.

Appendix Table 1.

Classification of Export Categories by Factor Intensity and Labor Skills

article image
Sources: Peneder (1999) and Landesmann and Stehrer (2003).

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  • Peneder, M., 1999, “Intangible Investment and Human Resources,” Journal of Evolutionary Economics, Vol. 12, No. 1-2, pp. 107 -34.

10

Prepared by Mali Chivakul.

11

BiH’s business cycle is computed using an HP filter (lambda = 1600) on annual GDP data from 1998 to 2007.

12

See Lee and others (2008) and IMF (2006) for more details on the empirical estimations and variable construction.

13

Jahjah (2006) estimated that remittances could be higher by 4.5-10 percentage points of GDP (at the time, the CBBH’s official estimate for private transfers is about 14 percent of GDP.

14

See IMF (2006) and Lee and others (2008) for a detailed explanation of the variables and the variable definitions.

15

CEE countries in the estimated sample are Czech Republic, Hungary, Poland, Slovakia, and Slovenia.

16

Due to BiH’s limited data on productivity (only going back to 2003), we are not able to estimate the RER before 2004.

17

Defined by gross value-added per employee. Data for Bosnia & Herzegovina are from the Statistics Agency. Data for the Euro Area, Croatia and Slovenia are from Eurostat. Croatia’s data are only up to 2004.

18

The VAT impact on exports in 2006 which is about 14 percent is taken out from the growth calculation.

19

Based on the classification by Landesmann and Stehrer (2003). Low-tech and labor intensive products include food, textiles, animal and vegetable oils, clothes, footwear, and leather products. Resource-intensive products include wood products, chemicals, metals and nonmetallic mineral products. Medium- to high-tech products include machinery and transport equipment and electrical and optical equipment. For more details, see Appendix Table 1.

20

Based on the classification by Peneder (1999). See Appendix Table 1 for more details.

21

There are 9 commodity groups based on product disaggregation at the SITC 1-digit level and market disaggregation into 11 regions based on the importance as Bosnia & Herzegovina’s export destination (Croatia, Serbia, Slovenia, Germany, Italy, Austria, Hungary, USA, other advanced European countries, other emerging European countries, the rest of the world).

Bosnia and Herzegovina: Selected Issues
Author: International Monetary Fund