Bosnia and Herzegovina
Staff Report for the First Review Under the Stand-By Arrangement

The staff report for Bosnia and Herzegovina’s (BiH) first review under the Stand-By Arrangement is presented. The precipitous drop in demand for BiH’s exports and the drying up of foreign direct investment triggered a sharp decline in private investment. Tightening credit conditions and the ensuing uncertainty put a further squeeze on spending on capital goods and consumer durables. Private consumption of nondurables softened but to a lesser extent, on the back of moderate growth in wages and social benefits.

Abstract

The staff report for Bosnia and Herzegovina’s (BiH) first review under the Stand-By Arrangement is presented. The precipitous drop in demand for BiH’s exports and the drying up of foreign direct investment triggered a sharp decline in private investment. Tightening credit conditions and the ensuing uncertainty put a further squeeze on spending on capital goods and consumer durables. Private consumption of nondurables softened but to a lesser extent, on the back of moderate growth in wages and social benefits.

I. Background

1. Macroeconomic developments remain broadly in line with program projections, except for a larger-than-anticipated contraction of the current account deficit. Following several years of strong growth increasingly accompanied by external and internal imbalances, economic activity in Bosnia and Herzegovina (BiH) began to decelerate in late 2008. The downturn spread quickly across all sectors in 2009, with the exception of refined petroleum and electricity production in Republika Srpska (RS). The precipitous drop in demand for BiH’s exports and the drying up of foreign direct investment triggered a sharp decline in private investment. Tightening credit conditions and the ensuing uncertainty put a further squeeze on spending on capital goods and consumer durables. Private consumption of non-durables softened but to a lesser extent, on the back of moderate growth in wages and social benefits. Core inflation has remained stable while headline inflation turned negative with declines in food and energy prices (Figure 1). The trade deficit has been narrowing faster than anticipated leading to a sharp reduction in the current account deficit (Figure 2).

BIH: Leading Indicators, December 2009

(percent change year-to-date over corresponding period in previous year)

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Figure affected by the re-start of a large refinery in late 2008.

Nov, 2009.

Jan - Sep, 2009.

Figure 1.
Figure 1.

Bosnia and Herzegovina: Inflation Developments, 2005-09

Citation: IMF Staff Country Reports 2010, 101; 10.5089/9781455207770.002.A001

Sources: BiH authorties; and IMF staff calculations.
Figure 2.
Figure 2.

Bosnia and Herzegovina: External Trade, 2004-09

Citation: IMF Staff Country Reports 2010, 101; 10.5089/9781455207770.002.A001

Sources: CBBH; and IMF staff calculations.

2. Financial market stress has eased, reflecting an improvement in market sentiment. The currency board (with the convertible marka pegged to the euro) continues to enjoy strong support and remains a key macroeconomic policy anchor. Meanwhile, there are signs of a return of confidence in the banking system: nongovernment deposits have been flowing back, which has allowed foreign parent banks to scale down their support for local subsidiaries. Foreign reserves of the Central Bank of Bosnia and Herzegovina (CBBH) have strengthened by 9 percent from the June 2009 lows, in large part owing to the first purchase under the SBA and SDR allocations (Figure 3). Commercial banks appear liquid and adequately funded. Nevertheless, the general worsening of economic environment and stricter lending standards have brought private sector credit growth to a halt (3.8 percent y-o-y decline in December 2009 compared with a 21 percent y-o-y increase in December 2008). With the downturn taking its toll on the financial health of enterprises and households, the system-wide NPL Banks have reacted by raising interest rates on loans, further tightening credit conditions.

uA01fig01

Bosnia and Herzegovina: Commercial Banks’ Funding Sources

(cumulative change since October 2008)

Citation: IMF Staff Country Reports 2010, 101; 10.5089/9781455207770.002.A001

BiH: Financial Soundness Indicators, 2008-09

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Source: CBBH.
Figure 3.
Figure 3.

Bosnia and Herzegovina: Central Bank’s Foreign Assets and Commercial Bank Reserves, 2008-09

Citation: IMF Staff Country Reports 2010, 101; 10.5089/9781455207770.002.A001

Sources: CBBH; and IMF staff calculations.

3. External financing has been somewhat better than expected. Non-bank private inflows—including FDI, and trade and private non-bank credits—were stronger than anticipated through September 2009. This was partly offset by lower-than-expected government foreign borrowing, and lower rollover rate for banks—91 percent against the program projection of 100 percent. Gross official international reserves were above program projections by €242 million at end-December 2009.

4. The difficult political situation complicates policymaking. Since the signing of the Stabilization and Association Agreement with the EU in June 2008, little progress has been made on reforms necessary for accession. Moreover, recent attempts by the international community to advance constitutional reform appear to have stalled, and conflicting views on the future makeup of the country suggest still little common ground. In addition, policymakers are keeping an eye on the October 2010 general elections.

5. Nevertheless, early program performance has been promising. All end-September and end-December 2009 quantitative performance criteria, an end-August 2009 structural benchmark on parliamentary approval of rebalanced entity budgets, and an end-February 2010 benchmark on the establishment of universal membership in the Deposit Insurance Agency were met (Tables 12 and Table 14). The authorities also took steps toward strengthening the financial sector, and reforming the budget process and the system of rights-based benefits—all corresponding structural benchmarks were met, albeit with some delay. Finally, substantial progress was made on improving fiscal data reporting, although only partial general government data have been published with a delay (continuous benchmark).

II. Policy Discussions

A. Macroeconomic Framework

6. The approved program’s macroeconomic framework remains broadly valid:

  • Real GDP is estimated to have contracted by 3½ percent in 2009 (compared to a 3 percent decline in the program). With external demand already showing signs of a recovery, output is set to grow modestly by ½ percent in 2010.

  • Inflation is expected to be somewhat lower than in the program, and remain low in line with inflation in the euro area.

  • The current account deficit has been narrowing faster than anticipated and the trend decline is expected to persist over the medium term, thus bringing the deficit to a level considered sustainable over the medium term (Appendix Table 1). This reflects the projected permanent decline in domestic absorption, and imports, relative to GDP (as in the rest of the region), driven by fiscal consolidation and the end of the rapid credit growth funded by foreign savings. Continued strong export performance should be underpinned by an assumed robust recovery in the growth of BiH’s trading partners, adequate external competitiveness (Box 1) and ongoing reforms to enhance it further, and a shift toward higher value-added exports.

  • The revised outlook for the capital and financial accounts reflects slower privatization in the Federation and lower debt rollover from parent banks to subsidiaries. Over the medium term, the program assumes that the entities will be able to service their external debt in part by privatization receipts (Federation) and by accessing international capital markets (RS). Official reserves are expected to remain adequate at 4-5 months of next-year imports.

Bosnia and Herzegovina: Key Macroeconomic Indicators, 2008-10

(In percent of GDP, unless otherwise indicated)

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Sources: Bosnian authorities; and IMF staff estimates and projections.
uA01fig02

Domestic absorption as a ratio to GDP

(constant prices)

Citation: IMF Staff Country Reports 2010, 101; 10.5089/9781455207770.002.A001

Source: IMF’s WEO database and staff estimates.

Bosnia and Herzegovina: Competitiveness

Real effective exchange rate (REER) developments indicate stable (based on relative consumer prices) to improving (based on relative unit labor costs) external competitiveness of BiH that has underpinned its growing export market shares. A closer look at the evolution of unit labor cost shows a decline in employment, while output and wages have been increasing. At the same time, BiH’s export structure has shifted toward higher-value added manufacturing goods. The growth of the more capital-intensive export sector—metal and aluminum—implies an upward shift in the capital-labor ratio over time. This argues for caution in interpreting the otherwise positive trends in competitiveness based on labor cost indicators.

Private sector growth in BiH is hampered by various structural impediments. According to the World Bank Doing Business Report 2010, a cross-country ranking of business environment indicators shows BiH’s sub-par performance relative to neighboring countries (116 out of 183 countries). This conclusion was confirmed in the mission’s meetings with private sector representatives. According to them, key factors impeding FDI and higher access of companies to foreign markets include: (i) political instability; (ii) complicated and “expensive” bureaucracy; (iii) lack of clear vision for economic development; (iv) corruption and weak legislative framework; and (v) poor quality control (i.e., local certification and standardization). Substantial opportunities lie in enhanced productivity via bigger investment in R&D and human capital.

uA01fig04
Note: From a list of 15 factors, respondents were asked to select the five most problematic for doing business in their country/economy and to rank them between 1 (most problematic) and 5. The bars in the figure show the responses weighted according to their rankings.Source: World Economic Forum, Competitiveness Report 2009-2010.

7. Risks to the outlook appear balanced. High frequency indicators suggest that the economy may be bottoming out and that growth is likely to pick up in early 2010. Also, indications of a faster economic recovery in the EU support better prospects for external demand and private capital inflows. However, downside risks remain. With nonperforming loans still edging upward, banks need to maintain adequate capital cushions—something that may act as a drag on the projected recovery in bank credit growth. Moreover, the difficult political situation could hamper program implementation.

B. Fiscal Policy

8. The 2009 fiscal deficit objective was exceeded and the fiscal outlook has worsened. Preliminary data indicate that, on account of revenue shortfalls and despite lower-than-programmed expenditures, the 2009 general government deficit reached 5.3 percent of GDP compared with the program target of 4.7 percent. Overruns on wages and transfers were offset by strict control over other current spending and by underperformance of the capital budget. The end-September and end-December 2009 targets for net bank financing were met, as the entities partially replaced expected budget-support funds from the IMF and the World Bank with funds from the SDR allocations, and increased float (by 1 percent of GDP) to finance the deficit. However, under unchanged policies, the fiscal deficit would reach 6 percent in 2010, thus putting fiscal sustainability at risk.

uA01fig05

Bosnia and Herzegovina: Tax Revenue, 2008-09

(Percent change, year-to-date)

Citation: IMF Staff Country Reports 2010, 101; 10.5089/9781455207770.002.A001

Source: Indirect Tax Authority; and staff estimates.
uA01fig06

Bosnia and Herzegovina: General Government Fiscal Balance, in percent of GDP

Citation: IMF Staff Country Reports 2010, 101; 10.5089/9781455207770.002.A001

Source: BiH authorities and Fund staff estimates

9. Against this backdrop, the revised fiscal strategy accommodates a slightly higher deficit for 2010, while advancing structural fiscal reforms. The fiscal balance has been revised to 4½ percent in 2010 (from the original 4 percent), with approval of all 2010 budgets and supporting legislation prior actions for the review (met). Structural fiscal reforms aim at putting public finances on a sustainable footing by helping reduce the public debt-to-GDP ratio to below 30 percent over the medium term (Appendix Table 2).1 On the revenue side, further increases in tobacco excises to bring them more in line with the EU have already been approved. As for expenditure:

  • State. Following wage reductions in 2009, the State will freeze wages at the 2009 levels. Substantial savings from past years will support an increase in employment in newly-created institutions and higher capital investment

  • Federation. The 2010 budget targets reductions in recurrent expenditure, thus allowing for an increase in investment expenditure (0.3 percent of GDP). A new civil service wage law will be prepared (end-March 2010 structural benchmark), which, in addition to rationalizing the wage bill, will also improve transparency by consolidating a large number of allowances into the base wage. Moreover, substantial savings are envisaged in transfers due to the elimination of special unemployment benefits for demobilized soldiers effective May 1, 2010 (prior action—met), the implementation of eligibility audits for civil and war benefit recipients, and strict control over pensions provided with favorable terms (LOI, ¶20-24).

  • RS. Spending on wages will be rationalized, including through reductions in wages of the highest paid government officials by 15 percent and of employees in public administration by 10 percent. Although spending on untargeted transfers to individuals has already been reduced substantially, the continuation of eligibility audits will yield further savings; and the first results of the pension reform will already be evident in 2010 (LOI, ¶25-27).

  • State and Entity authorities stand ready to take further compensatory measures, if needed, focusing mainly on the expenditure side.

Bosnia and Herzegovina: General Government Operations, 2006-10

(In percent of GDP)

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Sources: BiH authorities; and Fund staff estimates.

10. Despite larger deficits in 2009-10, the envisaged exit strategy from the use of Fund resources for the budget remains appropriate. Accommodating larger deficits in 2009-10 will widen the fiscal financing gap only slightly, and the additional financing needs will be met through bank financing. Over the medium term, the ongoing fiscal adjustment and the structural fiscal reforms envisaged under the program, along with a return of confidence and improved external conditions, would allow an exit from temporary budget financing using Fund resources. To this end, the Federation should be able to finance its transition to a more sustainable fiscal path through privatization proceeds, while the RS would tap international capital markets.

11. The authorities will undertake a series of structural fiscal reforms.

  • Rights-based benefits. An action plan to reform the system of rights-based benefits—which is an end-November 2009 structural benchmark for the Federation—was prepared in consultation with the World Bank and approved by the government on December 14, 2009 (Box 2). Moreover, framework legislation has been enacted by the Federation and the RS (prior action—met), with the objective of rationalizing and streamlining those benefits, and improving targeting (LOI, ¶20-21 and ¶27). The authorities have committed to consult with staff on the introduction of new rights-based benefits.

  • Pensions. The authorities plan to initiate reforms of the pensions systems (end-March 2010 structural benchmarks). In the Federation, a new law introducing second and third pillars is under preparation. The RS strategy—which has already been approved by government—aims at modifying the first pillar to ensure medium-term sustainability. Reform elements include efforts to increase contributions (through broadening of the tax base and improving administration) and streamline benefits (by increasing years of contributions and indexing pensions to inflation as opposed to wage growth) (LOI, ¶20-21 and ¶26).

  • Budget process. Albeit with some delay, important first steps have been made by the Federation to improve the budget process: amendments to the Organic Budget Law forbidding passing of unfunded legislation—an end-November 2009 structural benchmark—were approved by government on December 14 and submitted to parliament. To further promote fiscal discipline, and drawing on advice from the Fund, the government will initiate the preparation of a Fiscal Responsibility Law (LOI, ¶24).

12. The Entity governments are committed to safeguarding public investment and protecting vulnerable groups. Capital spending is projected to increase by 0.2 percent of GDP in 2010 and efforts will be made to improve implementation capacity; also, a number of investment projects that could be executed through public-private partnerships are already in the pipeline. Moreover, the authorities are committed to protect vulnerable groups, by improving the targeting of social benefits, and preserving the financial integrity of the public pensions and unemployment insurance funds.

Bosnia and Herzegovina: Social Sector Reforms

The proposed Development Policy Loan (DPL) from the World Bank aims to reform public expenditures that have been the main driver of pro-cyclical fiscal policies, notably excessive and regressive social transfers, and a high wage bill. In addition, the program will aim at lowering social contribution rates to encourage formal sector employment and enhance competitiveness and private sector development.

Pillar I of the reform program focuses on social benefits administration, and targeting of social protection programs. Short term measures include the revision of laws that would mandate means-testing for all civilian and war-related benefits, would reduce allowances for medal holders, and eliminate special unemployment benefits to demobilized soldiers.

In the medium term, census of income and property will be carried out to provide the basis for means testing. With a substantial elimination of double-dipping, expenditure on non-insurance social benefits would be reduced to a range of 1 to 2 percent of GDP by 2012 (from about 4 percent of GDP currently).

The public sector wage bill reform contemplated under Pillar II will result in more transparent salary laws that better link pay with responsibility. Wage growth would be contained and the wage bill lowered to give a signal of restraint for private sector settlements thus enhancing external competitiveness.

In support of competitiveness, Pillar III will harmonize the bases for social contributions, reduce health plan contributions and bring indirect taxes in line with EU legislation. Reforms in these areas will follow a number of steps, with the preparatory documents finalized by end-year, and enactment of relevant legislation to occur in 2010-11.

C. Financial Sector Policies

13. The authorities remain vigilant to any signs of stress in the banking system, which has thus far withstood the impact of the global financial crisis. The capital adequacy ratio has remained stable, partly reflecting the decline in risk-weighted assets in line with the decline in lending growth. Banks have also retained 2008 profits to increase their buffers. Nevertheless, profitability has declined and NPLs have crept up. Going forward, profitability is likely to be weak and NPLs are expected to edge up further. Thus, there was recognition of the need to continuously monitor developments and ensure that commercial banks have a forward looking plan to address any potential deterioration in capital. The authorities are also going to suggest to banks to retain their 2009 profits to further strengthen their capital base (LOI ¶29).

14. The authorities have secured commitments from the parents of the largest foreign-owned banks toward their continued support to BiH (LOI ¶30). Following meetings in Vienna in June 2009 and in Sarajevo in September 2009 under the European Bank Coordination Initiative (EBCI), specific bilateral commitment letters were received from 9 parent banks. The 13 subsidiaries of these banks account for 87 percent of banking sector assets. Parent banks agreed to maintain their exposures at the end-2008 level throughout the program period and to recapitalize their subsidiaries as needed. It was also agreed that a review of these commitments will be undertaken on a semiannual basis.

15. While exposure commitments of parent banks have been broadly consistent with expectations, lack of comprehensive data does not allow full evaluation of their exposure commitments. Data for the 9 parents indicate that parent banks’ exposure to their subsidiaries has declined by about 7 percent between December 2008 and December 2009. This trend is consistent with balance of payments developments. Nevertheless, banks have maintained liquidity buffers, as nongovernment deposits are flowing back into the system while credit demand remains weak amidst tighter lending standards. The decline in parent banks’ exposure to subsidiaries was partially offset by an increase in exposure to other entities during the same period. The CBBH has developed a reporting format that will allow a comprehensive monitoring of overall exposures to BiH going forward.

Parent Bank Exposure in BIH

(In millions of KM)

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Partial data for 3 of the 9 banks.

16. The program includes steps to ensure banks remain adequately capitalized. To this end, the CBBH in cooperation with the banking agencies are in the process of conducting stress tests on the subsidiaries participating in the EBCI. The stress tests are based on two macroeconomic scenarios, one relying on the program macroeconomic assumptions and another, more pessimistic scenario.2 Going forward, the authorities are expected to finalize the stress tests, discuss the results on a bilateral basis with the banks, and review each institution’s capital adequacy as per the commitment under the EBCI (LOI ¶30). Staff urges the CBBH to continuously monitor vulnerabilities in the banking system in part by conducting top-down stress tests on a regular basis in cooperation with the banking agencies.

17. Important steps have been made toward strengthening crisis preparedness and safeguarding financial stability. A Standing Committee for Financial Stability (SCFS) has been established and a Memorandum of Understanding on financial stability, crisis preparedness and management has been signed on December 22, 2009 (end-November 2009 structural benchmark). The SCFS plans to meet at least once every quarter or as necessary to discuss and exchange information related to financial stability. The authorities have also amended the regulation (on October 28, 2009) to allow all banks, regardless of ownership, membership in the deposit insurance scheme (end-February 2010 structural benchmark) (LOI ¶32).

D. Other

18. Substantial progress has been made on improving the quality of statistics (LOI, ¶33). A coordinating group has been set up, with the task of collecting and consolidating fiscal statistics harmonized with Eurostat and the IMF’s Government Finance Statistics guidelines from all levels of government. Albeit with some delay, the group has already published partial general government data for end-September 2009 and end-December 2009 (continuous benchmark). The authorities have stepped up their efforts to ensure that they meet the benchmark without delay in the future.

III. Program Modalities

19. The attached LOI describes the authorities’ progress in implementing their economic program and sets out their commitments for 2010.

  • BiH continues to face sizeable balance of payments financing needs over the next three years. Nevertheless. the Fund arrangement remains adequate to meet BiH’s balance of payments needs through 2012, alongside financing commitments from the European Commission and the World Bank. While the estimated external financing needs for 2009-10 have declined somewhat against the backdrop of a faster-than-expected external adjustment, it is proposed to leave the phasing as initially programmed given the fragility of the stabilization process and uncertainties going forward.

  • The first review under the SBA was delayed to give the authorities more time to adopt a number of reforms of rights-based benefits. Since the conditions prescribed by the SBA for the authorities to request the purchase of the tranche that becomes available on March 10, 2010 have been met, the authorities intend to draw the amount available at the completion of the review (SDR 121.75 million), with the entire purchase used for budget support. As noted above, going forward it is envisaged to stick to the program’s exit strategy from temporary budget financing using Fund resources.

  • New structural conditionality will continue to focus on the fiscal area (Box 3), and it is deemed necessary to address long-standing structural problems and ensure a return of public finances to a sustainable medium-term path.

20. BiH’s capacity to repay the Fund is expected to remain good. The country’s excellent record of serving its Fund obligations, the expectation that the program would lay the foundations for the return to a sustainable medium-term growth path, and a strong political commitment to the Fund-supported program provide assurances that BiH will be able to discharge its Fund obligations in a timely manner. By the end of the SBA, Fund credit outstanding is projected to be 7.6 percent of GDP (28.7 percent of gross reserves).

21. The updated safeguards assessment of the CBBH was completed in October 2009. The assessment found that in general the CBBH has further improved its safeguards framework by adopting a bank-wide risks assessment methodology, strengthening the internal audit function, and amending the Audit Committees’ by-laws. Nevertheless, the authorities have committed to further strengthen the safeguards framework (LOI ¶34).

IV. Staff Appraisal

22. Initial implementation of Bosnia and Herzegovina’s stabilization program has been encouraging. Fiscal restraint and structural fiscal reforms are targeting expenditure categories that led to large imbalances in recent years. Financial sector policies are helping to support adequate liquidity in the banking sector. As a result, the severity of the downturn has been contained, confidence in the currency board maintained, household deposits are recovering, and the international reserve position has strengthened. Early performance under the program has been satisfactory, with all quantitative performance criteria for end-September 2009 and end-December 2009 having been met. Structural reforms have progressed, albeit with some delay.

23. Continued challenges call for the steadfast implementation of strong policies. Although the short-term economic and financial outlook has stabilized, strong efforts are still needed to ensure fiscal and external sustainability. Temporary measures now need to yield to more systemic reforms of: rights-based benefits and untargeted transfers; public wages in the Federation; and pension systems. Successful implementation of these reforms requires broad political support and stronger consensus among social partners and the public.

Bosnia and Herzegovina: Stand-By Arrangement

Access: SDR 1,014.6 million, 600 percent of quota.

Length: 36 months.

Phasing: SDR182.6 million was made available upon the Board’s approval of the arrangement to address fiscal and balance of payment needs during the rest of the year. The availability of the second tranche (SDR 87.9 million) is subject to the completion of this (first) review. The ten subsequent quarterly tranches ending in June 2012, will equal SDR 744 million, and be contingent upon completion of further quarterly reviews.

Conditionality

Quantitative Performance Criteria

- Ceiling on accumulation of net credit of the banking system to:

  • ✓ consolidated general government

  • ✓ State government

  • ✓ RS consolidated government

  • ✓ Federation consolidated government

-Ceiling on new guarantees and the assumption of enterprise debt to banks by the public sector

- Ceiling on accumulation external debt service arrears

- Ceiling on contracting new short-term nonconcessional external debt

- Ceiling on accumulation of domestic arrears of:

  • ✓ the State government

  • ✓ the RS Government

  • ✓ the Federation government

Prior Actions

- Approve by State and Entity Parliaments 2010 budgets consistent with the program, including supporting legislation

- Enact by Entity Parliaments framework legislation in preparation for the transition to a means-tested system of rights-based benefits (Federation, RS)

- Enact law to eliminate special unemployment benefits granted to demobilized soldiers effective May 1, 2010 (Federation)

Structural Benchmarks

- Adhere to the Currency Board Arrangement as constituted under the law (Continuous)

- Publish on the State government’s web site quarterly consolidated general government accounts with a 5 week lag (Continuous)

- Agree on an action plan acceptable to the World Bank and IMF staffs to reform the system of rights-based transfers in the Federation (end-November 2009)

- Submit to the Federation Parliament a Law forbidding passing of unfunded legislation (end-November 2009)

- Form a standing committee of financial stability and sign the MoU on financial stability, crisis preparedness and crisis management (end-November 2009)

- The Deposit Insurance Agency to impose a principle of universal membership requirements, including for partially state-owned banks (end-February 2010).

- Carry out eligibility audits for civil and war benefit recipients; publish results (quarterly within 4 weeks after the end of each quarter) of audits, including expected savings from disqualifications (Federation, RS) (Continuous)

- Adopt by Parliament wage legislation consistent with the 2010 fiscal policy objectives (Federation) (end March 2010)

- Reform privileged pensions by entity governments (Federation, RS) (end March 2010)

- Prepare a strategy for pension reform by entity governments (Federation, RS) (end March 2010)

24. Credible fiscal measures are critical to restore fiscal sustainability. Staff acknowledges the authorities’ efforts to keep expenditure under control, and recognizes that the program’s 2009 fiscal deficit objective was exceeded owing to revenue shortfalls. With revenue performance still weak and strong expenditure pressures ahead of the October 2010 elections, the authorities are to be commended for their commitment to fiscal restraint. To this end, the revised 2010 general government deficit objective strikes an appropriate balance between fiscal policy’s response to the cycle and medium-term consolidation objectives. The revised fiscal program focuses on measures that would secure a permanent reduction in recurrent government spending, and strengthens structural fiscal reform commitments.

25. There is a pressing need to protect spending on public investment and vulnerable social groups. The program’s focus on lasting reforms to reduce recurrent spending and provide more space for capital expenditure is welcome, and staff emphasizes the need to improve implementation capacity. Social protection is a key element of the authorities’ program to reform social benefits. It is thus important to ensure that, through better targeting, these benefits reach the most vulnerable groups. Moreover, staff urges the authorities to strengthen the financial integrity of the public pension systems.

26. It is essential to remain vigilant to any sign of stress in the financial sector. Staff welcomes steps to enhance the monitoring of financial stability, and improve crisis preparedness and management, and urges the authorities to further increase cooperation between the central bank and banking agencies. The commitments by foreign parent banks to maintain their exposure vis-à-vis BiH and keep their subsidiaries well capitalized should help contain external financing gaps and support market confidence. Staff also welcomes improvements in the capacity to conduct stress tests and urges the authorities to continuously monitor vulnerabilities in the banking system.

27. Political risks to the implementation of the program are rising. With general elections approaching, the political support for the needed adjustment measures and key fiscal structural reforms may fade. To address these concerns, approval of the 2010 budgets and of key fiscal measures are prior actions for Board consideration of the request for completion of this review. In addition, the authorities recognize the need for continued careful program monitoring, and they are committed to adjust policies as circumstances change.

28. Full implementation of the authorities’ program offers the best chance for BiH to emerge from the economic crisis ready to resume stronger growth and make faster progress in EU-convergence. In light of performance to date and the policy intentions expressed by the authorities, staff support their request for completion of the first review under the Stand-By Arrangement.

Table 1.

Bosnia and Herzegovina: Selected Economic Indicators, 2008-15

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Sources: Bosnian authorities; and IMF staff estimates and projections.
Table 2.

Bosnia and Herzegovina: Balance of Payments, 2008-15

(In millions of euros, unless otherwise indicated)

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Sources: BiH authorities; and IMF staff estimates and projections.
Table 3.

Bosnia and Herzegovina: Selected Vulnerability Indicators, 2004-09

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

Banja Luka Stock Exchange’s BIRS index.

Sarajevo Stock Exchange’s SASX-10 index

Table 4.

Bosnia and Herzegovina: General Government, 2008-15

(In percent of GDP)

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Sources: Ministries of Finance; and IMF staff estimates.

The 2008 amount represents a discrepancy between above- and below-the-line totals.

Disbursements of budget support loans and grants from multilateral creditors are recorded under “Foreign financing for budget support” and “Grants for budget support”, respectively, in the year they are drawn, and under “Identified financing of financing gap” in projections. Projected issuance of international bonds in 2011-14 for general budget financing are recorded under “Foreign financing for budget support.”

Includes proceeds from privatization, succession funds, and the use of the 2009 SDR allocations.