Bosnia and Herzegovina
2012 Article IV Consultation and Request for Stand-By Arrangement—Staff Report; Informational Annex; Public Information Notice; Press Release; and Statement by the Executive Director for Bosnia and Herzegovina

Bosnia and Herzegovina’s (BiH) challenge is to cope with the adverse economic environment and prepare the ground for achieving sustainable export-led economic growth, raising living standards, and making progress toward EU accession. In addition to fiscal consolidation, this will require reforms to improve the composition of public expenditure and unlock the economy’s potential. Financial sector policies should aim at further enhancing the authorities’ crisis preparedness and contingency planning. These policies would also provide a solid basis for the stability of the currency board and enhanced national policy coordination.

Abstract

Bosnia and Herzegovina’s (BiH) challenge is to cope with the adverse economic environment and prepare the ground for achieving sustainable export-led economic growth, raising living standards, and making progress toward EU accession. In addition to fiscal consolidation, this will require reforms to improve the composition of public expenditure and unlock the economy’s potential. Financial sector policies should aim at further enhancing the authorities’ crisis preparedness and contingency planning. These policies would also provide a solid basis for the stability of the currency board and enhanced national policy coordination.

I. Introduction

A. Context

1. Bosnia and Herzegovina’s (BiH) past economic growth relied increasingly on domestic demand as the key driver. Private sector demand expansion was fuelled by a credit boom financed from abroad. This produced strong output growth amid a benign external environment and ample bank financing. However, the associated vulnerabilities became clear in the 2009 crisis when capital inflows came to a stop. Against this backdrop, the currency board arrangement, fiscal tightening, and financial support under the 2009 SBA helped safeguard macroeconomic stability (Box 1). But this has not been enough to propel the economy forward—staff projects that real GDP will not regain its 2008 level until 2013. Structural impediments continue to hamper economic performance—the large government crowds out the private sector and the business environment discourages investment and business expansion, leading to high unemployment and low labor force participation.

2. The protracted political crisis slowed reforms and progress toward EU accession. The long delay in the formation of a new State-level government and the breakdown in national policy coordination following the October 2010 elections—evidenced by the difficulty in reaching an agreement on the budget for the Institutions of BiH and the temporary interruption in the servicing of BiH’s public debt to some IFIs in early-2012—stalled economic reforms and progress toward EU accession. It also prevented completion of SBA reviews since October 2010; the SBA expired in July 2012, with only ⅓ of the approved amount disbursed. The new Council of Ministers that was confirmed in February 2012 has vowed to move expeditiously on EU issues. Cognizant of the risks emanating from the present uncertain global and regional economic environment, the authorities have put together a comprehensive program for which they are requesting Fund support.

B. Recent Economic Developments

3. The slow post-2009 economic recovery is losing momentum. Following the 2009 recession, BiH’s economy grew at a moderate pace in 2010–11. However, the pickup in economic activity did not spread from export-oriented industries to the wider economy. Domestic demand has been held back by stagnant wages and employment, and slow credit growth. Following steep declines in 2009–10, domestic investment has recovered some ground. Latest high frequency indicators point to a marked slowdown of economic activity amid falling external demand. Headline inflation has declined despite high world oil and food prices, and increases in utility prices and tobacco excises. Core inflation has remained below 1 percent, reflecting the softness of domestic demand.

BiH: Selected High-Frequency Indicators, 2010-12

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Sources: BiH authorities; and IMF staff estimates.

Percent change over the same quarter in previous year.

4. The current account deficit has started to narrow and official foreign exchange reserves have been volatile in recent months. The surge in imports during 2010–11 outpaced the recovery in exports, thus leading to a widening in the current account deficit to 8¾ percent of GDP in 2011. However, weak domestic demand this year led to a narrowing in the current account deficit in the first quarter of 2012 to 8 percent of GDP on an annualized basis. Official foreign exchange reserves remained broadly stable during 2011 despite some repatriation of funds by foreign parent banks. By March 2012, foreign parent banks had reduced their overall exposure to BiH by around 13 percent relative to the end-2008 benchmark (while the decline in exposure to banks was somewhat more pronounced), with most of the decline (10 percentage points) experienced by end-2010. Reserves came under renewed pressure earlier this year, mainly due to some banks’ and corporates’ repatriation of profits, and banks’ reduced demand for foreign funding. Positive momentum since the re-engagement with the Fund in program discussions contributed to a pickup in reserves in recent weeks.

uA01fig01

BiH: Central Bank’s Foreign Assets

(euro millions)

Citation: IMF Staff Country Reports 2012, 282; 10.5089/9781475511840.002.A001

Source:BiH authorities.

5. The banking system has remained relatively stable. The sector as a whole returned to profitability and maintained its capital adequacy through capital injections and profit retention (Table 11). Aggregate capital adequacy has remained above the minimum requirement, and top-down stress tests conducted by the authorities using end-March 2012 bank-by-bank regulatory data did not reveal significant weaknesses. However, nonperforming loans (NPLs) have remained at low double digits—12.6 percent for the banking sector as a whole as of June 2012. Finally, provisioning at 67 percent of non-performing assets at end-June 2012 is in line with the regional average.1

Table 1.

Bosnia and Herzegovina: Selected Economic Indicators, 2009–17

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

Bosnia and Herzegovina: Real Sector Developments, 2009–17

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Source: BiH, FBiH and RS Statistical Agencies, and Fund staff estimates.Notes: Nominal and real GDP series are based on the production approach.

Based on the BiH Labor Survey.

Number of registered unemployed persons in Unemployment Offices.

Table 3.

Bosnia and Herzegovina: Balance of Payments, 2009–17

(In millions of euros, unless otherwise indicated)

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

Positive entry in 2009 represents the general and special SDR allocations.

Table 4.

Bosnia and Herzegovina: General Government Statement of Operations, 2009-17

(Percent of GDP)

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Sources: BiH authorities; and IMF staff estimates and projections.
Table 5.

Bosnia and Herzegovina: General Government Statement of Operations, 2009-17

(KM million)

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