Statement by Willy Kiekens, Alternate Director for Bosnia and Herzegovina and Zorica Kalezic, Advisor to the Executive Director September 7, 2016

The economy of Bosnia and Herzegovina (BiH) continues to recover. Growth was 3.2 percent in 2015, despite fiscal consolidation forced by financing constraints, and is expected to be at about the same level this year. External and internal imbalances have eased substantially in the past year. However, since the global financial crisis, economic convergence with advanced European economies has lagged. Unemployment, especially among the youth, is high and persistent, and creates incentives for emigration. There are important challenges in the areas of improving the business environment, reorienting fiscal policy to support growth while ensuring sustainability, promoting credit while safeguarding financial stability, and ensuring the fragmented governance structure does not affect the single economic space.


The economy of Bosnia and Herzegovina (BiH) continues to recover. Growth was 3.2 percent in 2015, despite fiscal consolidation forced by financing constraints, and is expected to be at about the same level this year. External and internal imbalances have eased substantially in the past year. However, since the global financial crisis, economic convergence with advanced European economies has lagged. Unemployment, especially among the youth, is high and persistent, and creates incentives for emigration. There are important challenges in the areas of improving the business environment, reorienting fiscal policy to support growth while ensuring sustainability, promoting credit while safeguarding financial stability, and ensuring the fragmented governance structure does not affect the single economic space.

The program, for which the authorities request support under a three-year extended arrangement, is expected to correct the imbalances in the external sector, improve fiscal and financial sustainability and facilitate the implementation of critical structural reforms. By facilitating better cooperation and coordination, the program also addresses deficiencies of the institutional and policy fragmentation, and supports Bosnia and Herzegovina’s single economic space.

Macroeconomic outlook and risks

As the consequences of the 2014 floods dissipate, economic growth gradually recovered, reaching 3.2 percent in 2015. In 2015, the fiscal deficit was 0.8 percent of GDP, down from 2.9 percent in the previous year, mainly because of spending discipline. In the setting of a fully operational CBA, inflation in June 2016 was -1.4 percent, in line with price developments in the Euro Area. With solid export growth, the current account deficit narrowed from 7.5 percent in 2014 to 5.6 percent in 2015. Unemployment remains unacceptably high, but declined from 27.7 percent by the end of 2015 to 25.4 percent in April 2016. The average nominal net wage is stagnant, oscillating since 2014 in the range ±1.3 percent.

Stronger growth depends on the implementation of the Reform Agenda and the pickup of the growth across the EU. The reform agenda is a consensus on priorities for economic and social development. It aims at a 4 percent growth over the medium term, and supports the country’s progress toward EU accession.

The authorities are fully aware that the country’s post-conflict context and unconventional institutional setting, could pose a risk for the successful and timely implementation of the EFF. However, there is strong ownership of and commitment to the Reform Agenda and the authorities are determined to make progress with the EU accession process. The Stabilization and Association Agreement (SAA) was signed mid-July 2016, finalizing the process which was on hold since 2008. Simultaneously, the authorities agreed on the longstanding issue of how to coordinate the implementation of the SAA. Moreover, the entities (Federation of Bosnia and Herzegovina and Republika Srpska) developed a time-frame and strategy to ensure the implementation of the Reform Agenda.

Moreover, the authorities would like to stress that discussions with the international community recently gained strong momentum, which will lead to well leveraged support of the IFIs. The reform agenda is intensively discussed with the IFIs and the EU, and will be used as a platform for negotiating individual programs of financial and technical assistance from these partners. To that end, the requested EFF is considered by the authorities as the backbone framework which provides a comprehensive anchor for implementing structural reforms, ensuring fiscal sustainability and financial stability. Unlike previous SBAs, the EFF creates a platform for strengthened institutional cooperation and national policy coordination, respecting the sensitivities of the constitutional boundaries. The World Bank with a Country Partnership Framework (CPF) will concentrate its efforts on the restructuring of SOEs and related arrears, improvement of the public sector services, business environment reforms and building resilience of the country to natural shocks. The European Commission (EC) is particularly focused on economic governance, rule of law and public administration reforms, while the EBRD is seen as the key counterpart in the implementation of the infrastructure investment agenda.

To this end, the authorities are confident that their strong commitment and improved domestic cooperation, supported by the comprehensive efforts from the international community, will ensure successful implementation of the economic program, neutralizing vested interests in the political and economic landscape that could derail the EFF implementation. The authorities recognize that the local elections scheduled for October 2, 2016, will be an important test of this commitment.

Fiscal policy

Fiscal consolidation strikes a balance between gradually reducing public debt and supporting growth friendly structural reforms and development projects. Fiscal consolidation will be sustained. The composition and quality of public spending will improve. Deficiencies in social assistance will be addressed. The unfavorable bias towards consumption relative to investment will be corrected. The aim is to reduce current spending by 3 percent of GDP by 2019. The public debt ratio should fall by 4 percentage points to reach about 40 percent in 2019.

Public administration reforms, including limits on hiring and a wage freeze will reduce the public wage bill. With the help of the World Bank, public employment registries will be established by the end 2016. Better targetting of social spending, including veteran benefits and agricultural subsidies, will also reduce public spending.

Tax administration is strengthened. Better intragovernmental coordination will improve revenue collection. Tax payers’ information is now exchanged among agencies, improving tax compliance and addressing tax arrears by large tax payers. Audits of VAT refunds is another component of efforts to increase the efficiency of tax collection.

The tax revenue structure is improving and the labor tax wedge reduced. Although the average tax to GDP ratio of 41 percent of GDP is in line with regional and EU peers, the revenue structure is heavily skewed towards direct taxation. This harms labor cost competitiveness. To correct this handicap, social security contributions will be reduced and the personal income tax simplified. Fund technical assistance will help harmonize the base for social security contributions and expand this base by including work related incomes. Thus, the reduction in the social contribution rate will be fiscally neutral. A broad-based harmonized corporate income tax and reducing tax exemptions for exporters will enhance tax efficiency.

In cooperation with the World Bank, SOEs will be reformed, and pension and health care systems and the control of local governments’ finances improved. Weaknesses in the management of some of the remaining 574 SOEs led to an accumulating of arrears, most notably in missing pension contributions. This hampers the restructuring the SOEs and creates sizable contingent liabilities. A World Bank DPL (under discusion) will help restructure SOEs, by reducing explicit subsidies, direct transfers, and state aid and implicit liabilities.

The implementation of a more efficient spending control at the lower levels of government is facilitated by the progressive expansion of the treasury systems which helps to prevent the emergence of new liabilities (the WB ongoing arrears’ stock appraisal). In parallel, the authorities will, by the end of 2016, submit amendments to the Law on Debt, Borrowing and Guarantees and new Law on Public revenue allocation to the Parliament. This will strengthen controls over lower level governments and provide incentive-based financial scheme to those cantons and municipalities that refrain from excessive expenditures. Public spending inefficiency in the health sector and pension reforms are currently assessed by WB TA (the Health Sectors Project and Fiscal Resources for Growth DPL, currently under discussion).

Monetary policy framework

The authorities continue to adhere to the Currency Board Arrangement (CBA) as the medium-term monetary regime. The CBA provides a sustainable anchor for pursuing long-term economic policies, by being predictable, credible and transparent. Maintaining conditions conducive to the fully operational CBA, the CBBH is holding foreign reserves at comfortable levels of €4.6 billion in July 2016, while rigorously maintaining reserves coverage of the monetary base above 110 percent.

The authorities will continue efforts to preserve the independence and the credibility of the CBBH and the CBA. The authorities are cognizant that maintaining transparent financial links with the government, and refraining from government financing are the preconditions for a credible CBA. The CCBH is committed to withhold from using foreign reserves for any budgetary or public investment purposes and halt transfers of foreign reserves to the public sector. Faced with the challenging global interest rate environment, the CBBH cooperates with IMF TA on enhancing the efficiency of foreign reserves management and related investment practices. The envisaged adjustments in the Law on Banks will streamline the definition and the coverage of the reserve requirement.

Structural reforms

Positioned at the 79th place in Doing Business 2016, Bosnia and Herzegovina is lagging behind its regional peers, with lackluster business and investment environment, an inflexible labor market and bottlenecks in transport. The new Reform Agenda provides a comprehensive set of priorities to improve the business climate and boost competitiveness.

Reducing unemployment and inactivity remains a priority of the BiH authorities. In 2015 43.9 percent of the unemployed was not able to find a job for more than five years, which shows a serious skills demand/supply mismatch. Inflexible labor market rules and the labor tax wedge are preventing companies to efficiently adjust to changing economic conditions. Insiders are protected, mostly at the expense of young workers. Being concerned about these longstanding issues, the authorities in both entities adopted the new modern Labor Codes (end 2015) in which protection of workers is aligned with EU standards.

The authorities developed a comprehensive framework to address governance issues of SOEs and privatization plans regain momentum. The authorities classified SOEs into those requiring minor and into those requiering major restructuring, as a base for future restructuring, privatisation/liquidation. Large telecommunication companies (BH Telecom and HT Mostar) faced with weak financial results are under due diligence assessment which, depending on outturns, may trigger actions ranging from management outsourcing to privatization. In parallel, the authorities, together with the WB, were engaged in a comprehensive assessment of the viability of the railway companies, resulting in restructuring plans that will be adopted in both entities by the end 2016.

Deficiencies in the corporate resolution and insolvency frameworks, observed by the ICR ROSC, will be addressed. The new Bankruptcy Law is already adopted in RS (February 2016) and the draft bankruptcy legislation in FBIH is under parliamentary discussion. Both frameworks streamline foreclosure procedures, introduce tools and incentives to facilitate corporate debt restructurings and resolution, and adopt out-of-court restructuring guidelines. Legislation changes are leveraged by training of the commercial court judges and improving the regulation of the insolvency profession, with support of the WB Debt resolution and Business Exit advisory program.

Financial stability

The authorities are cognizant that credible CBA requires stability of the financial system. The banking system, although well capitalized and liquid at the aggregate level, contains significant pockets of vulnerability at the banks-specific level, evidenced in the weak asset quality and low bank profitability. With 12.1 percent, the NPL ratio is elevated but on downward path (13.7 percent in end-2015) predominantly due to NPL write-offs. In addition, the previous round of AQRs (2013) revealed weak capital position of a few banks, which are currently under the special supervision. Two small banks were resolved in a cost-effective manner, consistent with maintaining the stability of the financial system and protecting insured depositors.

The authorities developed a comprehensive set of measures, in line with the recent FSAP recommendations, to address the challenges in the financial sector. With an underdeveloped NPL resolution and recovery framework, the deteriorated asset quality forms an obstacle for regaining bank profitability. Together with very low credit growth (1.3 percent in June 2016), archaic banking legislation and subpar capacity of supervisory agencies, urgent and decisive action is required.

In order to address bank-specific vulnerabilities, comprehensive AQRs will be conducted on weaker banks (those who were under the detailed supervision during 2015 or which encountered higher than optimal credit growth during the pre-crisis period). Depending on the findings, banking agencies will recommend appropriate remedies.

The legal framework addressing NPLs recovery, resolution and liquidity requirements will be strengthened. Provisions under the new banking law allow for transferring/sale of non-cancelled NPLs to an entity other than a bank (which specializes in impaired debt collection). At the same time, the authorities are looking at regional suitable solutions for introducing the out-of-court restructuring framework that would help to facilitate a least-cost solution to loan impairment. With regards to maintaining precautionary liquidity, although the aggregate liquidity buffer (LCR and NSFR) is sizable (above 250 percent at the end of 2015), the authorities will introduce a LCR framework, while monitoring the required reserves holdings.

With the assistance of the WB and the IMF, the authorities substantially improved banking legislation and development banks governance. The authorities drafted a new Law on Banks, with related amendments to the banking supervisory agencies Laws and the Law on Depository Insurance Agency to be adopted by the end November 2016. The new laws address deficiencies in the agencies’ supervisory powers, resolution tools, consolidated supervision and definitions of banks and licensing. The resolution framework introduces new resolution powers to the supervisory agencies and related institutions, and new tools for timely corrective actions. With the new legislation, the harmonization in regulation between the entities will be largely achieved. The authorities, together with the WB and the IMF, are working on the development of bank frameworks to improve governance and streamline mandate, to limit their engagement in financial sector activities and direct govermental support.

The authorities will enhance cooperation, coordination and information exchange among the financial sector regulators. The Banking Coordination Group and the Standing Committee for Financial Stability are meeting regularly with the aim to mitigate systemic risks. There is cross representation of the entity level supervisory agencies (the FBA and BARS). Their adjustments will strengthen the comprehensive risk assessments of the financial sector, which will contribute to further strengthening the single economic space.

The authorities will accelerate efforts in combating money laundering and financing terrorism. As recorded in the 2015 MONEYVAL report, the level of compliance of the AML/CFT framework of BiH was significantly enhanced by the adoption of the AML/CFT Law and amendments to the BIH Criminal code, described as broadly compliant with the FATF standards. At the moment, the authorities are focused on putting in place an effective AML/CFT coordination mechanism on a policy level and ensuring that the risks and vulnerabilities of the aggregate system are appropriately identified.


The authorities believe that the EFF will support the implementation of necesary policy reforms and address external and fiscal imbalances. The front-loaded program will shift the country’s growth model, making the economy less dependent on domestic consumption, remittances and imports, and attract more foreign direct investment, boost exports and promote market integration, thereby advancing the EU accession process.