Program performance and economic outlook

The authorities admit that the complex institutional set-up and resulting fragile political situation has at times slowed down program implementation. They remain, however, strongly committed to the program and are determined to resist any pressures to backtrack. The EFF arrangement plays a pivotal role in supporting Bosnia and Herzegovina’s economic policy and reform agenda. It also plays a catalytical role in fortifying the single economic space within Bosnia and Herzegovina, while boosting cooperation with other IFIs, and paving the way for eventual EU and WTO integration.

Albeit somewhat lower than expected, growth remained stable in 2017, as consumption, the inflow of remittances, and higher exports to neighboring countries, compensated for lower than expected investment levels. Going forward, the authorities share staff’s assessment that at the current pace of reforms, growth is expected to reach 4 percent by 2022, supported by stronger investment and export growth as donor-financed capital projects and measures to improve competitiveness begin to bear fruit.

Fiscal policy

Gradual fiscal consolidation since 2014 is placing general government debt on a downward trajectory to below 40 percent of GDP by 2020. The 2018 budgets of the central governments of the Federation of Bosnia and Herzegovina (FBiH) and the Republika Srpska (RS), as well as the 2018 budgets of the State institutions, are in line with program targets. The authorities project a fiscal surplus of 1.4 percent of GDP for 2018, and will continue to run moderate fiscal surpluses over the medium term while preserving healthy margins of the temporary structural surplus.

The authorities managed to restrain current spending by introducing limits on hiring, as well as a wage freeze. They also better targeted social spending, veteran benefits, and agricultural subsidies. The authorities agree with staff that the current economic cycle is conducive for further reforms in terms of reducing public-sector employment. The authorities in the FBiH and the RS will finalize the Employee Register in early 2018. In addition, the completion of the functional review of public sector employment, scheduled for end 2018, will unveil organizational structures where further reductions in wages and/or employment are warranted.

Following the increase in fuel excises, important external financing resources will become available to finance long overdue public investment projects. Given the country’s limited access to international financing, the authorities had to rely on limited available domestic resources, to address Bosnia and Herzegovina’s development needs. To improve public investment efficiency, the authorities are working on an action plan to strengthen the public investment cycle from project allocation, to project appraisal and project implementation.

The authorities are taking decisive measures to address deficiencies in the PFM framework and to address the long-standing issue of public-sector arrears. Public-sector arrears are a legacy of twenty years of decentralized fiscal management. As a first step, the authorities have assessed the stock of arrears. Most arrears come from SOEs (primarily unpaid pension and health contributions spending), lower levels of government, and the health sector. In collaboration with the Fund and the World Bank, the authorities are working on a timetable and measures to address poor management, reporting, and the clearing of outstanding arrears. To avoid a further accumulation of arrears in SOEs, the authorities adopted the Law of Financial Operations, which prevents SOEs from paying salaries without making the necessary pension and health contributions. In addition, to strengthen control on borrowing at the cantonal and municipal level, the FBiH proposed a new Law on Debt, Borrowing, and Guarantees. The RS introduced a new reporting system to capture health sector arrears, and the authorities will develop an action plan to restore the financial sustainability of health institutions by the end of 2018.

Monetary policy framework and financial sector

The authorities continue to adhere to the Currency Board Arrangement (CBA). The CBA has served Bosnia and Herzegovina well as it represents a predictable, credible, and transparent anchor for economic policies. The authorities will also continue to uphold the independence and the credibility of the Central Bank of Bosnia and Herzegovina (CBBH). In line with IMF technical assistance recommendations, the CBBH enhanced the efficiency of foreign reserves management and related investment practices.

The authorities made significant strides in reforming and modernizing banking sector legislation. The authorities of the FBiH and the RS adopted a new Law on Banks, as well as amendments to the laws governing the banking supervisory agencies to strengthen their supervisory and resolution powers. The new legislation further enhances the single economic space as it is intended to strengthen cooperation, coordination, and information exchange between all financial sector regulators. To achieve such cooperation, coordination, and information exchange in practice, the authorities are finalizing a draft Financial Stability Memorandum of Understanding. Amendments to the Law on Deposit Insurance, have been submitted to Parliament, with the intention to have them adopted by end-March 2018.

The authorities have started addressing AML/CFT deficiencies. As the country is listed as a jurisdiction with strategic deficiencies, the authorities will continue to work closely with FATF and MONEYVAL. The authorities have made substantial progress with the criminalization of terrorist financing, developing an adequate AML/CFT supervisory framework, and establishing adequate cross-border currency controls. These efforts will be subjected to FATF verification.

Structural policy

The authorities remain committed to improve Bosnia and Herzegovina’s business climate to unlock the country’s growth potential. Existing structural bottlenecks prevent Bosnia and Herzegovina to make the most of its regional comparative advantages in wood processing, metal processing, and inorganic chemical industries. To this end, the authorities will focus on important infrastructure improvements to take advantage of the country’s geographical position. The recent decision to increase excises on fuel products will have a catalytical effect on mobilizing external financing to support the construction of the strategically important highway “Cordor V”, while two World Bank projects will support local road and railway connectivity. The new Law on Physical Planning at the cantonal level, adopted end 2017, simplifies the procedure for obtaining building permits. In addition, both the FBiH and the RS will lower parafiscal fees in 2018 and will, by June 2018, establish a one stop shop to simplify and shorten the time required to register business entities. The corporate resolution and insolvency frameworks are further fortified with the new Bankruptcy Laws (adopted in 2016 in the RS, and to be adopted in the FBiH in 2018), as it streamlines foreclosure procedures and introduces tools and incentives to facilitate corporate debt restructurings and resolution.

The authorities are gradually implementing structural reforms to stimulate job creation and address labor market rigidities. In line with their reform agenda, the authorities introduced a new Labor Code and the social partners have negotiated new, more flexible collective agreements. In order to spur wage competitiveness by lowering the robust tax wedge on labor, the FBiH plans to align legislation with the RS, by submitting to the Parliament amendments to the laws on personal income tax (introducing progressive taxation) and social security contributions (SSC). With World Bank assistance, the authorities launched a project providing financial incentives to promote formal private sector employment, and improve job retention rates and intermediation services. The project targets youth, women, and vulnerable groups such as long-term unemployed, as well as other disadvantaged groups at higher risks of being unemployed.

The pace of privatization remained satisfactory, although it proved to be more challenging than expected. At the same time the authorities will continue to address the governance problems of SOEs. The authorities are aware that the current SOE corporate governance policy frameworks and practices are not in line with international best practices. Progress has, however, been made in the largest loss-making companies. The RS, with World Bank support, has adopted an ownership and financial restructuring plan to achieve an operational transformation of the railway company of the RS. Similarly, the FBiH has taken bold measures to cut operational costs, and reduce staff of its railway company. The process to restructure and/or privatize the large SOEs in the telecom sector in the FBiH has started, and the finalization of the due diligence of these companies is scheduled for September 2018.