Background

Despite growing external risks and a challenging domestic political environment in the recent years, the BiH authorities have remained committed to their reform agenda under the current EFF-supported program. Although missing some PCs and structural benchmarks, which have delayed the program reviews, sizable efforts have been made to strengthen public finances, increase resilience of the financial regulatory and supervisory framework, enhance the business environment and economic competitiveness. Economic activity has strengthened and returned to economic potential, driven by strong private consumption and exports, which has alleviated pressures from high unemployment and emigration.

The COVID-19 pandemic, however, poses the most serious threat to the economy since the global financial crisis. Although the outbreak peaked later than in many other European countries, it will have dire consequences for its citizens and the number of confirmed COVID-19 cases in BiH has been increasing daily. In response, the authorities have declared a state of emergency throughout the country, closed schools and universities, shut down restaurants and shops, suspended public transportation, banned public gatherings, and imposed severe restrictions on the movement of people.

Economic and fiscal effect, and policy response

The negative effect of the COVID-19 outbreak on the country’s economy will be significant. Given BiH’s geographical position and the relatively small domestic market, the real GDP contraction this year will be severe at around 5 percent, as demand collapses and supply chains are disrupted.

Tourism receipts have fallen significantly, with hotels currently operating at 10 percent capacity. BiH has also been severely affected by the disruption of its trade links, as a result of the situation in the EU, its largest trade partner. The current account deficit is further projected to deteriorate significantly due to the anticipated decline in remittances by over 10 percent.

At the current juncture, the authorities’ immediately priority is to increase the ability to test for the coronavirus and secure more respirators, mobile x-ray machines, and protective equipment for healthcare providers. Overall the healthcare system in BiH is ill-equipped to deal with this outbreak. Most hospitals are operating at a loss, and arrears are significant. The system has recently been further weakened by a steady exodus of trained doctors and nurses to other countries. In this context, a surge in hospitalizations would quickly overwhelm the already limited capacity.

Against this background, the authorities plan to soon adopt revised budgets at all levels to integrate the new priorities. They expect the overall fiscal deficit to increase to around 4.5 percent this year due to substantially higher public health spending, social and economic support, and lower revenues following the border restrictions, as well as the contraction of economic activity in general. Targeted measures are planned to expand the existing social safety net and provide help to those most in need, including through unemployment benefits. Additional measures are under discussion with the business community to effectively support the most affected businesses and preserve employment. Fiscal surpluses averaging close to 2 percent of GDP in the last two years, together with large public sector deposits and excess banking sector liquidity, provide some space to address the immediate economic and social costs of the pandemic.

Monetary and financial policies

The authorities are committed to avoid foreign exchange or trade restrictions, or any other measures that would exacerbate the balance-of-payments difficulties. They will preserve the stability of the currency board and the Central Bank of BiH will not use its international reserves for fiscal purposes. The banks are currently liquid, well supervised, and in a relatively strong position to confront the crisis. Nevertheless, a protracted period of weak demand could cause businesses to experience liquidity shortages and lead to a surge in loan defaults. A six-month moratorium on loan repayments has been introduced, and the authorities consider other measures to provide relief for stressed but ultimately solvent borrowers. To further strengthen confidence and protect bank depositors, the authorities will seek adoption of the new Deposit Insurance Law and expeditiously move to conclude a credit line with the EBRD as a backstop.

Conclusion

The BiH authorities are confident that the policies outlined in their Letter of Intent will enable an effective use of the requested disbursement under the RFI in these extraordinary circumstances. They understand that preserving macroeconomic stability and putting economic growth on a higher trajectory over the medium term will be essential to sustain social stability and to create fiscal space for investment in human capital and infrastructure. The authorities are committed to resume fiscal consolidation once the consequences of the COVID-19 outbreak are contained, building on the progress achieved over the last years.

The BiH authorities will continue to consult with the Fund on their policies and provide staff with all the data and information necessary for the purpose of monitoring program implementation. They are hopeful that Fund financing will generate strong support from the donor community and would be grateful for a rapid response by both multilateral and bilateral donors.