For more information, see Bosnia and Herzegovina and the IMF

The following item is a Letter of Intent of the government of Bosnia and Herzegovina, which describes the policies that Bosnia and Herzegovina intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Bosnia and Herzegovina, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.
 

June 14, 1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431
U.S.A.

Dear Mr. Camdessus:

The attached statement describes the economic program of the Governments of Bosnia and Herzegovina and its constituent Entities for 1999. The governments confirm the commitments set out in the Memorandum on Economic and Financial Policies of April 21, 1998, and intend to consolidate the results achieved so far by pursuing policies aimed at building common institutions, enhancing inter-Entity cooperation, accelerating the transition to a market economy, and promoting a sustainable economic recovery. The reform agenda for 1999 also reflects our commitment to increase employment opportunities and improve living standards among the population of Bosnia and Herzegovina. Despite the adverse impact of the FR Yugoslavia conflict on economic activity, we remain committed to the full implementation of this reform agenda.

On the basis of recent policy performance and the policy objectives and commitments set forth in the attached document, we request the completion of the first review under the stand-by arrangement. The governments request a further extension of the arrangement through end-April 2000, augmentation of the program by SDR 16.91 million to offset partially the impact of the FR Yugoslavia conflict, and a waiver for the non observance of the performance criterion relating to the introduction of a new uniform chart of accounts for commercial banks by December 31, 1998. The access and phasing of purchases are shown in Table 1. The extension of the arrangement would provide the time needed to reach understandings on a program to be supported under a three-year arrangement under the Enhanced Structural Adjustment Facility.

Under the program for 1999, the implementation of macroeconomic policies will be monitored on the basis of quarterly quantitative performance criteria on government domestic borrowing, on currency board operations, and on external borrowing. The program also includes quarterly structural benchmarks, which will be monitored closely. Quantitative performance criteria will be set for end-June, end-September, and end-December 1999. Assessment of performance under the 1999 program will be based on quarterly program reviews, including reviews of financing assurances and budget outcomes.

The second review, to be completed by end-September 1999, will be based, inter alia, on the observance of the end-June performance criteria. The review will also assess progress in implementing the strategy for promoting the use of convertible marka throughout the country. On the structural side, the second review will assess the actions undertaken, notably in the areas of enterprise and bank privatization, payments system reform, and a review of compliance with the State Customs Tariff Law.

The third review, scheduled for completion by end-December 1999, will be based on the observance of the quantitative performance criteria and the structural benchmarks for end-September 1999, as well as the budgetary outcomes. The review will also focus on progress in reforming the payments system, implementation of key fiscal reforms, and the development of treasury systems at the State and Entity level. The fourth review, scheduled for end-March 2000, will focus on preparation and steps toward promulgation of the budgets for 2000, progress in implementing the enterprise and bank privatization programs and in reforming the payments system.

The Governments of Bosnia and Herzegovina and its constituent Entities believe that the policies and measures described in the attached Memorandum are adequate to achieve the objectives of its program, but stand ready to take any additional measures that may become necessary for this purpose. They will remain in close consultation with the Management of the Fund, in accordance with the Fund's policies on such consultations, and will provide the Fund with any information that it requests on the progress made in policy implementation and the achievement of program objectives.

We will adopt the Memorandum of Economic and Financial Policies as a government resolution and publicize its content to the media. Moreover, we would be grateful if you could arrange for this document to be posted on the IMF website, subsequent to Board approval.

In closing, we wish to thank you for the valuable assistance provided by the Fund in numerous key areas, especially the introduction and implementation of the currency board arrangement, and the particular attention that has been paid to the economic impact of the FR Yugoslavia conflict on Bosnia and Herzegovina.

Sincerely yours,

Council of Ministers of Bosnia and Herzegovina:

Svetozar Mihailovic
Co-Chairman
Haris Silajdzic
Co-Chairman
Neven Tomic
Vice Chairman
Peter Nicholl
Governor, Central
Bank of Bosnia and
Herzegovina

Edhem Bicakcic
Prime Minister
Federation of Bosnia
and Herzegovina
Dragan Covic
Deputy Prime Minister
and Minister of Finance
Federation of Bosnia
and Herzegovina
Milorad Dodik
Prime Minister
Republika Srpska
Bosnia and
Herzegovina
Novak Kondic
Minister of Finance
Republika Sprska
Bosnia and
Herzegovina

Attachment: Memorandum on Economic and Financial Policies


Table 1. Bosnia and Herzegovina--Schedule of Purchases Under
Proposed Stand-By Arrangement Extension, Rephasing and Augmentation1/


Amount of Purchase   AvailabilityConditions Include:

1.   SDR 29.03 millionJune 30, 1999   Board approval

2.   SDR 8.08 millionSeptember 15, 1999   Completion of second review and observance of end-June performance criteria

3.   SDR 8.08 millionDecember 15, 1999   Completion of third review and observance of end-September performance criteria

4.   SDR 8.08 millionMarch 15, 2000   Completion of fourth review and observance of end-December performance criteria 2/

Source: Staff estimates.

1/ Under the proposed schedule, the stand-by arrangement would be extended, rephased through end-April, 2000, and augmented by SDR 16.91 million.
2/ Performance criteria have been defined through end-December 1999. The authorities would intend, based on performance under the stand-by arrangement and progress in defining structural policies, to request the cancellation of the stand-by arrangement and its replacement by an arrangement under the Enhanced Structural Adjustment Facility.




Bosnia and Herzegovina--Memorandum of Economic and Financial Policies

I.  Introduction

  1. This memorandum describes the main economic developments in Bosnia and Herzegovina during 1998 and early 1999 and the objectives and policies for 1999 under the economic and financial program supported under a stand-by arrangement, which the Governments of Bosnia and Herzegovina and its constituent Entities have implemented since mid-1998.

  2. We expect that the program for 1999 will provide an adequate basis to initiate shortly discussions to replace the program supported under the stand-by arrangement with a program to be supported under the Enhanced Structural Adjustment Facility. A detaileddescription of our program for the remainder of 1999 is provided in the following sections of this memorandum.

II.  Recent Developments under the Stand-by Arrangement

  1. Economic recovery was strong in 1998 and remained largely aid-driven, although the unemployment rate still exceeds 30 percent. Inflation performance in 1998 differed significantly across Entities, with a 2 percent increase in the Federation, as against 78 percent in the Republika Srpska, in convertible marka (KM) and Yugoslav dinar terms, respectively. The less favorable inflationary outcome in the Republika Srpska reflects largely the steady depreciation of the Yugoslav dinar against the deutsche mark.

  2. Preliminary estimates indicate that the conflict in the Federal Republic of Yugoslavia (FRY) will have a substantial impact on economic activity in both Entities, particularly the Republika Srpska. In addition, we anticipate significant economic and humanitarian pressures arising from the influx of refugees from FRY.

  3. In the monetary area, the major achievement during 1998 was the successful introduction of domestic currency banknotes and coins with support from the international community, notably the Office of the High Representative (OHR). This was made possible by the establishment of country-wide operations by the Central Bank of Bosnia and Herzegovina (CBBH) and underpinned by the closure of the National Bank of Bosnia and Herzegovina (NBBH). Delays in closing the operations of the NBBH had posed a serious threat to the viability of the CBBH and the solvency of the financial system. In late 1998, the Federation government implemented a plan that has eliminated the scope for the CBBH to extend credit to the NBBH-in-liquidation, thereby removing the main residual risk to the currency board arrangement. In November 1998, FRY severed the links between its payments system and that of Republika Srpska, which impacted adversely on economic activity in the Republika Srpska. In December 1998, the Republic Srpska amended its internal payments law to remove the deutsche mark as a currency permissible for non-cash payments, accelerating further the use of the KM.

  4. Regarding fiscal developments, the implementation of automatic transfers from the Entities to the State to cover administrative expenditures and debt service obligations from June 1998 permitted normal execution of the State budget. For the Federation, overall receipts were significantly below budget, with a corresponding reduction in expenditures, mostly for military personnel and military invalids. The difficult fiscal situation led the Federation to several episodes of borrowing from the banking system and the payments bureau, which were rapidly reversed. Steps were taken to unify tax and social contribution regimes within the Federation, with somewhat lower rates. In the Republika Srpska, the budget outcome in 1998 was broadly in line with initial projections, despite the continued depreciation of the Yugoslav dinar. The Federation and Republika Srpska harmonized tax policies further during 1998 and, in May 1999, implemented a common external tariff policy. During 1998, the Republika Srpska lowered sales tax rates and raised excise charges to bring schedules closer to alignment with the Federation schedules adopted in 1997. In an effort to improve compliance, the Republika Srpska introduced declining marginal tax rate schedules for corporate and personal income taxes as income rises. Both Entities made substantial progress to improve the transparency of budget management. In line with Entity budget execution laws for 1998, no unmet expenditure commitments have been carried forward to future fiscal years. Arrears accumulated prior to 1998 will be settled through the privatization process.

  5. Bosnia and Herzegovina continued to experience a large external current account deficit in 1998, financed mainly by external assistance. The current account deficit, excluding official transfers, narrowed to about US$1.3 billion in 1998. Donor assistance in support of the Priority Reconstruction Program was mobilized through meetings co-chaired by the World Bank and the European Commission, resulting in disbursements of over US$0.94 billion in 1998. In October 1998, we signed an agreement with Paris Club creditors for a debt rescheduling on Naples terms. Significant progress was achieved in 1998 toward removing barriers to the movement of goods and people within the country and, in May 1999, a common, country-wide customs tariff regime and trade policy were implemented under State law. During 1998, the Entity customs administrations were reformed along common lines and permanent inter-Entity cooperation on customs administration was established. Debt management units responsible for monitoring external borrowing and debt-service obligations were established during 1998 at the State and Entity levels, with assistance from the World Bank and the U.S. Government. These units now collaborate closely and rely on a common and comprehensive external debt database.

  6. With regard to banking and enterprise reform, in 1998 elements of the legal framework for the banking sector were introduced in both Entities, including key provisions for strengthening supervisory capacity. In the Federation, a comprehensive package of laws related to the financial sector was adopted, including legislation setting the legal basis for the operation of the banking agency, and a new chart of accounts for commercial banks was adopted. Moreover, the Federation banking agency was granted financial autonomy in November 1998 on the basis of revenues from supervisory fees. In the Republika Srpska, a banking agency was established, but it still lacks an adequate legal basis and financing for its effective operation. The legal framework for privatization was adopted in 1998 in both Entities. A State Statistical Agency was established to disseminate and coordinate the compilation of data provided by Entity Statistical Institutes.

III.  Policies for 1999

  1. During 1999, real growth is expected to slow to about 8 percent, well below rates realized in recent years, owing to the impact of the conflict in FRY. Inflation would be limited to less than 5 percent in KM terms through continued fiscal restraint and strict application of currency board rules. The policies envisaged under the program for 1999 are conducive to a further expansion of domestically financed private investment, which would set the stage for a decreasing reliance on external assistance. In the near term, our strategy will continue to rely on substantial inflows of external assistance on concessional terms. Our medium-term economic strategy remains based on sound macroeconomic policies and the acceleration of structural reforms necessary for the transition to a market-based economy; reforms in the banking and payment systems, as well as privatization, will be instrumental to achieve these objectives.

A.  Monetary Issues

  1. One of our key objectives in 1999 is to further the country-wide use of the KM. To that end, we are implementing the following strategy: governments of both Entities convert into KM all foreign currency income received from foreign assistance and other sources, except for amounts that will be used within three months for foreign payments, and will aim to make all domestic payments in KM; the central bank exchanges KM on behalf of Entity governments without fees, and pays interest on specified categories of government KM deposits at the CBBH; the CBBH has entered into new agency agreements with payments bureaus aimed at clarifying the services to be provided by them; the central bank will intensify its public awareness campaign as to the soundness of the currency board arrangement and the KM. In the Federation, as a structural benchmark under the program, the Government will comply with the amended payment law to eliminate the DM and the kuna for non-cash payments by end-June 1999, and will adopt legislation mandating the use of KM in all government transactions and its adoption as a unit of account for all private and official financial transactions by end-June 1999. In the Republika Srpska, the Government has taken significant steps to increase the share of KM in salary and other payments; this share is expected to increase to 100 percent by end-June 1999, pari passu with increased KM revenue collections. Any remaining state sector financial transactions in dinars are conducted at an exchange rate broadly in line with the market rate. In addition, the Republika Srpska Banking Agency has introduced a liquidity requirement of 10 percent, to be held in KM, on all bank deposits. In order to mitigate the impact of bank compliance with the new measure, enforcement of the liquidity requirement will be phased through end-June, at which point the Republika Srpska Banking Agency will ensure compliance with this requirement by all banks. The Republika Srpska will develop a modern chart of accounts for commercial banks by end-June 1999, to be implemented fully from January 1, 2000.

  2. In recognition of the importance of closing the NBBH to strengthen confidence in the KM, the Federation Government agreed with Fund staff in December 1998 on a strategy to safeguard the currency board throughout the NBBH liquidation process. No financial transactions will be carried out on NBBH accounts, except as regards the implementation of the agreed strategy, and Cantons and selected government institutions are committed to cover the insolvency of the NBBH by end-August 1999. The key principles to be applied throughout the liquidation process are that commercial banks will not extend credit to Cantons for any purpose or accept uncovered deposits held at the NBBH or elsewhere in the banking system, and that any funds recovered by the NBBH liquidator will be used to repay depositors. The liquidation of the NBBH will be a key topic for discussion on the second review of the program. To the extent that funds from all sources fail to cover total NBBH liabilities, the residual uncovered part of government deposits at NBBH will be written off in the context of its final liquidation.

  3. The payments bureaus have a monopoly on payments transfers among legal and physical persons. With a view to future economic development, we are implementing a comprehensive reform strategy that calls for the removal of legislative barriers against banks making domestic payments on behalf of their customers and the sale of payment bureaus' assets to privately-owned clearinghouses. This strategy has been endorsed by the Governments of both Entities and the Council of Ministers; its key elements are attached as Annex I and constitute an integral part of our economic program. Implementation of the strategy is supervised by the Payments Council, which looks forward to drawing on technical expertise from a range of donors. As a structural benchmark under the program, commercial banks will be permitted to carry out payments activities on behalf of their customers in all areas of the country by end-July 1999. In addition, consistent with plans to develop Entity treasury systems, treasury activities currently performed by payments bureaus will be transferred to Entity Ministries of Finance by end-1999. In order to eliminate the competitive advantages of the Development Bank in the Republika Srpska, the Government will elaborate, in cooperation with Fund staff and other donors, a strategy to ensure that the process of separating the Development Bank from the payments bureau, and subsequent privatization, do not entrench a private monopoly over payments. This separation will be completed by end-August 1999.

B.  Fiscal Policies

  1. All levels of government reaffirm their commitment to run balanced budgets on a cash basis, with no borrowing from domestic sources and limited external borrowing, exclusively on concessional terms. Net of the impact of the conflict in FRY, the fiscal deficits indicated in Entity budgets are in accordance with those projected prior to the conflict. As in 1998, and despite the impact of the conflict in FRY, the Governments of both Entities will avoid arrears on the basis of budget execution laws, which permit reductions in all expenditure commitments other than transfers to the State, to bring them in line with available resources. Governments of both Entities will seek to minimize the impact of expenditure reductions on the most vulnerable groups. Entity obligations for State administrative outlays and external obligations will continue to be covered through automatic monthly transfers. Authorities from both Entities agreed to settle promptly all arrears to the BiH State administrative budget, and to adhere to the schedule of automatic payments for the remainder of the year. Based on technical assistance from the IMF and the World Bank, the State institutions will implement a treasury system to guide budget planning and execution, and--with support from the World Bank--establish the basis for the Supreme Audit Institution. To back this process, State ministries and budget beneficiaries will provide monthly reports on budget execution, including own revenues. By end-1999, treasury operations will be established within the State Government and Entity Ministries of Finance, and a framework will be elaborated for Entity-level Supreme Audit Institutions.

  2. The Federation budget for 1999 reflected conservative revenue estimates, measures to broaden the revenue base, and severely limited expenditure commitments; in light of projected shortfalls attributable to the impact of the conflict in FRY, there will be an increased need for external budgetary support. The Government has eliminated preferential treatment for imports from Croatia, replaced Entity-specific import surcharges with a system of economy-wide levies, and implemented a system of excise rates broadly harmonized with rates applied by the Republika Srpska that no longer distinguish between domestic and imported goods. During 1999, the Cantons will implement a budget reporting system consistent with that in the Federation in order: to provide a reliable basis to assess financial operations at all levels of Federation Government; to analyze their capacity to comply with obligations; and to monitor donor aid disbursements. Consistent with IMF standards, the Federation and Cantons will establish jointly a legal framework that defines procedures for arbitration regarding any fiscal measures of mutual concern by end-July 1999.

  3. In the Republika Srpska, revenue targets in the 1999 budget reflected the impact of measures implemented during 1998, including a shift to a market-based exchange rate for valuing transactions in Yugoslav dinars. During 1999, the Government has implemented policies to widen the revenue base, including the elimination of preferential treatment for imports from FRY and implementation of country-wide import surcharges and harmonized excise tax rates. The Government will reverse existing tax concessions and exemptions by end-June. Despite our best efforts to strengthen revenue collection, the conflict in FRY is having a substantial impact on the economy of the Republika Srpska and increases in external assistance would be important to meet expenditure commitments, particularly as a significant compression would affect social benefits for the most vulnerable. The Republika Srpska will implement during 1999 a budget classification system consistent with that implemented in the Federation and undertake reforms to bring pensions and other benefit entitlements in line with available resources. To improve budget planning and administration, the Customs Administration, Tax Administration, and the Financial Police will be integrated with the Ministry of Finance under the Republika Srpska Minister of Finance by end-June.

C.  Governance

  1. We have intensified efforts to fight corruption at all levels of government and customs duty evasion through enhanced inter-Entity cooperation. We are committed to utilize all means to punish those involved in illegal activities. In the interest of transparency, the State, Federation, and the Republika Srpska Governments will submit to the respective Parliaments, by end-July 1999, as a structural benchmark under the program, legislation and implementing regulations that require all public borrowing, lending or guaranteeing of obligations to be recorded in the respective official gazette before the contracts are legally valid and enforceable. The Governments are committed to press for the urgent adoption of this legislation and regulations by the respective Parliaments. We intend to improve the governance of the payments bureaus in both Entities through the appointment of governing boards.

D.  Structural Issues

  1. We are working closely with the World Bank, USAID, OHR and other donors to advance our ambitious agenda of bank and enterprise privatization. Discussions with the World Bank are well advanced to determine the disposition of state ownership of banks during 1999, either through privatization or liquidation. In this connection, we are committed to adhering to our agreements and understandings with the World Bank, especially as set out in the context of our earlier loan negotiations. As provided for under an agreement with donors, a privatization program for the Federation Investment Bank will be adopted by end-1999. In recognition of the need to ensure the autonomy of the Deposit Insurance Agency, the Federation Government will seek to amend the Law on Deposit Insurance by end-June 1999. The Federation Government is committed to ensuring the autonomy of the Federation Banking Agency to carry out its obligations under the Law on Commercial Banks, particularly as regards the closure of insolvent banks. In the Republika Srpska, the Government will send to Parliament a draft Law on Commercial Banks by end-July 1999. In addition, the Republika Srpska Government intends to establish an autonomous and self-financing deposit insurance mechanism by end-September 1999.

  2. During 1999, Governments will follow through on their commitments to donors through implementation of enterprise privatization programs in both Entities. In recognition that this would breach our understanding with the Fund not to borrow domestically, all levels of Government, including Cantons and Municipalities, will abstain from assuming or guaranteeing any obligations of banks or enterprises that were not specified in the initial contracts as obligations of Government, particularly as regards the privatization process. Moreover, the privatization process will be monitored closely to ensure that neither foreign nor domestic debts of enterprises or banks are transformed into explicit or implicit obligations of any level of Government.

  3. In other structural areas, the Entity Governments intend to achieve financial viability of the pension systems over the medium term through pension reform. Consistent with the law passed in 1998, the Federation pension system will continue to align these reduced entitlements with available resources so as to prevent the accumulation of pension arrears; the Republika Srpska will undertake similar legislative reforms for benefit entitlements. Moreover, by end-1999, the Federation Government intends to unify the two pension funds. The Entity Governments are committed to working with the World Bank to develop and implement comprehensive strategies for reform of labor markets, social safety nets, health and education.

E.  External Policies

  1. We are committed to making our best efforts toward finalizing bilateral agreements with our Paris Club creditors by end-September, regularizing our relations with all other remaining creditors in a manner consistent with the comparable treatment clause of the Paris Club agreement, and to facilitating timely negotiations regarding outstanding foreign claims on nongovernment. In order to ensure the integrity of the customs regime and to eliminate tax loopholes that existed across the Entities, we have eliminated preferential trading arrangements with FRY and Croatia. In the Federation, we are committed to ensuring full compliance with the State Customs Tariff Law. The Governments of the Federation and the Republika Srpska reaffirm their commitment to continued implementation of the uniform set of tariff surcharges and unified excise rates on imported and domestic goods, which began in May 1999. In the Republika Srpska, the export tax on unprocessed timber will be replaced by a stumpage tax; appropriate legislation will be sent to Parliament by end-July 1999. All Governments are committed to eliminating all remaining quantitative or licencing restrictions on imports and exports, except as regards health and security. Restrictions for reasons of health and security will be solely the prerogative of the BiH State Government.

  2. The Governments of Bosnia and Herzegovina intend to promote investment, both foreign and domestic, by providing a stable, predictable, and transparent legal environment, as well as macroeconomic policies conducive to a favorable business climate. In recognition of the need to protect scarce budgetary revenues, the Government will limit strictly exemptions on import tariffs, domestic taxes, and social contributions. By end-July 1999, implementing regulations for the State Custom Tariff Law will be issued by the Council of Ministers to ensure that exemptions from import tariffs will be granted solely for goods imported in connection with bona fide donor-financed projects, thereby removing the existing scope for selected enterprises to obtain relief from import tariffs. In addition, orders will be issued by end-July 1999, eliminating customs duty and tax exemptions for duty-free shops (other than at international airports departures, after customs clearance), duty free zones, and consignment sales. No new exemptions or tax relief, including through differential rates, will be granted on domestic taxes or social contributions, except as provided for by international treaties. Existing exemptions that have a limited validity period will be allowed to expire. The respective Governments will send to Parliaments by end-July 1999 draft laws stipulating that all tax or duty exemptions without a specified expiration date, and not provided for under the Custom Tariff Law or other relevant tax laws, will be eliminated by end-September 1999, with the exception of those that had been gazetted officially by end-July 1999. The law also will stipulate that any exemption provided for under the relevant laws will apply across the board, and no individual preferences will be granted. As regards foreign direct investment, no level of Government will grant exemptions or preferential treatments on import tariffs, domestic taxes, or social contributions, unless provided for under existing law, and, in that case, exemptions will be applied in a uniform manner.

  3. Under the Central Bank Law, there are no restrictions on payments and transfers for international transactions, other than those that may be required in order to comply with internationally mandated sanctions. Entity laws and implementing regulations on foreign exchange, consistent with the obligations of Article VIII, Sections 2, 3, and 4 of the IMF Articles of Agreement have yet to be promulgated or amended. With a view to accepting these obligations before end-December 1999, we will adopt such regulations. During the period of the arrangement, we will not impose or intensify restrictions on the making of payments and transfers for current international transactions, introduce or modify multiple currency practices, conclude any bilateral payments agreements that are inconsistent with Article VIII of the Fund's Articles, impose or intensify any import restrictions for balance of payments purposes, or accumulate any new external payments arrears, except transitionally on amounts subject to rescheduling.

  4. At the May 1999 donor meeting for Bosnia and Herzegovina, we sought further external assistance in support of the priority Reconstruction Program. In recognition of the large amounts of highly concessional resources that have been made available to Bosnia and Herzegovina, as well as the limited debt service capacity, the State and the Entities will refrain from external borrowing on nonconcessional terms. In particular, this precludes "in kind" loans. This prohibition on nonconcessional external borrowing will also apply to the granting of domestic or foreign payments guarantees or the assumption of liabilities under existing contracts that are not specifically identifiable as liabilities of the State, Entities, Cantons, or other levels of Government. The sole exception to this policy will be with regard to projects financed by the EBRD, IFC, EIB, European Commission, or other donors in conjunction with World Bank lending.

Annex 1

Reform of the Payments System and Liquidation of Payments Bureaus

Objectives of reform

The goals of modernizing the payment systems and liquidation of payment bureaus in Bosnia and Herzegovina are:

  1. to create the conditions for the emergence of a market-based payments systems, which underpins the development of an efficient and sound financial system;

  2. to increase the speed and ease, and reduce the cost of making payments within the country;

  3. to identify clearly, limit and manage the risks of the payments systems; and

  4. to adopt standards that will facilitate integration of the BiH economy with the world, particularly with Europe.

General features of the future system

Customer giro accounts will be moved from payments bureaus to banks, which will provide payments services in a manner that meets the demands of the market place.

Payments services

  • Payments from a customer of one bank to a customer of another bank will be cleared in a manner determined by the two banks through bilateral clearing accounts, successor regional or national clearing houses, or through the CBBH's Interbank Transfer System.

  • The provision of payments services, including clearing payment orders, will be the responsibility of banks, subject to the relevant legal and regulatory framework.

  • With CBBH leadership, payments services providers and users will cooperate through the BiH Payments Systems Council (BHPSC) to develop common standards and rules for payments.

  • Payments between banks on their own behalf, or on behalf of their customers, will be settled on the books of the CBBH by transferring reserve account balances.

  • Each bank has one reserve account with the CBBH, which is maintained by its head office with the branch of the CBBH that services the area in which its head office is located.

  • When the volume of payments is sufficient, time-critical payments will be made using a Real Time Gross Settlement System (RTGS) meeting European standards.

  • Payments bureaus

    • All payments bureaus (the SPP, ZAP, and ZPP)(1) will cease to exist by December 31, 2000, at the latest.

    • The nonpayment functions of the payments bureaus will be relocated to appropriate organizations, including the Ministries of Finance, by end-1999.

    • Tax and contributions systems will be redesigned to collect relevant information from sources other than the payments bureaus by end-June 1999.

    • Banks will have the opportunity to purchase the payments bureaus clearing functions, as well as other assets. A corporate body or bodies, owned by banks, will be set in place during 1999 to achieve this objective by the end of 2000, under rules and standards to be approved by the CBBH.

    • What remains of the original organizations will be dissolved and any monetary value will be transferred to the Entity budgets by December 31, 2000, at the latest.

    Payments systems

    • Foreign exchange payments services are provided by banks, utilizing the SWIFT system, without involvement of the payments bureaus.

    • The CBBH is providing an alternative interbank transfer system, which does not involve the payments bureaus to settle interbank transactions.

    • Banks will settle customer payments orders between the deposits of their own customers on their own books. Banks and other qualified financial institutions will be free to choose their mechanism of settlement.

    • Inter-clearinghouse customer payments will be carried out in the most efficient manner, which will be determined by the market.

    Payments system policy development

    The CBBH will have direct responsibility for the Interbank Transfer System and for the provision of KM banknotes and coins, as well as establishing standards for domestic payments. The BHPSC will advise and coordinate all relevant bodies for all issues related to payments systems policy. The BHPSC will be supported by a number of working groups dealing with technical and operational issues.

    Work program

    • The Federation internal payments law will be amended to give the ZPP/ZAP a supervisory board with a high level of professional competence, which is separated from the Ministry of Finance, other Federation Ministries, and governmental and public sector structures. The amendments will establish the new mandate and authority of the Board, clarify its accountability, specify the use of financial surpluses, and establish the transparency and accountability of the ZPP/ZAP operations and finances. Deadline: end-June 1999.

    • The ZPP/ZAP will implement a fee structure based on cost recovery per transaction, and provide transparent budget determination, and monitoring. Deadline: end-June 1999.

    • The management of ZPP/ZAP and the SPP will cooperate fully with international experts in preparing a functional analysis of their activities and information flows, with preliminary recommendations for the transfer of functions to other institutions. Deadline: end-June 1999.

    • The Government of the Republika Srpska will complete the full separation of the SPP from the Development Bank. Relevant laws will be amended to give the SPP a supervisory board with a high level of professional competence, which is separated from the Ministry of Finance, other RS Ministries, and governmental and public sector structures. The amendments will establish the new mandate and authority of the Board, clarify its accountability, specify the use of financial surpluses, and establish the transparency of the SPP operations and finances. The SPP will implement a fee structure based on cost recovery per transaction, and provide transparent budget determination and monitoring. Deadline: end-August 1999.

    • The Ministries of Finance of the Federation and the Republika Srpska will authorize immediately financial verification of accounts in ZPP/ZAP and SPP, under terms of reference satisfactory to international donors, to be undertaken by an internationally reputed auditing firm and to be completed by end-June 1999.

    • The Tax Administration Law will be amended, and tax reporting and other relevant instructions will be issued by end-June 1999 to ensure that adequate information is provided in the new payments systems environment. In the interim, the CBBH and banks will make arrangements to provide, as necessary, the giro account information now collected by the payments bureaus. The new tax information processing system will be fully operational by end-December 1999.

    • The State and the Entity Ministries of Finance will develop treasury functions by end-December 1999.

    • A Payments Transaction Law and supporting legislation will be adopted by each Entity to establish the rights and obligations of depositors, banks, and the CBBH by end-June 1999. The CBBH will develop the payments order standards for payments cleared through reserve accounts at the CBBH, bilaterally and through clearinghouses that are compatible with European standards by end-June 1999.

    • The CBBH will develop the payments order standards for payments cleared through reserve accounts at the CBBH, bilaterally and through clearinghouses that are compatible with European standards by end-June 1999.

    • The CBBH, in cooperation with banking agencies, will develop and publish standards regarding bank provision of payments services, including the opening of customer giro accounts by end-June 1999. The banks that satisfy these requirements will be permitted to offer payments services.

    • In the Federation, limits on cash holdings and cash deposit requirements related to enterprise and bank financial operations will be abolished by end-June 1999.

    • Statistical functions performed by the payments bureaus will be transferred to the relevant statistical institutions by end-1999.

    • The ZPP, SPP and ZAP will not undertake any new activities, effective February 10, 1999.

    • Annex II

      Ceilings on the Cumulative Change in Gross Credit
      from the Banking System to the General Government


       Limits

       (In millions of convertible marka)
       General Govt.State Govt.Entity Governments
       FederationRepublika Srpska
      Outstanding as of:
         December 31, 1998 (actual)11304856

      Cumulative change from level on
         December 31, 1998: 1/
      Prior action: repayment of FIB-4 
         June 30, 1999 -40-36-40
         September 30, 1999 -38-34-40
         December 31, 1999 -36-32 -40

      1/ Negative flows indicate deposits to the SDR account or other accounts at IMF. The targeted deposits as of June 30, 1999 include half of the amounts disbursed at the time of Board approval of the first review under the stand-by arrangement. The targeted deposits at September 30, 1999 and December 31, 1999 will be adjusted downward for delays in disbursements under the SBA.

      The general government is defined to include the State, Entity (Federation and the Republika Srpska), cantonal and municipal budgets, together with their respective extrabudgetary funds. Extrabudgetary funds include, but are not limited to, the pension funds, health funds, unemployment funds, and invalids and surviving family insurance funds in the two Entities.

      Banking system claims on the general government for the purposes of program monitoring are defined as the sum of: (i) claims from the monetary authorities (the Central Bank of Bosnia and Herzegovina and the payments bureaus); and (ii) loans, advances, securities or bills issued (or guaranteed) by the general government and held by commercial banks.

      For program purposes, those components of gross claims on the general government that are denominated in foreign currencies will be converted into convertible marka at the agreed accounting exchange rate prevailing on December 31, 1998.

      The limits will be monitored from the accounts of the banking system, supplemented by information provided monthly by the Entity Ministries of Finance.

      Annex III

      Currency Board Cover and Minimum Stock of "Free Reserves"
      of the Central Bank of Bosnia and Herzegovina


      Minimum

      (In millions of convertible marka)
      Stock of minimum "free reserves" 1/25

      Cumulative change from
      the minimum level of "free reserves"

      June 30, 19990
      September 30, 19990
      December 31, 19990

      1/ Corresponds to the minimum capital of CBBH. The free reserves of CBBH stood at KM 29 million at end-December 1998.

      Under the Central Banking Law and the program, the CBBH (acting as a currency board) is required to ensure that its domestic liabilities do not exceed the convertible marka counter-value of its net foreign exchange reserves. Net foreign exchange reserves of CBBH are defined as the difference of the following foreign assets and liabilities, both in convertible currencies and denominated in convertible marka.

      Under the Central Banking Law and for the purposes of the program, foreign assets include: (i) gold and other precious metal and stones; (ii) convertible foreign exchange notes held by the CBBH; (iii) credit balances in convertible foreign exchange--including SDRs--due to the CBBH on the books of foreign central banks or other financial institutions; (iv) liquid debt securities issued by the government and the central bank of the country in whose currency the securities are denominated and held by the CBBH on its own account; and (v) officially guaranteed forward and repurchase contracts of different types providing for future payments in convertible foreign exchange to the CBBH by non-residents.

      Under the Central Banking Law and for the purposes of the program, foreign liabilities include: (i) foreign exchange and convertible marka balances on the books of the CBBH due to non-residents, including foreign central banks and international financial institutions; (ii) credit balances due to foreign central banks, governments, international organizations, and foreign financial institutions; (iii) forward and repurchase contracts of different types providing for future payments in foreign exchange by the CBBH to non-residents; and (iv) any other liabilities due to non-residents.

      "Free reserves" of the CBBH are foreign exchange reserves not utilized as backing for the currency. They therefore consist of the CBBH net foreign exchange reserves in excess of the currency board liabilities. The program calls for quarterly minimum levels of free reserves. Foreign currency holdings will be converted into convertible marka at fixed exchange rates of December 31, 1998 (exchange rates other than that of the deutsche mark will be those published in the IMF International Financial Statistics). Valuation changes will be excluded from cumulative changes in free reserves. The above limits will be cumulative from the actual level as of December 31, 1998 and will be monitored from the accounts of the CBBH, with information on net foreign assets provided monthly by the CBBH. The information will be made available to the Fund within two weeks following the end of each month throughout the program period. As the stock of free reserves as of December 31, 1998 is equivalent to the initial capital of the CBBH, the implication is that the capital cannot be drawn upon to finance operational expenditures or the acquisition of physical assets.

      Annex IV

      Ceilings on Contracting or Guaranteeing of New Non-Concessional External Debt


      Of which:

      One year and under 1/

      Over 1 year 2/

      1-5 years 2/


      (In millions of U.S. dollars) 1/
      Cumulative change from December 31, 1998

         June 30, 1999000
         September 30, 1999000
         December 31, 1999000

      1/ The limit applies to the flow of short-term debt contracted or guaranteed by the general government or the CBBH with an original maturity of up to and including one year. The stocks and limits exclude normal import-related financing. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time the contract or guarantees become effective. Information on the stock of short-term debt limit will be reported monthly to the Fund.

      2/ The limit applies to the contracting or guaranteeing of external debt by the State Government, the Entity Governments, Cantonal or Municipal Governments, or the CBBH. It includes all new nonconcessional foreign loans with a maturity of more than a year, and within this limit with an original maturity of more than one year and up to including five years. The ceiling will be adjusted upward for borrowing from the World Bank, EBRD, EIB, IFC or bilateral co-financing of lending by these institutions. The maximum such adjustment will be limited to US$100 million for 1999. Excluded from the ceilings are concessional loans, defined as those with a grant element of at least 35 percent of the value of the loan, using currency-specific discount rates based on the commercial interest rates reported by the OECD (CIRRS).The average CIRRs over the last ten years--plus a margin reflecting the repayment period (1 percent for repayment period of 15-19 years; 1.15 percent for repayment period of 20-29 years; and 1.25 percent for repayment period of 30 years or more)--will be used as discount rates for assessing the concessionality of loans of a maturity of at least 15 years. For loans with shorter maturities, the average CIRRs of the preceding six-month period (plus a margin of 0.75 percent) will be used. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time of contracting or guaranteeing the debt. Information on the contracting and guaranteeing of new debt falling both inside and outside the limit will be reported monthly to the Fund.

      Annex V

      Minimum Reductions in External Payments Arrears 1/


      Limits

      (In millions of U.S. dollars)

      Outstanding as of:
         December 31, 1998 (estimated) 2/25
      Cumulative reduction from level on
         December 31, 1998:
         June 30, 199925
         September 30, 199925
         December 31, 2000 25

      1/ Excluding transitional increases on amounts subject to rescheduling. Arrears to multilaterals, excluding arrears to the IFC pending a determination as to whether these are government obligations.
      2/ External payments arrears as of end-1998 to the Council of Europe Social Development Fund and the European Investment Bank.

      The limit on the change in external payments arrears applies to the change in the stock of overdue payments on medium- and long-term debt contracted or guaranteed by the State, the Federation, the Republika Srpska, and the CBBH. The limit also applies to the change in the stock of short-term debt in convertible currencies with an original maturity of up to and including one year. The limit excludes reductions in connection with rescheduling of official and commercial debt and debt buy-back.

      Annex VI

      Summary of Key Elements of the Program for 1999

      Monetary Measures

      The Federation Government will comply with the amended payments law to eliminate the DM and kuna for non-cashpayments. Benchmark.

      end-June
      The Federation Government will adopt legislation mandating the use of KM in all government transactions and its adoption as a unit of account for all private and official financial transactions.

      end-June
      The Republika Srpska Banking Agency will introduce a 10 percent liquidity requirement, to be held in KM, on bank deposits denominated in currencies other than KM, to be phased through end-June.

      Completed
      The Republika Srpska Banking Agency will ensure compliance with the 10 percent liquidity requirement on all banks.

      end-June
      The Republika Srpska will develop a modern chart of accounts for commercial banks.

      end-June
      Payments System Reform Measures

      Commercial banks permitted to carry out payments activities on behalf of their customers in all areas of the country. Benchmark.

      end-July
      Set in place a state-wide corporation, owned by banks, to purchase the bureaus clearing functions, as well as other assets.

      end-December
      Complete the liquidation of SPP, ZAP, ZPP.

      end-2000
      Amend the Federation internal law to give the ZPP/ZAP a new supervisory board.

      end-June
      The ZPP/ZAP to implement a fee structure based on cost recovery per transaction.

      end-June
      Prepare a functional analysis of ZPP/ZAP and SPP activities, with preliminary recommendations for the transfer of functions to other institutions.

      end-June
      Government of the Republika Srpska to complete the full separation of the SPP from the Serb Development Bank.

      end-August
      Amend the relevant laws to give the SPP a new supervisory board.

      end-August
      The SPP to implement a fee structure based on cost recovery per transaction.

      end-August
      Complete a financial verification of accounts in the ZPP/ZAP and SPP by an internationally reputed auditing firm.

      end-June
      Amend the Tax Administration Law and issue tax reporting and other relevant instructions to ensure that adequate information is provided in the new system environment.

      end-June
      New tax information processing system fully operational.

      end-December
      Adopt Entity Payment Transaction Laws to establish the rights and obligations of depositors, banks, and the CBBH.

      end-June
      CBBH, in cooperation with banking agencies, to develop and publish standards regarding bank provision of services, including the opening of customer giro accounts. Banks that satisfy these requirements will be permitted to offer services.

      end-June
      In the Federation, abolish limits on cash holdings and cash deposit requirements related to enterprise and bank financial operations.

      end-June
      Transfer statistical functions performed by the bureaus to the relevant statistical institutions.

      end-December
      The bureaus will not undertake any new activities.

      February 10
      Fiscal Measures

      Promulgation of budget execution laws by the Entities, which permit reduction in all categories of expenditures, other than transfers to the State, to bring them in line with available resources.

      Prior Action
      Promulgation of realistic State and Entity budgets for 1999.

      Prior Action
      Repayment of bank borrowing by Federation Government, initially from the Federation Investment Bank, for use by the Civil Aviation Administration.

      Prior Action
      In the Republika Srpska, the Government will reverse existing tax concessions and exemptions.

      end-June
      In the Republika Srpska, the Customs Administration, Tax Administration, and Financial Police to be integrated into the Ministry of Finance under the authority of the Minister of Finance.

      end-June
      The Federation and Cantons to establish jointly a legal framework defining procedures for arbitration regarding any fiscal measures of mutual concern.

      end-July
      The State and the Entity Ministries of Finance to develop treasury functions. Benchmark.

      end-December
      The Republika Srpska to implement a budget classification system consistent with that of the Federation and undertake reforms to bring pensions and other benefit entitlements in line with available resources.

      end-December
      Structural Measures

      The State, Federation, and Republika Srpska Governments to submit to respective Parliaments legislation and implementing regulations that require all public borrowing, lending orguaranteeing of obligations to be recorded in the respective official gazette before the contracts are legally valid and enforceable. Benchmark.

      end-July
      Determine the disposition of State ownership of banks, either through privatization or liquidation.

      end-December
      Adopt a privatization program for the Federation Investment Bank.

      end-December
      For the Republika Srpska, adopt a Law on Commercial Banks.

      end-July
      Amend the Federation Law on Deposit Insurance to ensure the autonomy of the Deposit Insurance Agency.

      end-June
      The Republika Srpska Government to establish an autonomous and self-financing deposit insurance mechanism.

      end-September
      All levels of Government, including Ccantons, will abstain from assuming or guaranteeing any obligations of banks or enterprises that were not specified in the initial contracts as obligations of Government, particularly as regards the privatization process. Benchmark

      Continuous
      External Measures

      The Federation and the Republika Srpska to implement a common list of tariff surcharges.

      Prior Action
      The Federation and the Republika Srpska to harmonize excise rates on imported and domestic goods.

      end-May
      Implementing regulations for the State Customs Tariff Law to be issued by the Council of Ministers to ensure that exemptions from import tariffs will be granted solely for goods imported in connection with bona fide donor-financed projects.

      end-July
      Issue orders to eliminate customs duty and tax exemptions for duty free shops, duty free zones, and consignment sales.

      end-July
      No new exemptions or tax relief, including through differential rates, will be granted on domestic taxes or social contributions, except as provided for by international treaties. Existing exemptions that have a limited validity period will be allowed to expire.

      Continuous
      Elimination of the stock of arrears on external debt.

      end-June
      No accumulation of new external arrears, except transitionally on amounts subject to rescheduling.

      Continuous
      Governments to send to Parliament a law stipulating that all tax or duty exemptions without a specified expiration date, and not provided for under the Customs Tariff Law or other relevant tax laws, will be eliminated by end-September 1999or must be officially gazetted by end-July 1999.

      end-July
      No level of Government will grant exemptions or preferential treatments on import tariffs, domestic taxes, or social contributions, unless provided for under existing law.

      Continuous
      In the Republika Srpska, legislation sent to Parliament to replace the export tax on unprocessed timber by a stumpage tax.

      end-July
      Accept the obligations Article VIII, Sections 2, 3, and 4 of the IMF Articles of Agreement.

      end-December
      The State and the Entities will refrain from external borrowing on nonconcessional terms.

      Continuous

      1. ZAP: Zavod za platni promet, payments bureau in the Croat-majority area of the Federation; ZPP: Zavod za platni promet, payments bureau in the Bosniac-majority area of the Federation; and SPP: Sluzba za platni promet, the payments bureau in the RS.

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