Bosnia and Herzegovina and the IMF
Press Release: IMF Approves US$89 Million Stand-By Arrangement for Bosnia and Herzegovina
Country's Policy Intentions Documents
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Bosnia and Herzegovina—Letter
of Intent, Memorandum of Economic and Financial Policies, and Technical
Memorandum of Understanding
Sarajevo and Banja Luka, Bosnia and Herzegovina
May 31, 2002
Mr. Horst Köhler
The attached Memorandum of Economic and Financial Policies (MEFP) describes the policies that the State, Federation and Republika Srpska governments and the Central Bank of Bosnia and Herzegovina intend to implement during this year and next. These policies are aimed at ensuring continued macroeconomic stability and supporting sustainable economic growth. In this context, we view as central to our economic program the maintenance of a prudent fiscal policy as well as a completion of the structural reform agenda required to create a fully-functioning market economy. In support of these policies, we are requesting a 15-month stand-by arrangement in the amount of SDR 67.6 million (40 percent of quota).
We believe that the policies described in the attached MEFP are appropriate to meet the objectives of our economic program, but we stand ready to take additional measures to meet these goals should the need arise. During the period of the arrangement, we will consult with the Fund on the adoption of any such measures that may be necessary in accordance with the Fund's rules on such consultations and we will provide the Fund with any information it requests for monitoring progress in program implementation.
The program will be evaluated on the basis of quarterly quantitative performance criteria and structural performance criteria and benchmarks (summarized in the attached Tables and Annexes of the MEFP).We will also conduct with the Fund four reviews of economic developments under the program; these reviews will be undertaken by mid-November 2002, mid-February 2003, mid-May 2003, and mid-August 2003 respectively. All of these reviews will assess actions taken to further strengthen the credibility of the Currency Board, notably in regard to fiscal and labor market developments, and adherence to the commitment to avoid incurring new expenditure arrears. The first review will concentrate on the implementation of the 2002 budgets, design of the 2003 budgets as well as the application of structural measures including an evaluation of the new treasury system and actions to strengthen corporate governance. Quantative and structural performance criteria for end-September and end-December have been established in the attached memorandum of Economic and Financial Policies. Quantitative performance criteria for end-March 2003 will be specified at the time of the first review and performance criteria for end-June will be specified during the second review. The second and third reviews will focus on the implementation of the 2003 budget and continued implementation of those structural reforms of critical importance for macroeconomic performance, including public sector reforms.
1. In the six years since peace returned, significant progress has been made. The sense of confidence between the various communities has clearly begun to be restored and this is reflected in the increased momentum of refugee resettlement. And on the economic front, output has risen dramatically since its immediate post-conflict levels and inflation has stabilized at industrial country rates. These successes reflect the efforts of the peoples of Bosnia and Herzegovina, supported by the international community.
2. Significant challenges remain over the medium term. As international assistance declines from its recent extraordinary levels, economic growth will need to become self sustaining and less reliant on external aid. This transition, alongside the continued reintegration of the economy into the region and the ongoing transition to market-oriented economic structures, will provide the basis for increased prosperity and reduced unemployment and poverty. It will also set the stage for eventual EU accession.
B. Macroeconomic Outlook for 2002-2006.
3. In the context of the policies described in section C below, our goals for 2002-2003 are to stem the downward momentum in GDP growth rates, to maintain low inflation, and to secure a modest reduction in the external current account deficit:
4. Looking further ahead, in the next five years reconstruction aid flows will likely halve from their recent extraordinary levels of over 10 percent of GDP annually, requiring a substantial reduction in the external current account deficit relative to GDP. If this is to be realized alongside the high public and private fixed investment rates needed to achieve sustained real GDP growth of 4-6 percent a year, domestic savings will need to rise significantly.
5. In the first instance, this will require a comprehensive rationalization of public spending so as to lower domestic consumption. This will also create room for increased public investment to refurbish public infrastructure over the medium term while maintaining public external indebtedness below 65 percent of GDP. In addition, private savings rates will need to rise, notably through retained earnings in the corporate sector. This will require significant moderation in labor costs and ongoing efforts to improve the efficiency of all aspects of corporate operations. We will look to the International Monetary Fund for guidance on steps to be taken in the area of macroeconomic, fiscal, and tax policies to secure these needed adjustments in domestic savings and investment balances.
6. But the provision of savings for investment in this way will not alone suffice to stimulate fixed investment and activity. Four other areas will be critical:
Reforms in these areas will be pursued with the assistance of the World Bank and other responsible aid agencies.
7. Alongside strengthened domestic savings, these measures will provide the basis for strong export led growth of economic activity over the medium term. On this basis, the external current account deficit could decline by as much as 10 percentage points of GDP over the next five years.
C. Macroeconomic Policy Framework 2002-03
8. To achieve these objectives our policy framework has three central elements:
Monetary and Exchange Rate Arrangements
9. The currency board arrangement has served us well. It has secured low inflation in a difficult environment. And it has done this even in the context of a sizeable correction to relative prices between the two Entities. After initial difficulties, the KM is now accepted throughout the country as the unit of account, a means of settlement, and a store of value. Recently, these achievements have been crowned by large conversions of DM notes held by households and firms to KM in the context of the introduction of euro notes and coins. As a result, international reserves have surged to provide over five months of import cover.
10. As a structural performance criterion, we will continue to maintain
the strict currency board arrangement now in place. Under this arrangement,
the Central Bank of Bosnia and Herzegovina is prohibited from extending
credit to the government, from issuing central bank securities, and to
granting credit to banks and other private agents, including through the
purchase of securities. The currency board had been pegged to the DM.
In light of the withdrawal of the latter, the currency board has de facto
already been reanchored to the euro at the end-2001 DM:euro conversion
rate. This arrangement will be reflected in the Central Bank law once
amendments now in Parliament are passed. We will shortly adopt legislation
to widen the permissible range for the reserve requirement imposed on
commercial banks from the current 10-15 percent to
11. Commencing with this program, we will appoint the CBBH as the fiscal agent for the International Monetary Fund.
12. In 2002, we will implement budgetary policies that we project will secure a decline in the consolidated budget deficit for the whole country, including grants and on a commitment basis, from 6.3 percent of GDP in 2001 to 5.5 percent of GDP and a further decline to some 3 percent of GDP in 2003. We are also committed to securing, once and for all, to terminate the accrual of spending arrears that have so marred fiscal policy in the past. All levels of General Government in Bosnia and Herzegovina will also continue to abjure borrowing from domestic and external commercial sources, except as agreed in advance with the International Monetary Fund. As part of our efforts to minimize the need for such borrowing, we will transfer KM 110 million of the succession funds now held at State level to the Entities by end-May 2002. Its use at Entity level is described below. Both revenues and expenditures are projected to rise only modestly, with both declining relative to GDP.
13. This overall adjustment is reflected in the fiscal policies for the RS, the Federation, and at the State Level:
14. For 2003, we envisage further progress in fiscal consolidation. We expect to lower the overall deficit from 5.5 percent of BiH GDP in 2002 to some 3 percent in 2003, though a further adjustment will be made if reconstitution of succession monies used during 2002 is incomplete. With declines in grant aid, albeit partly offset by our continued efforts to strengthen tax administration, this will require expenditure containment. This will include the savings yielded by the military demobilization effected in 2002 of over 1¼ percent of GDP, a decline in spending directly funded by grants of some 2 percent of GDP, and further spending efficiencies of some ¼ of a percentage point of GDP. In addition, in case succession monies used for demobilization in the Federation are not reimbursed in 2002, we will further tighten our deficit in 2003. At end-2003, public external debt is projected at 61.4 percent of GDP, compared with 57.7 percent of GDP at end-2001. The increase reflects activities funded by donors and a sizeable assumption of debt of state owned enterprises in 2002, and this ratio is projected to decline in the medium term. We will continue our attempts to reach agreement on the final outstanding issue from the 1998 Paris Club Agreement which concerns the penalty interest rate, the moratorium period, and coverage of the agreement on our obligations to the Government of Japan. During 2002, we will also assume the debts of certain state-owned enterprises to Russia for gas imports and will continue our efforts to identify and restructure our remaining former Comecon-related debts.
15. These fiscal policies in 2002-03 will be accompanied by continued initiatives to strengthen the harmonization of our fiscal systems with each other. Any changes to be made to the indirect tax system will retain or strengthen the principle of harmonization. In particular, both Entities and the Brcko District will implement the excise attribution mechanism and stop double taxation on excises. The Brcko District will revise its legislation to include excise taxes in the base for calculating the sales tax, align the base and tax rates for sales tax with those in the two entities, and bring retail units in the "Arizona" market into the tax net. On the spending side, we will complete during 2002 a comprehensive review of public expenditures with the assistance of the World Bank which is already underway. This review will assess the need for adjustments to current expenditures to make room for additional public investment, and will prioritize new public investments focusing on refurbishment of our infrastructure. We will act decisively and quickly to implement the key findings of the review. We will abjure "across the board" tax amnesties and restructure overdue obligations through normal bankruptcy procedures.
16. These steps will be buttressed by strengthened fiscal operations:
17. Structural policies need to be considerably strengthened if Bosnia and Herzegovina is to realize its growth potential and reduce unemployment and poverty.
18. Prime among these steps will be an improvement in the business environment. Under the aegis of a prospective credit from the World Bank and according to timetables to be agreed with the Bank in the context of that credit, we will:
19. These steps will be accompanied by strengthened privatization programs with the support of international donors grouped under the International Advisory Group on Privatization.
20. In support of private sector development, we will continue to negotiate with our trading partners to increase our market access, notably in the region and in the EU. While we enjoy unrestricted access to EU markets, some of our agricultural exports have been impeded by insufficient proof that they meet health and safety standards. To address this problem, the State will seek authority from the EU for BiH veterinary and agricultural control offices to provide a certification of inspection based on EU standards. Additionally, by mid-2002, free trade agreements will be in effect with all of the former Yugoslav republics. We intend to negotiate bilateral agreements with Turkey and Bulgaria during 2002. These policies will dramatically reduce the maximum and average tariffs of 15 and 6.8 percent, respectively. Finally, we will act to complete preparations for WTO accession as soon as the new law on Customs has been adopted by the State parliament with a view to entering WTO in early 2003.
21. Increased availability of disciplined credit for business for current operations and investment will form a critical element of our growth strategy. The financial system is currently small relative to GDP and depositor confidence in it, though much strengthened recently, needs to be deepened further. We will strengthen our financial system by completing banking sector privatization, strictly enforcing prudential banking regulations, and creating the infrastructure for a capital and securities market. All remaining state-owned banks will be privatized according to the timetable prescribed by law. Those state-owned banks that have not been privatized by the final deadline will undergo the bank resolution procedures prescribed by law. By 31 December 2002, all commercial banks will have a minimum capital of KM 15 million. Banks that fail to meet this minimum capital requirement will be placed under the bank resolution procedures prescribed by law. We intend to create a country-wide Deposit Insurance Agency to supercede the current Entity based arrangements. In the Federation, we intend to create a financial agency to channel certain credit lines from international donors to end users. However, this agency will not require any resources from the government, it will not engage in any commercial bank operations, and it will not extend any credits except those directly related to financial resources extended by international donors. Once the agency's work is complete, it will be abolished.
22. The poor quality of our statistical data base bedevils our efforts to formulate policies. With the support of the European Union, the IMF, the World Bank and bilateral donors, we will take the necessary steps to improve the quality and coverage of economic data. We will improve the coordination between the three statistical institutes and the Central Bank with a view to creating countrywide statistical data, including consolidated government finance statistics. In 2002, we will initiate the first comprehensive household budgetary survey, update the registry of enterprises and, with the support of CAFAO, finalize the preparation of comprehensive exports and import database broken down on a commodity basis. The Central Bank will compile and publish comprehensive quarterly balance of payments data by end 2002. During the following two years, we will produce our first set of national accounts on an expenditure basis, will produce real GDP estimates for 1998-2002, will continue our efforts to estimate the size of the parallel economy, will produce a revised CPI and a revised industrial production index based on updated weights, and improve the quality of data on foreign direct investment. We will also initiate the first population census since the end of the war and launch regular consumer and business surveys.
This memorandum sets out the understanding between the government of Bosnia and Herzegovina and the IMF mission regarding the definitions of quantitative and structural performance criteria and targets for the stand-by arrangement (Tables 1 and 2) as well as data reporting required for monitoring the implementation of the program.
The following definitions are to be used in monitoring the program. In the following definitions, the end-quarter test dates apply to the last working day of each quarter for both banking and budgetary statistics.
A. Ceiling on the Stock of Gross Credit from the Banking System to the General Government
Application of performance criteria:
B. Operation of the Central Bank of Bosnia and Herzegovina
Under the Central Banking Law and the program, the CBBH is required to ensure that the value of its domestic liabilities does not exceed the convertible marka counter-value of its net foreign exchange reserves. Furthermore, the CBBH will not pay a dividend until its capital and reserves exceeds 10 percent of its monetary liabilities.
Application of performance criteria:
C. Ceiling on External Payments Arrears
Application of performance criteria:
D. Ceiling on Contracting or Guaranteeing of New Non-Concessional External Debt
Application of performance criteria:
E. Ceiling on Contracting New Concessional Debt
Application of performance criteria:
II. Data Reporting
The Bosnia and Herzegovina authorities will report the following data to the Fund within the time limits listed below. The authorities will also provide, no later that the first week of each month, a summary of key macroeconomic policy decisions taken during the previous month. Any revisions to past data previously reported to the Fund will be reported to the Fund promptly, together with a detailed explanation. The Bosnia and Herzegovina authorities will make every effort to move speedily towards sending the required data by electronic mail.
All magnitudes subject to performance criteria or indicative targets will be reported in millions of convertible marka where the corresponding target is in convertible marka, or in millions of U.S. dollars where the target is in U.S. dollars.
The Bosnia and Herzegovina authorities will supply the Fund with any additional information that the Fund requests in connection with monitoring performance under the program on a timely basis.
Monthly data reporting
The Bosnia and Herzegovina authorities will send to the Fund the following data no later than 3 weeks after the end of each month:
(i) Stock of free reserves of the CBBH; the balance sheet of the CBBH.
(ii) The commercial bank survey and monetary survey;
(iii) Banking supervision indicators including capital adequacy ratio, loan-loss provisioning data, bad loan information (classification);
(iv) Revenues, expenditures and financing data for all levels of government (including the State, Entities, and Cantonal (for FBiH));
(v) Pension funds payment data and cut-off dates for contributions collection;
(vi) Revenues, expenditures and financing data for the Brcko District;
(vii) Revenues, expenditures and financing data for the extrabudgetary funds (including health funds, unemployment funds and (in the RS) the children's fund).
(viii) Debt service payments by the State to creditors.
(ix) Report on privatization revenues, including revenues received and the balances held in escrow accounts.
(x) Monthly Statistical Data on Economic and Other Trends review published by the Federation `s Office of Statistics and Monthly Statistical Review published by the Republika Srpska Institute of Statistics.
(xi) Data sheets issued by the Republika Srpska Institute of Statistics.
Quarterly data reporting
The Bosnia and Herzegovina authorities will send to the Fund the following quarterly data within the timeframes indicated:
(i) State debt service projections for current year;
(ii) Summary of government guarantees on quarterly basis;
(iii) Summary of government loans and degree of concessionality (grant element);
(iv) Summary of short-term loans by government on quarterly basis;
(v) Budget execution data by individual canton;
(vi) Report on privatization revenues, including revenues received and use of funds.
(vii) Summary of the financial activities of the RS Goods Reserve;
(viii) Execution of foreign-financed investment projects.
1 For the Federation central government, its share of the succession monies will be used to finance the military demobilization scheme, and during 2002, those monies will be reconstituted prior to release of any "delayed spending commitment" items.