Public Information Notices

Bosnia and Herzegovina and the IMF





Public Information Notice (PIN) No. 00/22
March 16, 2000
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes Article IV Consultation with Bosnia and Herzegovina

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On March 8, 2000, the IMF Executive Board concluded the 1999 Article IV consultation with Bosnia and Herzegovina.1

Background

Following progress in the immediate post-war period (1996-97) in establishing the essential institutions of the country and in rebuilding the basic infrastructure of the economy, the authorities embarked in May 1998 on an ambitious economic reform program, supported under the stand-by arrangement. Under this program, the authorities have managed to reduce macroeconomic imbalances, and the credibility of the currency board arrangement and acceptance of the Convertible Marka (KM) have increased considerably. The program has succeeded in bringing country-wide inflation to single digits and economic reform has progressed.

However, a difficult political environment, governance problems, and the fallout from the recent conflict in Kosovo have undermined performance. Real GDP growth in 1998-99 has fallen short of expectations under the standby arrangement and the pace of structural reform has been disappointing in many respects. After a promising start, progress in developing Bosnia's basic economic institutions has been slow, and, despite the substantial contribution of the international community to the reconstruction effort, the country's infrastructure remains weak. Territorial divisions along ethnic lines continue to hamper integrated policy implementation, particularly economic reforms. Fundamental reforms that were delayed include the privatization of banks and enterprises and the harmonization of excise taxes across Entities. The Entities agreed on a list of harmonized excise taxes on June 8, 1999, but it took more than 9 months to fully implement the agreement.

Progress in some other structural reforms has been better, with the most impressive strides made in the operationalization of State institutions; and the pace of structural reform has increased in 1999 with the implementation of several key measures. By far the most successful achievements have been the consolidation of the Central Bank and the introduction of the new currency. In this regard, the rapid acceptance of the KM throughout the country is a testament to the sound implementation of the currency board. Important progress in inter-Entity cooperation was also made with an agreement on a common, country-wide customs tariff regime in mid-1998. In parallel, barriers to the internal movement of goods and people have also been eliminated. An automatic transfer mechanism to cover the country's debt service and the State's administrative costs replaced the previous system of ad hoc transfers from Entities to the State. In 1999, the authorities have also taken steps to eliminate most sales tax and customs exemptions and reform the payments system, and initiated the process of Bosnia's accession to the World Trade Organization.

Although macroeconomic policy implementation in 1998-99 suffered some setbacks, and macroeconomic developments in 1999 were affected by Kosovo, progress in this area has been on the whole positive. The maintenance of fiscal discipline has been key in this regard, and, in retrospect, Bosnia appears to have weathered the Kosovo conflict quite well. Since mid-1999 there have been promising signs of recovery of production and trade—especially in the Federation—and real GDP growth is estimated at 10 percent in 1999, following growth of 15 percent in 1998. Inflation, meanwhile, has continued to decline.

After four years of intensive reconstruction supported by unprecedented external aid, Bosnia still faces immense challenges to achieve sustainable development. Unemployment remains at about 40 percent of the labor force. Structural deficiencies affect most areas of the economy, and discretionary administrative intervention in the economy encourages corrupt practices, limits the development of the private sector, and inhibits foreign direct investment.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They praised the authorities for the positive macroeconomic performance in 1999, particularly in light of the challenges posed by the Kosovo conflict. Directors noted that the continued decline in inflation was due both to strict adherence to currency board rules and to the implementation of prudent fiscal policies. The credibility of the currency board arrangement had also contributed to a notable increase in the acceptance of the Convertible Marka in all areas of the country.

Looking ahead, Directors underscored that the main challenge facing the authorities is to press ahead with structural reforms in order to establish conditions conducive to the development of the private sector and to lay the basis for fiscal sustainability. In this connection, Directors expressed disappointment that structural policy implementation had been slow, and urged the authorities to show more commitment to the implementation of their economic program. While recognizing the difficult political circumstances, Directors underscored the need for the authorities to reach consensus on a consistent basis to ensure the timely implementation of policies. Directors stressed that it would be critical, in the period ahead, for the authorities to reach agreements to achieve the comprehensive economic reforms that could be supported by the Fund and the international community. They noted that continued donor technical assistance will be needed to help develop the country's implementation capacity.

While welcoming the reduction in the fiscal deficit in 1999, Directors underscored the need for strengthened fiscal discipline and improved transparency. With respect to the 2000 State and Entity budgets, Directors stressed that the authorities should be prepared to reduce expenditure commitments—other than transfers to the state—to bring them into line with available resources. They also regarded strict control of the finances of local governments and extrabudgetary funds as essential. Directors urged the authorities to enhance inter-Entity cooperation on fiscal matters, particularly with regard to the harmonization of tax policies. More generally, they stressed that the implementation of sustainable fiscal policies at all levels of government would require the development of treasury systems to ensure appropriate control of budget execution.

Looking beyond 2000, Directors considered that a further strengthening of government finances would be essential to raise domestic saving and to generate the resources needed to increase social spending. Several speakers particularly emphasized that sustainable fiscal reform would require a substantial reduction in the burden of military expenditure on the budgets and a further reform of the tax system, including the elimination of tax exemptions. Other speakers emphasized that the tax system should be simplified and made more transparent, and tax administration should be strengthened.

Directors underscored the need to accelerate markedly the pace of structural reform. They regretted that delays in implementing structural reforms were holding back the development of the economy. More vigorous pursuit of those reforms would help accelerate growth and generate much-needed employment. Directors emphasized that a key means of encouraging private investment was to accelerate the privatization of the public sector enterprises that still dominate the economy. They encouraged the authorities to complete the privatization of small enterprises, and to start with the privatization of the larger enterprises. In this connection, several Directors considered that privatization of the main utilities, which remain in the state sector, was a critical step to modernize the economic infrastructure.

Directors also noted that the establishment of a sound and modern financial sector should be a priority. They urged the authorities to close insolvent banks and place sound private banks at the core of the financial system. Directors welcomed the recent elimination of the monopoly held by payments bureaus, and urged the authorities to phase out these bureaus entirely by the end of 2000.

With regard to labor market reform, Directors emphasized the need to set in place an appropriate legal framework. They urged the authorities in the Federation to amend the present labor law, to avoid legalizing overly generous benefits, and to promote labor market flexibility.

Directors welcomed the actions that had been taken to address problems of governance, such as tax and customs fraud. Nonetheless, they expressed concern at the governance problems in Bosnia and Herzegovina, which are related in part to a lack of transparency in the institutional setup. A number of Directors called upon the authorities to intensify their efforts to establish an adequate legal framework, to detect and prosecute official corruption, and to promote transparency. Directors stressed that establishing a fully transparent economic system would be important to enhance the climate for foreign direct investment in Bosnia and Herzegovina.

Directors took note of the extensive technical assistance provided by the Fund to Bosnia and Herzegovina in support of its economic reconstruction and transition efforts. They pointed out that future priorities for technical assistance should be to develop treasury systems, to improve tax policy and administration, and, especially, to enhance the transparency of government operations. Technical assistance in payments system reform and statistics should also continue. Improving the quality and availability of statistical information, in particular, is essential to the effectiveness of the intensive monitoring effort by the Fund that is necessary.

It is expected that the next Article IV consultation with Bosnia and Herzegovina will be held on the standard 12-month cycle.


Bosnia and Herzegovina: Selected Economic Indicators

  1996 1997 1998 1999 2000 1/

Real Economy          
GDP (in millions of U.S. dollars) 2,741 3,423 3,899 4,418 5,233
Real GDP (percentage change) 69 30 12.4 10 15
Industrial Production (percentage change)          
Federation 88 36 24 11 ...
Republika Srpska 39 27 23 2 ...
Consumer Price Index (twelve-month average)          
Federation (in KM terms) -25 14 5 0 3
Republika Srpska (in KM terms) 2/ 17 -7 2 14 3
           
Public Finance (in percent of Entity GDP)
Federation Budget          
Revenue 10 13 13 12 12
Expenditure 13 14 15 14 14
Balance -3 -1 -2 -2 -2
Republika Srpska          
Revenue 24 15 19 29 28
Expenditure 24 15 24 33 31
Balance 0 0 -5 -4 -3
           
Money and Credit (end-of-period, percentage change)
Broad Money 96 52 31 32 10
Foreign Assets (net) 60 -11 1 25 3
Domestic Assets (net) 36 63 30 7 7
           
Balance of Payments (in millions of U.S. dollars; unless otherwise indicated)
Trade Balance -1,546 -1,758 -1,709 -1,415 -1,459
Current Account Balance -1,306 -1,482 -1,234 -947 -946
Total External Debt 3,620 4,076 2,981 3,226 3,603
Gross Official Reserves 235 80 175 475 515
Reserve Cover (months of imports) 1.5 0.4 0.7 2.2 2.1
           
Exchange Rates          
Exchange Rate Regime Fixed rate
Present Rate (March 13, 2000) KM 1 per DM 1

Sources: Bosnia and Herzegovina authorities; and IMF staff estimates.

1/ Staff projections.
2/ Using Yugoslav dinar/DM parallel exchange rate for prices denominated in Yugoslav dinars.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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