IMF Executive Board Concludes 2008 Article IV Consultation with Bosnia and Herzegovina

Public Information Notice (PIN) No. 08/122
September 22, 2008

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 September 17, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bosnia and Herzegovina.1


Bosnia and Herzegovina's economy has been exhibiting robust growth, but macroeconomic imbalances have emerged. In 2007, the economy grew by 5.8 percent, with domestic demand becoming an engine of growth, supported by robust credit growth, healthy wage increases, and a sizeable fiscal impulse. The domestic demand boom was mirrored by a widening external current account deficit, which reached 13 percent of GDP. Export growth moderated to 15 percent, and imports resumed their faster growth following a temporary, VAT-related slowdown in 2006. Data for early-2008 point to a further widening of the current account deficit, mainly driven by higher food and energy prices. Headline inflation increased to 8.2 percent in May 2008, reflecting largely food and energy price shocks although underlying inflation has also picked up.

Fiscal policy has become procyclical and added further stimulus to domestic demand. The general government registered a deficit of 0.1 percent of GDP in 2007, compared with a 2.2 percent surplus in 2006. Driven mainly by sharp increases in transfers to households, capital spending, and wages, total government expenditure approached 50 percent of GDP in 2007. Strong revenue performance has continued in 2008, but mounting spending pressures in the Federation of Bosnia and Herzegovina (Federation) have led to liquidity problems and threaten its fiscal position.

Financial deepening accelerated in 2007, but remains in line with regional trends. Benefiting from a low interest rate environment, private sector credit growth in 2007 contributed 7.7 percentage points to the credit-to-GDP ratio, bringing it to 56 percent. Concerns about the speed of credit expansion prompted the Central Bank of Bosnia and Herzegovina (CBBH) to increase reserve requirements at end-2007—from 15 to 18 percent. There are early indications that global financial tensions have started to affect foreign funding. While bank soundness indicators remain favorable, bank profitability declined in the first quarter of 2008.

A breakthrough has recently been made on fiscal structural reforms with the approval of the Fiscal Council law and an agreement on a permanent indirect tax revenue allocation formula. However, progress on other structural reforms has been uneven and Bosnia and Herzegovina trails its best-performing peers on most structural indicators. Moreover, policies are diverging between the two Entities, with the Republika Srpska (RS) making steady progress on reforms and the Federation finding it difficult to mobilize action on needed reforms. The signing of the Stabilization and Association Agreement with the European Union (EU) on June 16, 2008, opens Bosnia and Herzegovina's road to EU accession and could help accelerate reforms.

Executive Board Assessment

Executive Directors welcomed Bosnia and Herzegovina's solid growth performance, which largely reflects the effects of reforms in key sectors, the benefits of the currency board, and a favorable external environment. Directors congratulated the authorities on the recent signing of the Stabilization and Association Agreement with the EU, and hoped that it would become a catalyst for accelerated progress in structural reforms.

At the same time, Directors expressed concern about the emerging macroeconomic imbalances and the unfinished structural reform agenda. They noted that the current account deficit has been moving toward unsustainable levels, underlying inflationary pressures have intensified, and the recent fiscal policy loosening is exacerbating demand pressures. While noting the staff's assessment that the level of the real effective exchange rate does not raise significant external stability concerns at this stage, Directors emphasized that the key challenge for the authorities will be to strengthen policies and enhance structural reforms to reduce vulnerabilities, promote sustainable strong growth, and reduce unemployment. This will require improved policy coordination, and a tighter fiscal and incomes policy stance to counteract private sector-driven macroeconomic imbalances and support the currency board, which has served the economy well.

Directors welcomed the authorities' intention to tighten the fiscal stance in 2008, and encouraged the authorities to aim for a balanced budget target in 2009. They underscored the importance of maintaining wage discipline in the public sector, reducing large, untargeted social spending, and improving the efficiency of the public sector. Containing unfunded social transfers in the Federation will require their fundamental overhaul. Directors also encouraged the authorities to use privatization proceeds to support the country's growth objectives without compromising macroeconomic stability.

Directors emphasized the need for improved fiscal policy coordination. They welcomed the recent establishment of the Fiscal Council and agreement on a permanent indirect tax revenue-allocation formula. The Fiscal Council should be made operational as soon as possible and should be assigned a coordinating role in the design of the 2009 general government budget and in the setting of medium-term fiscal targets. A more medium-term-oriented fiscal policy would not only help maintain sound public finances but would also increase the efficiency of public spending. Moreover, budgetary procedures in the Federation need to be overhauled to ensure that new legislation is funded.

Directors welcomed the authorities' efforts to contain risks to financial stability, and encouraged the authorities to further improve the oversight of risk management, closely monitor credit risk, and urge banks to increase capital buffers, if necessary. Directors welcomed the signing of the memorandum of understanding on cooperation among the central bank and the two banking supervisors, and encouraged the authorities to intensify the policy coordination between these institutions and to continue to work toward unifying bank supervision.

Directors welcomed recent progress in improving statistics, and encouraged the authorities to persevere with their efforts to improve data quality, including by following up on the recommendations of the recently-completed Data Report on the Observance of Standards and Codes (ROSC).

Bosnia and Herzegovina: Selected Economic Indicators, 2004-08

   2004 2005 2006 2007 2008





Est. Proj.
  (Percent change)

Real GDP

6.3 4.3 6.2 5.8 5.5

CPI (period average) 1/

0.3 3.6 6.1 1.5 7.4

Money and credit (end of period)


Broad money

24.3 18.2 24.7 21.6 15.2

Credit to economy

27.5 27.5 23.3 28.1 25.1
  (In percent of GDP)

General government budget



44.2 45.5 47.5 48.7 47.9

Expenditure (on a commitment basis)

44.7 44.7 45.3 48.7 49.7

Overall balance

-0.5 0.8 2.2 -0.1 -1.9

External public debt

25.5 25.6 21.2 18.1 14.6

NPV of external public debt

19.5 19.6 16.2 13.8 11.2

Total public debt

25.5 25.6 22.0 30.5 34.3
  (In millions of euros)

Balance of payments


Exports of goods and services

2,373 2,832 3,589 4,062 4,934

Imports of goods and services

5,704 6,393 6,493 7,656 9,273

Current account balance

-1,318 -1,555 -816 -1,401 -2,007

(In percent of GDP)

-16.3 -18.0 -8.4 -13.0 -16.0

Gross official reserves

1,768 2,145 2,761 3,425 3,325

(In months of imports)

3.7 4.0 5.1 5.4 4.3

External debt service

419 267 412 321 450

(In percent of exports of goods and services)

17.6 9.4 11.5 7.9 9.1

Exchange rate regime

Currency board since August 1997

Exchange rate, July 16, 2007

1KM = Euro 0.5113

Real effective exchange rate (2000=100, increase=appreciation)

91.6 92.3 90.8 89.1 ... 2/

Sources: Bosnian authorities; and IMF staff estimates and projections.

1/Based on weighted averages for the Federation and Republika Srpska. In 2006, affected by the VAT introduction.
2/Adjusted for VAT effects.

1 Under 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.


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