## _cr10347 ## Source details **Canonical URL:** [_cr10347](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10347.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10347.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10347.pdf.json) --- ### I. Introduction - Study objective: examine sources of post-crisis economic growth, identify main impediments to domestic supply expansion, and highlight the need for growth-promoting government policies. - Approach: evaluate BiH’s growth performance relative to potential; analyze the production process to quantify contributions of physical and human capital and technological change to real GDP growth; use growth accounting framework to structure discussion of drivers, impediments, and growth-promoting policies. ### II. Growth performance and medium-term prospects - Pre-crisis growth model: - Relied on booming domestic demand financed from abroad. - Key financing sources (2000–2008): remittances: 15–18 percent of GDP each year; foreign direct investment; unrequited transfers to government; a credit boom funded by foreign banks. - 2009 recession dynamics: - Collapse in demand for Bosnian exports and severe curtailment of cross-border financial inflows. - Private investment and spending on consumer durables collapsed; private current consumption softened to a lesser extent due to moderate wage and social benefit growth. - Resulted in a large improvement in external trade balance. - 2010 and medium term: - Stagnation in 2010; growth expected to rebound but external demand tempered since main trading partners (EU and Western Balkan countries) lag emerging Asian economies. - Domestic demand in 2010 expected to remain soft as banks hoard capital and keep interest rates high while working through loan losses. - Over the medium term, domestic demand expected to remain below pre-crisis levels relative to domestic income, reflecting fiscal consolidation and the end of the credit boom funded from abroad. - Conclusion: real GDP expected to remain permanently below the prevailing pre-crisis trend despite a rebound in real GDP growth. ### III. Potential output and output gap - Methodology: - Hodrick-Prescott (H-P) filter on natural log of real GDP with smoothing parameter of 100. - Because of a structural break in 2009–10, H-P filter run separately for 1999–2008 and 2011–2015; growth rate during and in immediate aftermath of global crisis assumed zero. - Key quantitative results: - Post-crisis potential growth rate (average): 4.7 percent. - Pre-crisis potential growth rate (average): 4.9 percent. - Result: post-crisis potential growth slightly below pre-crisis, leaving real GDP permanently below prevailing pre-crisis trend. - Note: short 2011–2015 span makes derived long-run trend from H-P filter indistinguishable from a simple fitted time trend. ### IV. Growth accounting — setup, calibration, and data - Production function and calibration: - Cobb-Douglas aggregate production function with constant returns to scale; Solow residual = total factor productivity (TFP). - Real GDP: production-approach real GDP from ASBiH. - Investment flows: real gross fixed capital formation (GFCF) from national accounts. - Depreciation rate (δ): constant annual 4 percent. - Physical capital stock: perpetual inventory method Kt = (1 − δ)Kt−1 + It. - Base-year capital stock: estimate for 2003 using Harberger (1978) approach; potential growth rate of capital stock circa 2003: 6.8 percent. - Resulting real capital stock to real GDP ratio in 1999: 2.15. - Human capital stock proxy: number of employees (no quality augmentation). - Share of labor in real income ((α−1)): set to 0.468 (average share of compensation of employees in income-approach estimates of real GDP in 2007–2008); implied α = 0.532. - Analytical caveat: - Overestimation of base-year capital stock would underestimate capital’s contribution to growth and overstate TFP gains. - Appendix Table data excerpts (selected rows preserved exactly): - 1999 12,246 25,813 2,886 0.87 3.60 81.04 3.13 1.1 - 2000 12,884 27,764 2,984 0.89 3.69 81.04 3.13 1.1 - 2001 13,352 29,617 2,964 0.90 3.75 81.04 3.13 1.1 - 2002 14,014 31,953 3,521 0.91 3.78 81.04 3.13 1.1 - 2003 14,505 34,415 3,740 0.91 3.78 81.04 3.13 1.1 - 2004 15,421 36,831 3,793 0.91 3.78 81.04 3.13 1.1 - 2005 16,030 39,320 3,961 0.91 3.78 81.04 3.13 1.1 - 2006 17,015 41,028 3,281 0.91 3.78 81.04 3.13 1.1 - 2007 18,060 43,906 4,519 0.97 3.78 82.24 3.92 9.0 - 2008 19,083 47,131 4,981 1.05 3.77 82.54 3.92 3.4 - 2009 18,496 49,103 3,858 1.03 3.77 82.94 3.62 4.1 ### V. Supply-side drivers, structural change, and implications - Pre-crisis supply-side drivers: - Massive build-up of productive capacity—financed by FDI and a credit boom funded by foreign savings—on average accounted for three-forth of observed output growth in 1999–2008. - Decline in unemployment rate in 2007–08 boosted labor force contribution to output growth. - 2009 output loss accompanied by decline in capital utilization effectiveness and employment losses. - Implications for future growth: - Post-crisis growth likely more dependent on gains in human capital and TFP. - Return to normal credit growth (switch from foreign borrowing to domestic deposits) implies lower pace of capital accumulation unless private/public savings increase or structural reforms create fiscal space for stepped up public infrastructure investment. - Consistent with cross-country finding of permanently lower post-crisis growth of capital (IMF, 2009). ### VI. Labor market — characteristics, constraints, and reform priorities - Labor market statistics and issues: - Unemployment rate: 24–25 percent (recent years); young people below age 25: close to 50 percent out of work. - Long-term unemployment: 75 percent of unemployed > two years; 50 percent > five years (BHAS, 2008). - Labor force participation: economically active men (15–64) ~67 percent (≈10 percentage points below EU average); working-age women ~40 percent (trails Balkan peers by 15 percentage points and EU by 22 percentage points). - Contributors coverage: only 41 percent of population 15–64 pay contributions in RS and 32 percent in the Federation. - Informal economy size: ~37 percent of GDP in the Federation and 21 percent in Republika Srpska (ETF, 2007). - Private remittances: between 15 and 18 percent of GDP each year. - Noninsurance cash benefits programs collectively amount to 4.5 percent of GDP and cover 183,500 individuals. - Minimum net wages: KM 308 in Federation, KM 370 in RS (since July 1, 2010). - Overall social security contribution rates in RS and Federation: 34 percent (calculated at average wage including allowances); OECD average cited as 29.5 percent. - Education and skills: - Near universal primary education; shares with completed secondary and higher education fall short of old and new EU members’ averages. - Approximately two-thirds of secondary students enrolled in four year technical or three year vocational schools. - One third of managers of exporting firms cited inadequate skill pool as an obstacle (2009 Enterprise Survey, WB). - Labor regulation and institutional issues: - Labor Laws fairly flexible but extensive and rigid collective bargaining rules; non-enforcement leads to informality. - Employment Funds: registration incentives for benefits inflate registered unemployment; ratio of unemployed to staff in Employment Funds: 1,100 to 1. - Growth-promoting labor market policy priorities and measures: - Align collective bargaining and wage determination with market principles; separate public sector wage determination. - Rationalize and simplify coefficient and tenure premium systems. - Comprehensive education reform: legislative overhaul of pre-school, vocational, and higher education; framework for continued education and life-long learning. - Public sector hiring and benefits restraint. - Refocus Employment Funds on active job placement; eliminate incentives to register as unemployed solely to access benefits; develop job activation programs. - Condition non-insurance cash benefits on recipients’ income and ability to work and carry out rigorous eligibility audits. - Revise unemployment benefits in the Federation: decrease maximum payout length, set minimum benefit below minimum net wage, and condition entitlement on minimum prior contributions. - Support from World Bank (“Social Safety Nets and Employment Support Project” (WB, 2010a)) and EU “Improving Active Labour Markets.” ### VII. Business environment, private-sector competitiveness, and policy recommendations - Business environment indicators: - World Bank Doing Business Report 2010: BiH ranks 116 out of 183 countries. - Global Competitiveness Report (GCR) 2010/2011 rank: 102nd out of 139 countries. - GCR information and technology special publication rank: BiH 110th; Croatia 51st; FYR Macedonia 73rd; Serbia 84th. - World Bank governance indicators: rule of law 44th percentile; control of corruption 46th percentile; government effectiveness 35th percentile. - Recent reforms and measurable progress: - Adoption of VAT in January 2006; procedures cut by 7 percent, time by 15 percent, and cost by 26.5 percent on average (WB, 2010c). - Computerization of municipal cadastres: 33 percent growth in transferred titles (WB, 2010c). - Republika Srpska removed 58 percent of unnecessary regulations under the “regulatory guillotine”; estimated KM 23 million annual savings for businesses. - New Companies Law in RS effective July 2009 to simplify registration. - Persistent constraints: - Limited progress toward single economic space; slow decision making, duplication of policies, unclear division of powers (OECD 2010). - Complicated/expensive bureaucracy, corruption, weak legislative framework (WEF Competitiveness Report 2009). - Electricity connection: ten procedures and 127 days vs SEE average 5.7 procedures and 109.2 days (OECD, 2010). - More than one-quarter of enterprises cited political instability as main operational problem (BEEPS IV). - Access to finance: more than half of enterprises report financing as an obstacle (OECD, 2010). - Financial sector and alternatives: - Banking sector dominated by foreign-owned banks; credit growth curtailed by global crisis; banks cut loan portfolios and raised interest rates (World Bank, 2010a). - Nonbank sector: dormant stock exchanges; leasing market expanding; factoring underdeveloped; no specific factoring regulation. - Credit guarantee schemes at entity level in infancy; Export Credit Agency inadequately funded. - Privatization and SOE restructuring: - Voucher privatization in 2000–2001 privatized ~1000 enterprises in Federation and 600 in RS; follow-up privatization of strategic enterprises slow. - VPEs/SOEs suffer from poor corporate governance, heavy indebtedness; estimated gap equivalent to 15 percent of GDP to clear pension and tax arrears and recapitalize VPEs (World Bank, 2008). - Labor-related impediments to restructuring: fictitious workers, legal requirements to clear unpaid wage and social security arrears prior to dismissal. - Infrastructure: - Telephony services: high quality and lower cost vs region. - Roads: 96 percent paved; total road density and air traffic below SEE average. - Ongoing Corridor 5c projects and motorway institutional strengthening; railway upgrades with donor support. - Growth-promoting policy recommendations: - Increase regulatory efficiency: streamline regulations, quicker startups, fewer authorizations, simplify licenses/permits, reduce number of different tax payments, improve business closure mechanisms. - Speed up regulatory guillotine and IFC Subnational Competitiveness Programs. - Improve access to finance: expand credit and export guarantees; develop leasing and factoring. - Accelerate privatization of large strategic enterprises and medium-size public companies; restructure underperforming VPEs using government creditor position when needed; convert debt to equity only when accompanied by operational restructuring. - Offer cash-out options to resolve disguised unemployment in SOEs/VPEs, repaid from reduced future losses and higher taxes. - Fully implement planned large infrastructure projects to boost investment spending and competitiveness. ### VIII. External sector: pre-crisis, crisis adjustment, and external stability analysis - Pre-crisis external patterns: - Current account deficit widened sharply in 2007, reached 15 percent of GDP in 2008. - Exports growth: 15 percent in 2007 (average 30 percent during 2004–06); imports growth: 17 percent in 2007 (average 7.1 percent during 2004–06). - Private transfers and factor income from abroad averaged around 25 percent of GDP during 2002–06. - Domestic private savings remained negative throughout post-war era. - Domestic savings (percent of GDP series preserved): - Domestic savings: 1998 -22.0; 1999 -26.2; 2000 -18.6; 2001 -20.6; 2002 -18.5; 2003 -16.8; 2004 -13.9; 2005 -13.2; 2006 -7.9; 2007 -4.1; 2008 -5.3; 2009 -1.3 - Private: 1998 -19.3; 1999 -23.2; 2000 -14.7; 2001 -20.0; 2002 -18.4; 2003 -19.2; 2004 -17.2; 2005 -17.9; 2006 -12.6; 2007 -7.9; 2008 -5.8; 2009 -0.1 - Public: 1998 -2.7; 1999 -3.1; 2000 -3.9; 2001 -0.7; 2002 -0.1; 2003 2.4; 2004 3.4; 2005 4.7; 2006 4.7; 2007 3.7; 2008 0.5; 2009 -1.1 - Crisis 2008–09 adjustment: - Overall current account adjusted by 6.4 percent of GDP in 2008–09. - Exports of goods fell about 17 percent in 2009; imports of goods fell 24 percent in 2009. - Export/import value and price changes (Jan–Dec 2009; Jan–Mar 2010; Jan–Jun 2010) preserved as in source: - Change in exports of goods value Jan–Dec 2009 -17.9; Jan–Mar 2010 24.4; Jan–Jun 2010 32.7 - Change in imports of goods value Jan–Dec 2009 -24.4; Jan–Mar 2010 -1.3; Jan–Jun 2010 4.8 - Change in exports price Jan–Dec 2009 -15.9; Jan–Mar 2010 7.3; Jan–Jun 2010 18.7 - Change in import price Jan–Dec 2009 -13.6; Jan–Mar 2010 7.9; Jan–Jun 2010 8.9 - Change in terms of trade Jan–Dec 2009 -2.8; Jan–Mar 2010 -0.5; Jan–Jun 2010 9.1 - Change in exports volume Jan–Dec 2009 -2.3; Jan–Mar 2010 15.9; Jan–Jun 2010 11.8 - Change in imports volume Jan–Dec 2009 -12.5; Jan–Mar 2010 -8.5; Jan–Jun 2010 -3.7 - Capital flows and reserves: - Gross international reserves: €3.2 billion or 5.7 months of imports at end-2008; declined to about 5.3 months of prospective imports at end-2009. - Financial and capital account surplus: declined from 13.4 percent of GDP in 2008 to 6.3 percent of GDP in 2009. - FDI: dropped from 5.0 percent of GDP to 1.4 percent of GDP (preliminary outturn for 2009). - Liquidity drains and buffers (selected entries, percent of GDP): - Potential Liquidity Drains (A+B+C+D): Dec-07 55.2; Dec-08 50.9; Dec-09 53.2; Jun-10 55.0; Dec-10 54.9 - Potential Liquidity Buffers (E+F): Dec-07 46.2; Dec-08 38.1; Dec-09 39.4; Jun-10 40.5; Dec-10 42.1 - Potential buffers' coverage including banks' short-term liabilities to nonresidents (E+F)/(A+B+C+D): Dec-07 83.6; Dec-08 74.9; Dec-09 74.1; Jun-10 73.5; Dec-10 76.6 - Memorandum: central bank FX reserves/household deposits: Dec-07 130.2; Dec-08 121.4; Dec-09 110.2; Jun-10 98.6; Dec-10 101.0 - Competitiveness and structural findings: - Exports remain tilted toward raw-materials and unprocessed products; iron, steel, aluminum account for more than a quarter of BiH exports. - REER-CPI and REER-ULC indicate external competitiveness largely stable; REER-ULC shows some gain in cost competitiveness. - GCR 2010/2011 rank 102/139; Doing Business 2010 rank 116/183. ### IX. Model-based external stability analysis and REER assessments - Methodologies used: - IMF CGER methodologies: Macroeconomic Balance (MB), External Sustainability (ES), and Equilibrium Real Exchange Rate (ERER); PPP and Balassa-Samuelson discussed. - MB findings (select outputs preserved): - BiH CA Norm estimates range between 0.33 percent surplus and 0.16 percent of GDP deficit. - CA norm including grants: -1.67; -2.16; -4.09 (values shown in source table excerpts). - Medium term projection CA: -5.0 -5.0 -5.0 - Gap (+ indicates REER overvaluation, - undervaluation): 3.34 2.85 0.91 - REER overvaluation (+) based on CA elasticity to REER assumptions: 18.08 15.42 4.91 - External Sustainability (ES) approach: - Baseline (BiH-specific parameters): equilibrium CA deficit stabilizing NFA at ~8 percent of GDP ≈ -4.4 percent of GDP; implies 0.6 percent gap to medium-term estimate and 2.4 percent of GDP gap compared to 2009 outcome. - Alternative scenarios (higher interest rates, lower NFA, lower real growth) require higher adjustment. - ERER and PPP findings: - ERER estimates vary between 4.4 percent undervaluation to 8.8 percent overvaluation depending on specification. - PPP / Balassa-Samuelson implies a real exchange rate undervaluation of -8.2 percent. - Summary table excerpts preserved: - Medium-term current account projection: -5.0 - Balassa-Samuelson: ... -8.2 - External Sustainability Approach: -4.4 3.0 - CGER Macroeconomic Balance Approach: Pooled: -1.7 18.1; ALM: -4.1 4.9 - Equilibrium REER Approach: CPI-based REER: ... -4.2; Unit labor cost-based REER: ... 8.8 - Comparison with 2008 Article IV: - 2008 estimated equilibrium CA deficit range 7.5–13.5 percent of GDP; post-crisis fundamentals narrowed estimated range to 1.7–4.4 percent of GDP. - Policy-relevant conclusion: - No case for significant overvaluation of REER. - Pre-crisis external vulnerabilities materially reduced. - Preserving external stability requires: maintaining fiscal discipline; addressing labor market rigidities; improving productivity; removing impediments to entrepreneurship and good governance. ### X. Fiscal policy, cyclically adjusted balances (CAB), and fiscal institutions - CAB methodology and parameterization: - Output gap: YGAPt = (Yt − YPt)/YPt. - Standard approach: (CAB/YP)t = (B/Y)t – α YGAPt with α ≈ 0.45. - Disaggregated approach: apply H-P filter on revenue bases and use OECD average fiscal elasticities: PIT and CIT elasticity 1; indirect revenues elasticity 0.9; SSC elasticity 0.7. - Modified approach: account separately for absorption gap (AGAP) with parameters β = μ = 0.23; formula (CAB/YP)t = (B/Y)t – β*YGAPt – μ*AGAPt. - Main findings on fiscal stance: - Fiscal policy in BiH was highly pro-cyclical over recent years; discretionary stance significantly contributed to surplus deterioration in 2007–08. - Discretionary expansions in 2007 and 2008 across all three CAB measures. - In 2009, modified CAB indicates overall balance deterioration largely due to automatic stabilizers while fiscal stance posted a discretionary contraction of 1.1 percent. - Quantitative CAB results (percent of GDP; Fund staff estimates preserved): - Overall balance: 2005 0.9; 2006 1.8; 2007 0.0; 2008 -3.6; 2009 -5.7 - CAB, standard: 2005 1.4; 2006 1.9; 2007 -0.3; 2008 -4.2; 2009 -4.8 - CAB, disaggregated: 2005 1.4; 2006 2.7; 2007 -0.3; 2008 -3.9; 2009 -4.8 - CAB, modified: 2005 -1.5; 2006 1.0; 2007 -1.8; 2008 -6.5; 2009 -5.4 - Output gap: 2005 -1.3; 2006 -0.3; 2007 0.7; 2008 1.2; 2009 -1.9 - Absorption gap: 2005 11.8; 2006 3.7; 2007 7.5; 2008 11.8; 2009 0.8 - Discretionary measures (selected, 2006–09): - VAT introduced at 17 percent in 2006; Federation PIT rate lowered from 30 percent to 10 percent in 2008 then unified in 2009; RS PIT and SSC reforms and CIT rule changes in 2007–2009; SSC employee/employer adjustments in 2009. - Expenditure-side: progressive increases in wages and social benefits since 2006; war-related entitlements expanded. - Policy guidance: - Make CAB integral to budget documents; use CABs to separate discretionary actions from automatic stabilizers. - Medium-term objective: lower size of government, improve spending efficiency, build savings in good times. - Coordinate sub-national fiscal policies; internalize reform costs and contingent liabilities; strengthen capacity to cost reforms and assess cyclical position. ### XI. Fiscal Council (FC) and Advisory Group recommendations - FC mandate: - Coordinate fiscal policies across levels of government to ensure macroeconomic stability and fiscal sustainability. - Adopt Global Framework of Fiscal Balance and Policies in BiH each May (medium-term fiscal targets, macro projections, distribution of indirect revenue, upper borrowing limits). - Advisory Group: proposed expanded functions: - Ex-post assessment of fiscal performance via CAB movements. - Elaborate and publish macroeconomic projections for budgets. - Assess government policies against fiscal anchor considering cyclical developments. - Draft an annual or semi-annual monitoring report for public dissemination. - Transparency recommendation: - Monitoring reports should be public and possibly published on the government website. ### XII. Public pension systems — pressures, privileged pensions, and reform steps - Structure and recent trends: - Two entity-administered PAYG pension funds: Federation and Republika Srpska (RS). - Federation public pension spending: rose from 7.7 percent of GDP in 2005 to 10.0 percent of GDP in 2009. - RS public pension spending: rose from 7.8 percent of GDP in 2005 to 9 percent of GDP in 2009. - System weaknesses and statistics: - System dependency ratios (beneficiaries/contributors): RS 0.73; Federation 0.75. - Demographic dependency rates (65+/15–64): RS 0.3; Federation 0.2. - Contributors coverage: 41 percent (RS) and 32 percent (Federation) of population 15–64 pay contributions. - Accrual and indexation features create incentives for short contribution careers and generous real pension growth. - Privileged pensions (Article 94 amendment and impact): - January 2009 amendment recognized double-counting of years of service for military/police during 1992–95 war as budget liabilities. - End-2009: about 78,000 veterans used this provision creating a new central government annual obligation KM 71 million. - Total annual obligations of central government toward PIO in 2009 with this amount included: KM 190 million (1.2 percent of GDP). - Jan–Mar 2010: number of veterans increased to 80,000 thousand; annual obligation raised to KM 77 million (0.5 percent of GDP). - Footnote: in 2009 central government’s current obligations toward PIO amounted to KM 181 million but transferred only half, prompting PIO to run down reserve fund. - Average privileged pension is 1.43 times higher than system average; equalizing it to system average would reduce privileged pension spending by 30 percent. - Many beneficiaries receive pensions below KM 300. - Risks and recommended reforms: - Rapid increase in beneficiaries and relatively high privileged pensions threaten contributory scheme. - Intermediate steps: strictly enforce/tighten eligibility criteria; partly align privileged pensions with system average. - Longer-term measures: raise retirement age; increase required contributory service length; tackle disincentives to formal employment and improve contribution compliance. - Federation adopted pension reform strategy in June (needs more detail and public debate); RS Parliament adopted RS pension strategy ready for implementation post-October election. - Fiscal sensitivity example (10% deterioration in system dependency ratio, table entries preserved): - Federation: System dependency ratio 0.75 -> 0.83; Required transfers from budget, millions of KM: 151 -> 276; Percent of Entity GDP: 1.01.8 - Republika Srpska: System dependency ratio 0.73 -> 0.80; Required transfers from budget, millions of KM: 145 -> 368; Percent of Entity GDP: 1.84.4 ### XIII. Conclusions and medium-term outlook (policy-relevant findings) - Following 2009 recession and 2010 stagnation, BiH potential growth rate likely to stay slightly below pre-crisis value; domestic output to remain permanently below the prevailing pre-crisis trend. - Pre-crisis growth mostly driven by rapid factor accumulation; post-crisis growth will need to rely more on gains in human capital and TFP. - Structural reform priorities to enhance human capital and technological change: - Labor market reforms: align collective bargaining and wage determination with market principles; rationalize coefficients and tenure premiums. - Education system reforms and life-long learning framework. - Public sector hiring and benefits restraint. - Refocus Employment Funds on active job placement; develop activation programs. - Condition non-insurance cash benefits on recipients’ income and ability to work and implement rigorous eligibility audits. - Drastic improvement in business environment: streamline regulations, enable quicker startups, reduce authorizations and number of different tax payments. - Enhance corporate governance via ownership change and enterprise restructuring; implement planned large infrastructure projects to boost investment spending. *Source: IMF staff study prepared by Plamen Iossifov and Khaled Abdelkader (both EUR); material as presented in the provided content unit.* ### References ............................................................................................................. ### _cr10347 - References ### I. Introduction - Study objective: examine sources of post-crisis economic growth, identify main impediments to domestic supply expansion, and highlight the need for growth-promoting government policies. - Approach: evaluate BiH’s growth performance relative to potential; analyze the production process to quantify contributions of physical and human capital and technological change to real GDP growth; use growth accounting framework to structure discussion of drivers, impediments, and growth-promoting policies. ### II. Growth Performance and Medium-Term Prospects - Pre-crisis growth model: relied on booming domestic demand financed from abroad. - Key financing sources (2000–2008): - Remittances: 15–18 percent of GDP each year. - Foreign direct investment, unrequited transfers to government, and a credit boom funded by foreign banks. - 2009 recession dynamics: - Global financial crisis led to collapse in demand for Bosnian exports and severe curtailment of cross-border financial inflows. - Private investment and spending on consumer durables collapsed. - Private current consumption softened to a lesser extent due to moderate wage and social benefit growth. - Result: large improvement in external trade balance. - 2010 and medium term: - Stagnation in 2010; growth expected to rebound. - Main trading partners (EU and Western Balkan countries) expected to lag behind booming emerging Asian economies, tempering external demand for BiH noncommodity exports. - Domestic demand in 2010 expected to remain soft as banks hoard capital and keep interest rates high while working through loan losses. - Over the medium term, domestic demand expected to remain below pre-crisis levels relative to domestic income, reflecting fiscal consolidation and the end of the credit boom funded from abroad. - Conclusion: real GDP is expected to remain permanently below the prevailing pre-crisis trend despite a rebound in real GDP growth. ### III. Potential Output and the Output Gap - Methodology: - Decompose output into long-run potential and business-cycle component using the Hodrick-Prescott filter with a smoothing parameter of 100 applied to real GDP series in natural logarithm. - Because Fund staff projections indicate a structural break (in domestic demand) in 2009–10, run H-P filter separately on sub-periods 1999–2008 and 2011–2015; assume growth rate during and in immediate aftermath of global crisis was zero. - Key quantitative results: - Post-crisis potential growth rate: 4.7 percent (average). - Pre-crisis potential growth rate: 4.9 percent (average). - Result: post-crisis potential growth slightly below pre-crisis, leaving real GDP permanently below prevailing pre-crisis trend. - Notes: - Short time span of 2011–2015 makes the derived long-run trend from H-P filter indistinguishable from a simple fitted time trend. - H-P smoothing parameter: 100. ### IV. Growth Accounting — Setup and Calibration - Production function: Cobb-Douglas aggregate production function with constant returns to scale; Solow residual = total factor productivity (TFP). - Implementation requires mapping theoretical concepts to available data and addressing deficiencies in BiH statistics. - Data choices and calibration: - Real GDP: use production-approach real GDP estimates published by the Agency for Statistics of Bosnia and Herzegovina (ASBiH). - Investment flows: measure using national accounts data on real gross fixed capital formation (GFCF). - Depreciation rate: constant annual depreciation rate of 4 percent. - Physical capital stock construction: perpetual inventory method (Kt = (1 − δ)Kt−1 + It). - Base-year capital stock: estimate for 2003 using Harberger (1978) approach; use potential growth rate of capital stock circa 2003 of 6.8 percent. - Resulting real capital stock to real GDP ratio in 1999: 2.15. - Human capital stock proxy: number of employees (no augmentation for quality due to data limitations). - Share of labor in real income (parameter (α−1)): set to 0.468 (average share of compensation of employees in income-approach estimates of real GDP in 2007–2008). - Implied α = 0.532. - Analytical note: - Overestimation of base-year capital stock would underestimate the contribution of capital to real GDP growth and overstate importance of TFP gains. ### V. Growth Accounting — Data and Contextual Indicators - BiH labor market characteristics (relative to peers, 1997–2008): - One of the lowest labor force participation rates in Europe. - One of the highest unemployment rates in Europe. - Investment context: - Share of investment in real GDP in BiH similar to other Balkan countries and higher than in the Euro area. - Post-2002 capital accumulation fueled by a credit boom funded from abroad; recognized as exuberant in hindsight. - Definition reminder: - Domestic absorption = sum of residents’ private and public consumption and investment of domestic and foreign goods and services. *Source: IMF staff study prepared by Plamen Iossifov and Khaled Abdelkader (both EUR); material as presented in the provided content unit.* ### 7. On the supply-side, the pre-crisis growth of output was mostly driven by rapid ### _cr10347 - 7. On the supply-side, the pre-crisis growth of output was mostly driven by rapid ### Supply-side drivers and pre-crisis growth - The massive build-up of productive capacity—financed by foreign direct investment and a credit boom funded by foreign savings—on average accounted for three-forth of the observed output growth in 1999–2008. - The decline in the unemployment rate in 2007–08 helped boost the contribution of the labor force to observed output growth. - The 2009 output loss was accompanied by a decline in the effectiveness of capital utilization and employment losses. ### Implications for future growth - Post-crisis growth of the BiH economy will likely become more dependent on gains in human capital and total factor productivity. - The projected return to normalcy of credit growth—reflecting the switch of banks’ funding from foreign borrowing to domestic deposits—suggests that, unless private and public savings increase significantly relative to the baseline projection and/or structural reforms create fiscal space for stepped up public infrastructure investment, the pace of capital accumulation and its contribution to real GDP growth will be lower in the post-crisis period. - This is consistent with a large cross-country study which finds a permanently lower post-crisis growth of capital (IMF, 2009). - Future growth will therefore need to rely more on gains in human capital and total factor productivity. ### Labor market — main characteristics and constraints - Structural change since the 1990s produced persistent labor market imbalances: share of heavy and light industries in total value added declined from 43 percent of GDP in 1990 to around 20 percent in 2008; shares of merchant and public services increased by 10 percentage points in 1994–2008. - Current specialization is low-skill: 43 percent of exports classified as low-skill goods (ETF, 2007). - Unemployment: - BiH unemployment rate at 24–25 percent (recent years), remaining one of the highest in Europe. - Young people below age 25: close to 50 percent out of work. - 75 percent of unemployed have been out of work for more than two years, and 50 percent for more than five years (BHAS, 2008). - Labor force participation: - Share of economically active men (15–64) around 67 percent, about 10 percentage points below the EU-wide average. - Labor force participation among working-age women around 40 percent, trailing Balkan peers by 15 percentage points and the EU by 22 percentage points (BHAS, 2008; ILO 2009). - Women activity rates are below regional and EU comparators in both entities; RS outcome around 10 percentage points better than in the Federation. - Low enrollment in pre-school programs noted as a contributing factor. - Education and skills: - Near universal primary education achieved, but shares with completed secondary and higher education fall short of old and new EU members’ averages. - Approximately two-thirds of secondary students enrolled in four year technical or three year vocational schools with narrowly-specialized and sometimes outdated programs. - One third of managers of exporting firms cited inadequate skill pool as an obstacle (2009 Enterprise Survey, WB). - Informal sector: - Size of grey economy estimated at around 37 percent of GDP in the Federation and 21 percent in Republika Srpska (ETF, 2007). - Informal employment concentrated in agriculture and light manufacturing; accounts for a large share of net employment generation (WB, 2005). - Informal jobs are lower paid, do not pay social security and health care contributions, and lack job security, reducing incentives for lifelong learning and career development. - Non-labor income and social benefits contributing to informality: - Private remittances amount to between 15 and 18 percent of GDP each year. - Government-run, noninsurance, cash benefits programs (war invalids benefits, medal holders benefits, demobilized soldiers unemployment benefits (terminated on May 1, 2010), civilian victims of war benefits, and non-war invalids’ benefits) collectively amount to 4.5 percent of GDP and cover 183,500 individuals. - Close to 21,000 recipients of pensions granted under favorable conditions to former military personnel. - In the Federation, unemployment benefits cover only 1.5 percent of registered unemployed (compared to 2.2 percent in the RS); unemployment benefit equals 40 percent of the average net wage and is extended for periods of 3 to 24 months based on total years of work experience; unemployment benefit is slightly higher than the net minimum wage. - Workers in the informal sector have access to free health care as long as they remain registered as “formally” unemployed. - Labor regulation and collective bargaining: - Labor Laws in RS and the Federation are fairly flexible but supplemented by extensive and generally rigid collective bargaining rules, many carried over from the old market socialism model. - System of coefficients and tenure premiums exist; minimum net wages: KM 308 in Federation, and KM 370 in RS (since July 1, 2010). - Non-enforcement of rigid regulations leads to informality, creating rents for officials and uncertainty among employers and new investors, and leaves workers without protection (WB, 2005). - Employment mediation and funds: - Employment Funds (RS and Federation: 1 central and 10 cantonal funds) primarily funded by payroll contributions; administer unemployment benefits and health insurance coverage for registered unemployed. - Administrative burden from passive service provision crowds out active job placement; applicants for non-insurance cash transfers (except war veterans’ benefits) required to register as unemployed to qualify for benefits. - Number of unemployed registered at Employment Funds exceeds 40 percent of the BiH labor force, whereas labor force surveys suggest actual unemployment around 24 percent. - High ratio of unemployed to staff in Employment Funds: 1,100 to 1. - Labor tax wedge and public sector: - Overall social security contribution rates in RS and Federation similar at 34 percent (calculated at average wage including allowances); OECD average cited as 29.5 percent. - Large labor tax wedge discourages formal job creation. - Public sector share in total employment among highest in Europe; public sector wages significantly above private sector and offer greater job security and nonwage benefits. ### Growth-promoting policies — labor market reforms (priorities and measures) - Ongoing and planned legislative work: - Federation government working on draft amendments of Labor Law, Work Safety Law, and Law on Employment Mediation and Social Security of Unemployed. - Plans for a new Labor Law in RS. - Employment strategies adopted at country, Federation, and RS levels in 2010; next step to prepare periodic action plans with concrete measures and costing linked to annual budgets. - Pressing priorities identified (from WB, ILO studies) to be addressed in action plans and amendments: - Better alignment of collective bargaining and wage determination with market principles: - Separate public sector wage determination from other sectors. - Formulate criteria for representation of social partners in tripartite bargaining. - Limit coverage of collective agreements to enterprises represented in the process. - Rationalize and simplify system of “coefficients” and other wage/employment/benefit determinants (WB, 2005). - Comprehensive reform of the education system: - Complete legislative overhaul of pre-school, vocational, and higher education. - Follow through reforms of primary and secondary education (ILO, 2009). - Design framework for continued education and life-long learning. - Public sector hiring and benefits restraint to contain crowding out of formal private sector employment. - Refocusing Employment Funds on active job placement: - Relieve them from administering benefit programs unrelated to core mandate. - Eliminate incentives for registration as unemployed solely to gain access to benefits while working in the informal economy (ILO, 2009). - Develop job activation programs. - Reform human resource management to increase active job placement competencies and link compensation/career progression to performance. - Work supported by financing and technical assistance from the World Bank (“Social Safety Nets and Employment Support Project” (WB, 2010a)) and the European Union project “Improving Active Labour Markets.” - Increase incentives for quick re-entry into the workforce: - Condition all non-insurance cash benefits on recipients’ income and ability to work and carry out rigorous eligibility audits. Reforms in this area supported by the “First Programmatic Public Expenditure Development Policy Loan” approved by the World Bank in 2010 (WB, 2010b). - Revise unemployment benefits in the Federation to decrease the maximum length of the payout period, set the minimum amount of unemployment benefits below the minimum net wage, and explicitly condition entitlement on payment of unemployment contributions over a minimum prior period. *Source: IMF staff chapter text as provided in the content unit.* ### 21. The quality of the business environment in Bosnia and Herzegovina lags behind ### 21. The quality of the business environment in Bosnia and Herzegovina lags behind ### Overview - According to the World Bank’s Doing Business Report 2010, BiH ranks 116 out of 183 countries on overall quality of the business environment. - An enabling business environment encompasses an efficient regulatory and enforcement system, enhanced corporate governance, and quality infrastructure. ### Recent reforms and measurable progress - Post-Stabilization and Association Agreement: significant steps to reduce or abolish customs duties on a wide range of imports from the EU. - Adoption of the Value-Added Tax (VAT) in Bosnia and Herzegovina in January 2006 promoted tax efficiency and provided firms an incentive to register (EBRD, 2008). - Procedures were cut by 7 percent, time by 15 percent, and cost by 26.5 percent on average (WB, 2010c). - Bosnia and Herzegovina has seen a 33 percent growth in transferred titles since the computerization of all municipal cadastres (WB, 2010c). - FBiH House of Peoples adopted amendments to 34 laws and amendments as part of the “regulatory guillotine” project. - Republika Srpska removed 58 percent of unnecessary regulations under the project, with an estimate that this reform would bring KM 23 million of savings annually for businesses. - New Companies Law in the RS, effective from July 2009, aims to simplify registration of new companies and align company law with EU standards (EBRD, 2009). - European Commission’s formal recommendation in May 2010 to lift the visa-regime for BiH citizens noted. ### Regulatory inefficiencies and business operation constraints - Progress towards creating a single economic space within the country has been limited (OECD 2010), causing slow decision making, duplication of policies, and unclear division of powers. - World Economic Forum’s Competitiveness Report 2009 identified complicated and “expensive” bureaucracy, corruption, and weak legislative framework as key impediments. - Licensing and tax compliance burdens: - Ten procedures and 127 days are needed for a business to get connected to the electricity network in Bosnia and Herzegovina, compared to a South Eastern Europe (SEE) average of 5.7 procedures and 109.2 days (OECD, 2010). - In the 2008/09 Business Environment and Enterprise Performance Survey (BEEPS IV), more than one-quarter of enterprises surveyed identified political instability as the main problem affecting their operations. - The Foreign Investor Council White Book highlights business registration as a particular problem for foreign investors (FIC, 2009). ### Access to finance - More than half of enterprises report access to financing as an obstacle to their development (OECD, 2010). - The financial sector is dominated by banks, the vast majority of which are foreign-owned. - The global financial crisis curtailed rapid credit growth; banks cut back loan portfolios and raised interest rates (World Bank, 2010a). - Nonbank financial sector: - Stock exchanges are dormant with limited potential to raise new funds for companies. - Leasing legal framework developed and market expanding rapidly. - No specific regulation covers factoring, which remains underdeveloped. - Credit guarantee schemes: - Entity-level efforts to extend credit guarantees are in their infancy. - In the RS, RS Investment Development Bank extends credits to commercial banks for below-market lending to individuals (mortgage) and companies in agriculture and export sectors. - National export guarantee scheme run by the Export Credit Agency is inadequately funded and has had a limited impact. ### Privatization, enterprise restructuring, and corporate governance - War and slow reconciliation (1992–1995) resulted in substantial delays in privatization and enterprise restructuring compared with other Eastern European countries. - Privatization history: - About 1000 enterprises in the Federation and 600 enterprises in the RS, holding around a quarter of total assets of state-owned enterprises, were privatized under a voucher privatization scheme in 2000–2001 (IMF, 2005). - Follow-up privatization of strategic enterprises has been slow; several large strategic companies in the Federation remain to be privatized. - Republika Srpska privatized its largest industrial assets in 2004–2006, but a number of loss-making medium enterprises remain hard to sell (World Bank, 2008). - VPEs and SOEs issues: - Many state-owned and voucher-privatized enterprises suffer from poor corporate governance and heavy indebtedness. - Voucher-to-share conversion created weak incentives; many VPEs are undercapitalized and operate below potential. - Broad calculation of pension and tax arrears owed to the government by VPEs, plus additional capital estimated to ensure successful operations, yields an estimated gap equivalent to 15 percent of GDP (World Bank, 2008). - SOEs burdened with arrears to suppliers, unpaid health and pension fund contributions, and delayed salary payments. - Labor and restructuring impediments: - Fictitious workers and legal requirements for clearance of unpaid wage and social security arrears prior to dismissal delay workforce rationalization and deter buyers. - Historical use of SOEs as social safety net and hiring of veterans contributed to overstaffing. ### Infrastructure - Telephony services: high quality and lower cost compared with the region. - Roads: 96 percent of the roads are paved (high compared with the region), but total road density and air traffic in BiH are below the SEE average (OECD, 2010). - Transport capacity concerns expressed by foreign investors regarding movement of inputs and shipping final goods (World Bank, 2008). - Roads sector projects: several projects signed with international financial institutions for parts of the 330 km Corridor 5c and institutional strengthening of the Motorway Directorate in both entities. - Railways: various upgrade and modernization projects ongoing with bilateral donors and international institutions (EBRD, 2008). ### Growth-promoting policies and recommendations - Priorities identified in World Bank, OECD, EBRD, and World Economic Forum studies: - Increase efficiency of the regulatory system by streamlining regulations to allow quicker business startups, fewer authorizations, simplification of licenses and permits, reduction in the number of different tax payments, and improved mechanisms for business closure (WB, 2008). - Speed up regulatory reform under the “regulatory guillotine” project and IFC Subnational Competitiveness Programs, especially in the Federation. - Ameliorate access to finance through greater emphasis on credit and export guarantees and development of alternative financing sources, such as leasing and factoring (OECD, 2010). - Corporate sector policy focus: - Speed up privatization of large strategic enterprises in the Federation and medium-size public companies in both entities. - Restructure underperforming voucher-privatized enterprises (VPEs): - Use government’s de facto status as main creditor to effectuate restructuring, which may entail temporary government shareholding. - Convert debt to equity in viable VPEs only when interested investors are identified and accompany conversions with operational restructuring; debt forgiveness may be offset by higher future tax collections (WB, 2008). - Resolve disguised unemployment in SOEs and VPEs by offering a cash-out option to such workers based on minimum severance and pension payment, potentially repaid from reduced future company losses and higher tax revenues (WB, 2008). - Infrastructure: full implementation of planned large infrastructure projects can support growth through boosting investment spending and improving competitiveness. ### Conclusions and medium-term outlook - Following a recession in 2009 and stagnation in 2010, the potential growth rate of the BiH economy would likely stay slightly below its pre-crisis value, resulting in domestic output remaining permanently below the prevailing pre-crisis trend. - Pre-crisis growth was mostly driven by rapid accumulation of factors of production; post-crisis growth will likely become more dependent on gains in human capital and total factor productivity. - Structural reform priorities to enhance human capital and technological change include: - Labor market reforms: better alignment of collective bargaining and wage determination with market principles. - Education system reform follow-through. - Public sector hiring and benefits restraint. - Refocusing Employment Funds on active job placement policies. - Conditioning non-insurance cash benefits on recipients’ income and ability to work and rigorous eligibility audits to reduce fraud. - Drastic improvement in the business environment: streamline regulations, allow quicker business startups, reduce authorizations, and reduce the number of different tax payments. - Enhance corporate governance through ownership change and enterprise restructuring; implement planned large infrastructure projects to boost investment spending. *Source: IMF staff report section titled "The quality of the business environment in Bosnia and Herzegovina lags behind".* ### Appendix Table 1. BiH: Data Used in Growth Accounting Exercise ### Appendix Table 1. BiH: Data Used in Growth Accounting Exercise ### Data and methodology notes - Real GDP: Production-approach real GDP: 2003–2008–chained series constructed from Agency for Statistics of Bosnia and Herzegovina (ASBiH) data on real GDP at previous year’s prices; 1999–2003–chained series constructed from unpublished data provided by the ASBiH. - Real capital stock: constructed using the perpetual inventory method (K_t = (1-δ) × K_{t-1} + I_t) applied on an assumed base value of real capital stock in 2003 and using a constant annual depreciation rate (δ) of 4 percent. The base value of real capital stock in 2003 is obtained by dividing the real gross fixed capital formation (GFCF) in 2003 by the sum of the rate of depreciation and the potential growth rate of the capital stock estimated at 6.8 percent. - Gross fixed capital formation (GFCF) 2005–2008: nominal GFCF estimated by applying the share of GFCF in expenditure-approach GDP published by ASBiH to production-approach nominal GDP; real GFCF estimated by dividing nominal GFCF by its deflator, constructed as a chained series from ASBiH data on year-on-year changes in GFCF price index; 1999–2004–chained series constructed from unpublished ASBiH data. - Population: 1999–2015 from the International Labour Organization's Labour Statistics Database, which extrapolates annual values from the bi-decennial median estimates published by the Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat. - Labor market variables: 2006–2009 data from the BiH Labor Survey published by ASBiH; 1999–2005 assumed equal to 2006 values (first available data point). Activity rate and unemployment rate series follow the same source/assumptions. - Formulas shown in table: Y; K = (1-0.04) x K_{-1} + I; IH = P x D x LF x (1-U) PDLFU (as displayed in source table). ### Key data excerpts and methodological constants - Depreciation rate used: 4 percent. - Potential growth rate of capital stock used for base-year calculation: 6.8 percent. - Selected GFCF and population indicators (as presented in the table rows for 1999–2009; entries shown exactly as in source): - 1999 12,246 25,813 2,886 0.87 3.60 81.04 3.13 1.1 - 2000 12,884 27,764 2,984 0.89 3.69 81.04 3.13 1.1 - 2001 13,352 29,617 2,964 0.90 3.75 81.04 3.13 1.1 - 2002 14,014 31,953 3,521 0.91 3.78 81.04 3.13 1.1 - 2003 14,505 34,415 3,740 0.91 3.78 81.04 3.13 1.1 - 2004 15,421 36,831 3,793 0.91 3.78 81.04 3.13 1.1 - 2005 16,030 39,320 3,961 0.91 3.78 81.04 3.13 1.1 - 2006 17,015 41,028 3,281 0.91 3.78 81.04 3.13 1.1 - 2007 18,060 43,906 4,519 0.97 3.78 82.24 3.92 9.0 - 2008 19,083 47,131 4,981 1.05 3.77 82.54 3.92 3.4 - 2009 18,496 49,103 3,858 1.03 3.77 82.94 3.62 4.1 (Note: the table columns correspond to Gross fixed capital formation (mln 2003 KM); Population (mnl); Share of working age population (persons aged 15+) in total (%); Activity rate (share of labor force in working age population, %); Unemployment rate (share of unemployment in labor force, %); and other series as laid out in the source table.) ### External sector: pre-crisis and crisis developments (findings) - Pre-crisis: - Current account deficit widened sharply in 2007, and reached 15 percent of GDP in 2008. - Exports growth: 15 percent in 2007 compared to an average of 30 percent during 2004–06. - Imports growth: 17 percent in 2007 compared to an average of 7.1 percent during 2004–06. - Private transfers and factor income from abroad averaged around 25 percent of GDP during 2002–06. - Domestic private savings remained negative throughout the post-war era. - Domestic savings (In percent of GDP) series (1998–2009 as presented): - Domestic savings: 1998 -22.0 1999 -26.2 2000 -18.6 2001 -20.6 2002 -18.5 2003 -16.8 2004 -13.9 2005 -13.2 2006 -7.9 2007 -4.1 2008 -5.3 2009 -1.3 - Private: 1998 -19.3 1999 -23.2 2000 -14.7 2001 -20.0 2002 -18.4 2003 -19.2 2004 -17.2 2005 -17.9 2006 -12.6 2007 -7.9 2008 -5.8 2009 -0.1 - Public: 1998 -2.7 1999 -3.1 2000 -3.9 2001 -0.7 2002 -0.1 2003 2.4 2004 3.4 2005 4.7 2006 4.7 2007 3.7 2008 0.5 2009 -1.1 - Crisis (2008–09) adjustment: - Overall current account adjusted by 6.4 percent of GDP in 2008–09. - Exports of goods fell by about 17 percent in 2009; imports of goods fell by 24 percent in 2009. - Export value and import value changes (Jan–Dec 2009 vs Jan–Dec 2010 and subperiods) as presented: - Change in exports of goods value Jan–Dec 2009 -17.9; Jan–Mar 2010 24.4; Jan–Jun 2010 32.7 - Change in imports of goods value Jan–Dec 2009 -24.4; Jan–Mar 2010 -1.3; Jan–Jun 2010 4.8 - Change in exports price Jan–Dec 2009 -15.9; Jan–Mar 2010 7.3; Jan–Jun 2010 18.7 - Change in import price Jan–Dec 2009 -13.6; Jan–Mar 2010 7.9; Jan–Jun 2010 8.9 - Change in terms of trade Jan–Dec 2009 -2.8; Jan–Mar 2010 -0.5; Jan–Jun 2010 9.1 - Change in exports volume Jan–Dec 2009 -2.3; Jan–Mar 2010 15.9; Jan–Jun 2010 11.8 - Change in imports volume Jan–Dec 2009 -12.5; Jan–Mar 2010 -8.5; Jan–Jun 2010 -3.7 - Key export price drivers: metal, aluminium prices and component-based export deflator for BiH for other exports (all WEO). - Key import price drivers: oil, gas, food prices and euro area export deflator for other imports (all WEO). - Capital flows and reserves: - Gross international reserves reached €3.2 billion or 5.7 months of imports at end-2008. - Financial and capital account surplus declined from 13.4 percent of GDP in 2008 to 6.3 percent of GDP in 2009. - FDI dropped from 5.0 percent of GDP to 1.4 percent of GDP (preliminary outturn for 2009). - Gross international reserves declined to about 5.3 months of prospective imports at end-2009. ### Liquidity drains and buffers (selected table entries) - Potential Liquidity Drains (A+B+C+D) (In percent of GDP): Dec-07 55.2; Dec-08 50.9; Dec-09 53.2; Jun-10 55.0; Dec-10 54.9 - A. Cash, excluding cash in vaults: Dec-07 10.0; Dec-08 9.3; Dec-09 8.4; Jun-10 8.2; Dec-10 8.3 - B. Deposits by residents (nongovernment): Dec-07 41.7; Dec-08 38.9; Dec-09 42.4; Jun-10 41.1; Dec-10 44.3 - B.1. Domestic currency: Dec-07 20.8; Dec-08 18.9; Dec-09 20.3; Jun-10 20.4; Dec-10 21.0 - B.2. Foreign currency: Dec-07 20.9; Dec-08 20.1; Dec-09 22.1; Jun-10 23.7; Dec-10 23.2 - C. Commercial banks' short-term foreign liabilities: Dec-07 3.5; Dec-08 2.7; Dec-09 2.4; Jun-10 2.7; Dec-10 2.4 - D. Nonbank short-term external debt: all periods 0.0 - Potential Liquidity Buffers (E+F): Dec-07 46.2; Dec-08 38.1; Dec-09 39.4; Jun-10 40.5; Dec-10 42.1 - E. Central bank and central government liquid external assets: Dec-07 29.9; Dec-08 25.6; Dec-09 27.0; Jun-10 26.7; Dec-10 29.2 - F. Commercial banks' liquid foreign currency assets: Dec-07 16.2; Dec-08 12.5; Dec-09 12.4; Jun-10 13.8; Dec-10 12.9 - Potential buffers' coverage of potential drains (percent): - including banks' short-term liabilities to nonresidents (E+F)/(A+B+C+D): Dec-07 83.6; Dec-08 74.9; Dec-09 74.1; Jun-10 73.5; Dec-10 76.6 - excluding banks' short-term liabilities to nonresidents (E+F)/(A+B+D): Dec-07 89.2; Dec-08 79.0; Dec-09 77.6; Jun-10 77.4; Dec-10 80.2 - Memorandum item: central bank FX reserves/household deposits: Dec-07 130.2; Dec-08 121.4; Dec-09 110.2; Jun-10 98.6; Dec-10 101.0 ### Non-model indicators of competitiveness and structural findings - REER indicators: - Both REER-CPI and REER-ULC indicate external competitiveness largely stable; REER-ULC shows some gain in cost competitiveness, likely driven by decline in employment and simultaneous increase in output and wages (indexes presented with 2002=100 in source charts). - Bilateral REER: broadly stable pre-crisis; recent appreciation vis-à-vis Serbia (due to nominal depreciation of the Serbian currency); broadly stable vs Croatia and EU partners. - Export performance and composition: - Export market share improved rapidly during 2003–08; strong real export growth and market share gains especially over 2003–07. - Exports remain tilted towards raw-materials and unprocessed products; dependence on international commodity markets high (iron, steel, aluminum account for more than a quarter of BiH exports). - First half of 2010: partial recovery in key exporting industries (metals, steel, aluminum, wood), and mineral products (including launch of production of refined oil products in Republika Srpska) noted. - Structural constraints: - Shortage of skills in export-related industries identified as significant and constraining future growth (World Bank enterprise survey and firm-level evidence cited). - BiH lags peers in cross-country competitiveness: - Global Competitiveness Report (GCR) 2010/2011 rank: 102nd out of 139 countries. - GCR information and technology special publication rank: BiH 110th; Croatia 51st; FYR Macedonia 73rd; Serbia 84th. - World Bank governance indicators: BiH ranks in 44th percentile on rule of law, 46th percentile on control of corruption, and 35th percentile on government effectiveness. - World Bank Doing Business Report 2010: BiH ranking 116 out of 183 countries. *Sources: Agency for Statistics of Bosnia and Herzegovina, International Labour Organization's Labour Statistics Database, Fund staff estimates.* ### 19. These rankings are broadly ### _cr10347 - 19. These rankings are broadly ### Private-sector competitiveness and impediments - Two companies unaffected by the crisis and that managed to expand were part of international supply chains in furniture and machinery production industries. Their success was driven by updates in technology, investment in human capital, milder interference with local bureaucracy due to being part of supply chains, and easy access to short-term working capital through intra-firm financing. - IMF staff survey of private sector representatives and World Economic Forum Competitiveness report survey results identified key impediments for companies to access foreign markets: - (i) political instability; - (ii) complicated and “expensive” bureaucracy; - (iii) lack of clear vision for economic development; - (iv) corruption and weak legislative framework; - (v) poor quality control (i.e., local certification and standardization). - Substantial opportunities lie in enhanced productivity via bigger investment in R&D and human capital. - World Bank Doing Business Ranking (183 countries) listings shown in source (percentile ranks and country ordering preserved in the source graphic). ### D. Model-Based Analysis of External Stability Analysis — overview - Model-based analyses focus on identifying deviations of the current account balance and the real effective exchange rate (REER) from equilibrium values. - Arriving at well-specified equilibrium values for both the current account balance and the exchange rate is difficult; methodologies have advantages and disadvantages and often yield different estimates. - External stability benchmarking is particularly difficult for economies like Bosnia and Herzegovina (BiH) due to: - short historical time series including market socialism and 1992–95 war effects, - ongoing data quality issues that introduce uncertainties to statistical inference. - Judgments about exchange rate assessments (over- or under-valuation or broadly in line with fundamentals) become an important part of analysis. ### Methodologies employed - Approaches used include IMF’s Consultative Group of Exchange Rate Issues (CGER) methodologies and three concepts of equilibrium: - Macroeconomic balance approach (MB), - External sustainability approach (ES), - (Reduced form) equilibrium real exchange rate approach (ERER). - The notion of purchasing power parity (PPP) is discussed in the context of competitiveness. - Estimates for BiH are obtained by adopting coefficients from different studies and applying them to Bosnian data and trading partners. ### BiH: Macroeconomic Balance Approach — selected parameter outputs (as presented) - Fundamentals, coefficients and variables shown in source table (selected excerpts preserved in original layout): - Fiscal balance % of GDP coefficients and BiH values: -0.59 -2.55 1.96 0.19 0.320 -0.119 0.373 0.628 0.070 - Old Age Dependency % of Population: 19.54 25.99 -6.45 -0.140 -0.230 -0.292 0.903 1.483 -5.706 - Young Age Dependency % of Population: 22.19 22.72 -0.54 ...... -0.018 ...... -0.399 - Population Growth: 0.29 0.15 0.13 -1.220 -0.460 ... -0.160 -0.060 ... - Lagged current account: -11.02 .... -0.028 0.309 - NFA % of GDP: 25.00 25.00 0.020 ... -0.028 0.500 ... -0.700 - Oil Balance (% of GDP): -6.21 -6.21 0.230 0.310 ... -1.427 -1.924 ... - Real GDP PC growth: 4.20 3.15 1.05 -0.210 -0.270 0.004 -0.220 -0.283 0.017 - Relative Income: 18.30 18.30 0.020 ... 0.366 ...... - Financial integration/GDP: 25.77 -0.430 -11.080 - Log GDP per capita* Financial integration/GDP: 219.54 0.045 9.879 - Constant: 100.00 0.137 13.700 - BiH CA Norm estimates from table: - BiH CA Norm: 0.33 -0.16 -2.095 - Total Grants, percent of GDP: 2 2 2 - CA norm including grants: -1.67 -2.16 -4.09 - Medium term projection CA: -5.0 -5.0 -5.0 - GAP (+ would indicate REER overvaluation, - undervaluation): 3.34 2.85 0.91 - REER overvaluation (+) based on CA elasticity to REER assumptions: 18.08 15.42 4.91 ### Macroeconomic balance and external sustainability findings - Preliminary MB analysis suggests the current account deficit slightly exceeds the sustainable level. - Equilibrium current account estimates range between 0.33 percent surplus to 0.16 percent of GDP deficit. - After adjusting the current account norm estimates by the level of fiscal foreign grants, sustainable current account deficit estimates are from 1.7 to 2.2 percent of GDP. - Underlying medium-term projection current account deficit is proxied at -5.0 percent of GDP. - Taking into account financial integration and potential EU convergence (based on Abiad, Leigh and Mody (AML) (2007)) yields an equilibrium current account deficit of -4.0 percent of GDP, implying a gap from medium-term projection of about 1.0 percent of GDP. ### External sustainability (ES) approach results and scenarios - Baseline (BiH-specific parameters): equilibrium current account deficit stabilizing net foreign liability position at around 8 percent of GDP (average of previous 5 years) is about -4.4 percent of GDP, implying: - 0.6 percent gap towards its medium-term estimate, and - 2.4 percent of GDP gap compared to the outcome of 2009. - Alternative scenarios (higher interest rates, lower NFA, lower real growth) suggest need for higher adjustment in the current account. ### Equilibrium Real Exchange Rate (ERER) and PPP approaches - ERER approach uses CGER methodology: panel regressions of CPI- or ULC-based REER on fundamentals including NFA, productivity differential, commodity terms of trade, government consumption, trade restriction index, and price controls. - Variables / coefficients excerpted from source: - NFA: 0.04 0.04 - Productivity differential: 0.19 0.12 - CEE countries: 1.3 - Commodity TOT: 0.55 0.39 - Government consumption: 2.91 2.65 - Trade restriction index: 0.12 0.14 - Price controls: -0.04 -0.02 - Parameters used in example calculations: - Net Foreign Assets/GDP (2003-2008 average): -8% - Grants / GDP average in medium-term: 2% - Real Growth: 5% - Real Interest Rate: 3% - Depending on CPI-based or ULC-based REER and sample (with or without CEE), estimates fluctuate between 4.4 percent undervaluation to 8.8 percent overvaluation. - PPP / Balassa-Samuelson findings: - PPP method and Balassa-Samuelson effect imply a real exchange rate undervaluation of -8.2 percent (undervaluation sign preserved from source), consistent with the hypothesis that the REER should appreciate in line with relative productivity differential and that convergence to developed partners is underway. ### REER misalignment summary (as in source table) - Medium-term current account projection: -5.0 - Balassa-Samuelson: ... -8.2 - External Sustainability Approach: -4.4 3.0 - CGER Macroeconomic Balance Approach: - Pooled: -1.7 18.1 - ALM: -4.1 4.9 - Equilibrium REER Approach: - CPI-based REER: ... -4.2 - Unit labor cost-based REER: ... 8.8 - Note: Undervaluation (-) and overvaluation (+) notation preserved from source. ### Comparison with 2008 Article IV analysis - 2008 Article IV consultations estimated the range of equilibrium current account deficit between 7.5–13.5 percent of GDP. - Post-crisis shifts in macroeconomic fundamentals narrowed the estimated range of the equilibrium current account deficit to 1.7–4.4 percent of GDP. ### E. Conclusions — policy-relevant findings and recommendations - No case for significant overvaluation of the real exchange rate is found. - Pre-crisis threats to external stability associated with unsustainably large current account deficits have been substantially reduced. - Foreign non-debt creating flows have declined but remain sufficient to support external stability. - Risks related to foreign bank liabilities rollovers remain benign. - Preserving external sector stability requires short- and medium-term policy measures including, but not limited to: - maintaining fiscal discipline; - enhancing external competitiveness by addressing long-standing labor market rigidities; - further improving productivity; - removing impediments to entrepreneurship and good governance. *Source: Excerpts from the IMF chapter/section as provided in the supplied content.* ### 1. Fiscal policy in Bosnia and Herzegovina (BiH) has been pro-cyclical prior to the ### _cr10347 - 1. Fiscal policy in Bosnia and Herzegovina (BiH) has been pro-cyclical prior to the ### Background - Purpose: introduce measures of cyclically adjusted fiscal balance (CAB) to inform desirable fiscal stance in BiH and to anchor fiscal policy decisions to allow counter-cyclical policy conduct and signal government “effort”. - Fiscal performance indicators: - Overall and primary balances used as measures of sustainability. - Adjusted balances (domestic, augmented, structural) serve to inform fiscal impulse and underlying stance. - Fiscal stance drivers: - Discretionary policy actions and the economic cycle. - Automatic stabilizers operate as revenues fall and some expenditures (e.g., unemployment benefits) rise during downturns. - Large part of public expenditure (wages, pensions, other current and capital spending) is not cycle-sensitive. ### Derivation of the CAB for BiH - Output gap concept: - YGAPt = (Yt - YPt)/YPt, where Y is actual GDP and YP potential GDP; negative gap = demand shortfall, positive gap = excess demand. - Standard (aggregated) approach: - Formula: (CAB/YP)t = (B/Y)t – α YGAPt. - Interpretation: B and CAB are actual and cyclically adjusted balances; α measures automatic effect (1 percentage point change in output gap on fiscal balance in percent of GDP). - Estimated automatic response: α ≈ 0.45 (close to revenue-GDP ratio). Assumes only revenue side exhibits automatic responsiveness for simplicity. - Disaggregated approach: - Rationale: revenue/expenditure bases (consumption, employment, wages, profits) may move differently from GDP. - Method: apply HP filter on revenue bases extended to 2015 to obtain BGAPi; use fiscal elasticities borrowed from OECD average: - personal income tax (PIT) and corporate income tax (CIT): OECD average 1 (as stated in source). - indirect revenues elasticity: 0.9. - social security contributions (SSC) elasticity: 0.7. - Formula: CAB = Σi (REVi * BGAPi * α_REViGAPi). - Modified approach: - Rationale: in presence of large unsustainable current account deficits and booms in absorption, output gap may not capture automatic effects on budget. - Separate absorption gap (AGAP) effects for indirect taxes; regressions suggest tax collections rose with external imbalances. - Formula: (CAB/YP)t = (B/Y)t – β*YGAPt – μ*AGAPt. - Parameter values used: β = μ = 0.23 (about half of revenue excluding grants consists of indirect taxes and the other half of direct taxes). Non-tax revenue assumed non sensitive to cycle. - Absorption gap derived from analysis of external stability in chapter II. - Construction caveats: - Measurement errors in potential GDP complicate interpretation. - Constant elasticity assumption may distort estimates if revenue composition changes; long-run elasticities may not hold in recessions/expansions. - CAB may not capture other non-cyclical forces (commodity prices, interest rates, foreign grants/loans). - Choice of scaling variable (nominal GDP vs potential GDP) affects interpretation. ### Assessment of Fiscal Policy Based on CAB - High-level finding: - According to standard CABs, fiscal policy in BiH was highly pro-cyclical over the past few years; discretionary stance significantly contributed to deterioration in the surplus in 2007–08. - Specific observations: - 2007–08 discretionary loosening and expenditure increases created expenditure dependency and depleted resources for downturn smoothing. - In 2009, part of higher deficit was due to automatic stabilizers; discretionary loosening also occurred. - Different cyclical positions of revenue bases and large external imbalances (not captured by potential GDP) can affect CAB interpretation (e.g., private consumption/indirect revenue above potential in 2007–08; PIT and SSC bases above potential in 2008–09 due to wage increases). - Discretionary measures (Box 1 highlights, 2006–09): - ITA: - 2006 Introduction of VAT at a flat rate of 17 percent. - 2008 Association Agreement with EU (lowered import tariffs on EU goods). - 2009 Increase in the road fee (+0.10 KM/l), excises on coffee and progressive increase in excises on tobacco. - 2009 Exemption of IPA funds from VAT. - Federation: - PIT: 2008 rate lowered from 30 percent to 10 percent and exemptions redefined; 2009 unification at the Federation level with elimination of cantonal taxes. - SSC: 2006 introduced new law; 2009 lowered contributions from wages (employees) from 32 percent to 31percent and on wages (employers) from 11,5 percent to 10,5 percent. - RS: - PIT: 2007 new law changed the tax base, introduced exemptions, and progressive rates; 2009 shift in calculation of tax base (net to gross wage) and lower (single) rate (8 percent) and redefined exemptions. - CIT: 2007 new law eliminating exemption on reinvestments. - SSC: 2009 shift in calculation of tax base (net to gross wage) and lower rate (from 42percent to 30.6 percent). - Other expenditure-side developments: progressive increases in wages and social benefits since 2006 in a pro-cyclical fashion; unemployment benefits increased during good times with rights awarded to demobilized soldiers in the Federation in 2006. - Quantitative results (percent of GDP; Fund staff estimates): - Table 1: BiH: Measure of Cyclically Adjusted Balance, 2005-09 (Percent of GDP) - 2005 overall balance: 0.9 - 2006 overall balance: 1.8 - 2007 overall balance: 0.0 - 2008 overall balance: -3.6 - 2009 overall balance: -5.7 - CAB, standard: 2005 1.4; 2006 1.9; 2007 -0.3; 2008 -4.2; 2009 -4.8 - CAB, disaggregated: 2005 1.4; 2006 2.7; 2007 -0.3; 2008 -3.9; 2009 -4.8 - CAB, modified: 2005 -1.5; 2006 1.0; 2007 -1.8; 2008 -6.5; 2009 -5.4 - Output gap: 2005 -1.3; 2006 -0.3; 2007 0.7; 2008 1.2; 2009 -1.9 - Absorption gap: 2005 11.8; 2006 3.7; 2007 7.5; 2008 11.8; 2009 0.8 - Table 2: CABs and the Fiscal Stance, 2006-09 (Differences, in percent) - Standard approach: - Overall balance: 2006 0.9; 2007 -1.8; 2008 -3.7; 2009 -2.0 - Discretionary stance: 2006 0.5; 2007 -2.2; 2008 -3.9; 2009 -0.6 - Automatic stabilizers: 2006 0.4; 2007 0.4; 2008 0.2; 2009 -1.4 - Disaggregated approach: - Overall balance: 2006 0.9; 2007 -1.8; 2008 -3.7; 2009 -2.0 - Discretionary stance: 2006 1.3; 2007 -3.0; 2008 -3.6; 2009 -0.9 - Automatic stabilizers: 2006 -0.4; 2007 1.2; 2008 0.0; 2009 -1.1 - Modified approach: - Overall balance: 2006 0.9; 2007 -1.8; 2008 -3.7; 2009 -2.0 - Discretionary stance: 2006 2.6; 2007 -2.8; 2008 -4.7; 2009 1.1 - Automatic stabilizers: 2006 -1.6; 2007 1.1; 2008 1.1; 2009 -3.1 - Interpretation differences across approaches: - Standard and disaggregated CABs show similar pro-cyclical worsening, with discretionary expansion contributing to deterioration. - Modified CAB diverges notably in 2009: because 2008 absorption boom raised revenues above potential, the cyclically adjusted deficit was higher in 2008, and in 2009 the absorption bust produced a large automatic contraction of revenues; in 2009 the modified approach indicates the overall balance deterioration was largely due to automatic stabilizers while the fiscal stance posted a discretionary contraction of 1.1 percent. ### Incorporating Cyclical Developments into Medium-Term Planning - Role of CABs: - Essential tools for designing and assessing counter-cyclical policies. - Can enhance credibility of medium-term frameworks by separating discretionary actions from automatic stabilizers. - Recommendation: make CAB integral part of budget documents and discussions involving discretionary measures to demonstrate direct effect of policies on underlying fiscal stance and provide market signals. - Medium-term fiscal objective: - Aim to lower the size of government and improve spending efficiency to support inclusion of informal economy, export competitiveness, and currency board sustainability. - Build savings in good times to sustain lower balances during crises. - Considerations for implementing counter-cyclical policy: - Coordination of sub-national governments’ policies to avoid dilution of central fiscal objectives; use intra-governmental transfers to support counter-cyclicality. - Internalize expected reform costs (contingent liabilities from reforms, severance payments, changes in social security contributions, clearance of public enterprise debts) and expected increases in non-discretionary expenditure (pension outlays). - Budget flexibility: reassess revenue earmarking and indexation of expenditures (wages and social benefits) that limit counter-cyclical conduct. - Financing availability and debt sustainability: counter-cyclical policy constrained when savings insufficient, external financing unavailable or costly, or debt sustainability at risk; CAB use can enhance transparency and credibility to contain borrowing costs. - Capacity building: strengthen capacity to analyze CAB indicators, assess cyclical position, and cost reforms. *Prepared by Izabela Karpowicz (FAD). Sources: Fund staff estimates.* ### 21. The Fiscal Council (FC) has the task of coordinating fiscal policies among the ### _cr10347 - 21. The Fiscal Council (FC) has the task of coordinating fiscal policies among the ### Fiscal Council (FC) mandate and operations - The FC has the task of coordinating fiscal policies among the various level of government with a view to ensuring macro-economic stability and fiscal sustainability. - Annual duties: - Adopts the Global Framework of Fiscal Balance and Policies in BiH each May, which includes: - medium-term fiscal targets, - macroeconomic projections, - the distribution of indirect revenue for the coming year, - upper borrowing limits. - Institutional support: - The FC relies on the Advisory Group, responsible for preparation and proposal of decisions and other legal acts adopted by the FC. - The FC could be put in charge of monitoring fiscal policy conduct. ### Advisory Group: proposed expanded functions - Suggested redefinition of functions to include: - ex-post assessment of fiscal policy performance by observing movements in the CAB. - elaborating and publishing macroeconomic projections as input into the Budgets. - assessing governments’ policies against the pre-determined fiscal anchor, with assessments done in light of cyclical developments in revenues and expenditures. - drafting a monitoring report annually or semi-annually. - Transparency recommendation: - The monitoring report should be available to the public and could be published on the government’s web site. ### Conclusions on fiscal stance and policy in the crisis context - Global downturn implications: - Deficits have swelled in countries experiencing revenue shortfalls and/or adopting anti-crisis measures, and in countries maintaining regular spending patterns. - Judgement of fiscal stance must take into account developments outside authorities’ immediate control and recognize the operation of automatic stabilizers. - Recent BiH experience: - Fiscal policy in BiH has been highly pro-cyclical in the recent past. - Over 2007–08, deterioration in the fiscal stance was faster than suggested by traditional balance indicators and only partially related to cyclical factors. - All three CABs show discretionary expansions in 2007 and 2008. - In good times fiscal expansion fueled by public wage and war-related entitlement benefit increases created spending expectations and prevented building savings. - In 2009, counter-cyclicality was partially achieved through further external borrowing. - Discretionary expenditure during the crisis year in the Federation, due to inadequate composition geared towards current spending, did not support economic recovery. - Policy guidance going forward: - Fiscal policy should focus on lowering the size of the government to support debt sustainability, private sector development and currency board stability. - Medium-term objectives should be pursued while countervailing the cycle where possible. - Fiscal policy should allow automatic stabilizers to operate and use well-timed, temporary, and targeted fiscal stimulus when necessary. - The fiscal response should internalize the cost of reforms and contingent liabilities from non-discretionary expenditures. - Although infrastructure needs may justify greater structural deficits, projections for rising health and pension spending due to unfavorable demographic trends call for building up savings ahead of increased demand on entitlements. - Strengthen capacity to cost reforms and incorporate cyclical developments into medium-term planning. ### Public pension systems: overview and urgency of reform - Structure: - BiH public pension system consists of two entity-administered pension funds: one in the Federation, the other in Republika Srpska (RS). - Systems are pay-as-you-go (PAYG), with current workers’ contributions from wages and salaries funding pension payments. - Recent spending trends: - Federation: public pension spending rose from 7.7 percent of GDP in 2005 to 10.0 percent of GDP in 2009. - RS: public pension spending rose from 7.8 percent of GDP to 9 percent of GDP over the same period. - Reform is necessary for credible fiscal sustainability in both entities. ### Pension system design features exacerbating pressures (Box 1) - Accrual structure: - Accrual rates higher for first twenty years than next twenty years; after 40 years retirement is triggered — encourages short contribution careers. - Disability provisions: - Disability pension provisions more generous than old-age pension; broad eligibility standards (including inability to perform one’s last job) create incentives to retire on disability grounds. - Indexation: - Law limiting pension payments notwithstanding, pensions have been effectively indexed to wage growth; this indexation is described as overly generous compared with indexing to inflation or a combination of wage growth and inflation. - System dependency ratios: - System dependency ratios (beneficiaries divided by contributors) are 0.73 in the RS and 0.75 in the Federation. - Demographic population dependency rates (population 65+ divided by population 15–64) are 0.3 in the RS and 0.2 in the Federation. - Contributors coverage: - Only 41 percent of the population aged between 15 and 64 pay contributions in the RS and only 32 percent in the Federation. - Contributing factors: - High numbers of disability and survivor pensions (war-related) and high informalization of the economy reducing contributors. ### Dependency ratios: trends and fiscal implications - Problem statement: - Main pressure comes from unfavorable system dependency ratios—too few paying contributors for the number of pensioners. - Need for policies to increase formal sector employment and contribution compliance; tighten retirement criteria; tie pension calculation more closely to contributory history. - Contribution-rate limits: - Raising contribution rates is not a viable long-term option because current high levels provide disincentives to formal employment and would aggravate dependency ratios. - Political economy: - Across-the-board cuts in pensions (about 30 percent of average wage in the Federation and less in the RS) may not be politically or socially acceptable, risking demands for budget top-ups. ### Quantified fiscal impact of a 10% deterioration in system dependency ratio (Table 2) - Federation: 10% Increase in System Dependency Ratio (2009 -> +10%) - System dependency ratio: 0.75 -> 0.83 - Replacement rate (average pension/average gross wage): 0.34 -> 0.34 - Contribution rate: 0.23 -> 0.23 - Required transfers from budget, millions of KM: 151 -> 276 - Percent of Entity GDP: 1.01.8 - Note: Gross wage is a calculated average wage of the contributors. - Republika Srpska: 10% Increase in System Dependency Ratio (2009 -> +10%) - System dependency ratio: 0.73 -> 0.80 - Replacement rate (average pension/average gross wage): 0.28 -> 0.28 - Contribution rate: 0.17 -> 0.17 - Required transfers from budget, millions of KM: 145 -> 368 - Percent of Entity GDP: 1.84.4 ### Conceptual fiscal framework for PAYG pensions (Box 2) - Basic identity (no budget transfers): - Payroll tax rate (α) = (number of pensioners M / number of active contributors N) × replacement rate (β) - Expressed: N/M · = β α (as presented in the source) - Allowing budget transfers (τ): - (1 − τ) · (M/N) · β = α (expressed in the source as )1( N M - Coverage and demographics: - M/N can be related to demographic dependency ratio (M*/N*) via coverage parameter γ: - )1( * *  N M (as presented in the source) - γ (pension system coverage ratio) depends on system maturity, retirement policies, labor force participation, and labor market conditions. - Policy implication: - Demographic changes, youth emigration, and informal employment reduce N or increase M, implying the need to change contribution rates, benefits, or increase budget transfers to maintain balance. ### Federation privileged pensions - Origin and scope: - Privileged pensions originated from government decrees introduced to facilitate the reform of the BiH military, offering early retirement to military personnel. - Benefits were extended to army volunteers, war veterans and families of fallen soldiers. - Coverage and funding: - As of April 2010, decrees covered about 21,500 beneficiaries. - These pensions are administered by the Federation Pension and Disability Insurance Fund (PIO) but largely funded from general government revenues. - Annual provision is included in the central government’s budget under transfers to other levels of government (i.e., the PIO). *Source: _cr10347 - 21. The Fiscal Council (FC) has the task of coordinating fiscal policies among the* ### 9. In January 2009, an amendment of Article 94 of the PIO Law, recognized the ### 9. In January 2009, an amendment of Article 94 of the PIO Law, recognized the ### Privileged pensions amendment and fiscal impact - Amendment of Article 94 of the PIO Law (January 2009) recognized existing provisions for double-counting of years of service for members of BiH Army, the Croatian Defense Council and police forces during the 1992–95 war as budget liabilities. - By end-2009 about 78,000 veterans used this provision creating a new obligation of the central government budget toward the pension fund in an annual amount of KM 71 million. - With this amount included, total annual obligations of the central government budget toward the PIO reached KM 190 million in 2009 (1.2 percent of GDP). - During Jan–March 2010 the number of veterans increased to 80,000 thousand raising the annual obligation to KM 77 million (0.5 percent of GDP). - Footnote: In 2009 the central government’s current obligations toward the PIO amounted to KM 181 million, but the government transferred only half of that amount, prompting the PIO to run down its reserve fund to meet these obligations toward ultimate beneficiaries. ### Risks to the contributory pension scheme - Rapid increase in the number of beneficiaries is a key risk (the number of war veterans using double-counting of years of service could go up for as many as soldiers during the 1992–95 war). - Relatively high average pension entitlement for privileged beneficiaries. - Although payment obligations related to privileged pension beneficiaries are expected to be funded from general government revenues, a strapped central budget increases the temptation to squeeze conventional pensions to accommodate privileged pension demands. ### Reform recommendations and intermediate steps - Reform of the privileged pension component needs to be a priority within the overall pension reform strategy. - Intermediate steps to gain better control over this spending category: - Strictly enforcing the existing eligibility criteria. - Tightening the eligibility criteria. - Partly aligning the average privileged pension with the public pension system’s average. - Today, the average privileged pension is 1.43 times higher than the system average; equalizing it with the system average would reduce privileged pension spending by 30 percent. - Any reduction in the level of privileged pensions would need to be done selectively, rather than across the board, because of great disparity in individual pensions—many beneficiaries receive pensions that are below KM 300. ### Conclusions on pension system pressures - The two entity pension funds, administered on a pay-as-you-go principle, have been under increasing financial pressures—from demographic trends, deterioration of the general fiscal situation, and the design of the pension systems themselves. - Expenditure on public pensions has been one of the fastest-growing components of public expenditure in the two entities. - High and rising system dependency ratios—too few paying contributors relative to the number of pensioners—are a symptom of system weakness. - In the Federation, the system of privileged pensions (with early retirement benefits for selected groups) poses risks to the contributory pension system. - Quadrupling in the number of beneficiaries in the last three years and the corresponding increase in budget cofinancing requirements have strained the Entity budget and resulted in a run-up of arrears in payment obligations of the budget toward the PIO. ### Steps to put public pension systems on a sound footing - Tackle disincentives to formal sector employment and take measures to raise contribution payment compliance. - Introduce further parametric changes, including: - An increase in the retirement age. - An increase in the length of required contributory service. - Reform the system of privileged pensions. - Status of reforms: - The Federation government adopted a pension reform strategy in June; the strategy needs greater detail and public debate before Parliament consideration and before it can serve as a blueprint for implementation. - The RS Parliament has adopted the RS pension strategy and the government is ready to begin implementation immediately after the October election. ### Key statistics and table excerpts (preserve original figures) - End-2009 usage and obligations: - Number of veterans using Article 94 provision by end-2009: about 78,000. - New central government annual obligation toward the pension fund from this provision: KM 71 million. - Total annual obligations of the central government budget toward the PIO in 2009 (with this amount included): KM 190 million (1.2 percent of GDP). - Jan–March 2010: - Number of veterans: 80,000 thousand. - Annual obligation raised to: KM 77 million (0.5 percent of GDP). - Average privileged pension relative to system average: 1.43 times higher. - Equalizing privileged average pension with system average would reduce privileged pension spending by 30 percent. - Many beneficiaries receive pensions below KM 300. *Source: IMF staff summary of Federation pension provisions and analysis as presented in the original document.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10347.pdf_