Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Bosnia and Herzegovina

July 24, 2007

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.

Public Information Notice (PIN) No.07/85
July 24, 2007

On July 16, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bosnia and Herzegovina.1


Bosnia and Herzegovina labors under a complex political system, which causes fragmentation and duplication of many domestic policy functions, and weakens incentives for cooperation between the Entities and the State. A modest first-round attempt at constitutional reform failed in 2006; key measures, like police reform—a condition for signing the Stabilization and Association Agreement with the EU—are stalled; and policy coordination is weak.

The economy is nevertheless enjoying its fourth consecutive year of stable growth underpinned by the currency board. Export growth of 29 percent on the back of productivity gains, export price increases, and improvements in reporting following the introduction of the value added tax (VAT), combined with robust domestic demand, pushed real GDP up 6 percent in 2006. The currency board anchored prices: headline inflation, reflecting the VAT effect and administered price hikes, averaged 7 percent last year but declined to 1½ percent in early 2007. The recorded current account deficit was almost halved last year to 11.5 percent of GDP reflecting the improvement in the trade gap. Bank borrowing and other unidentified inflows pushed official reserves to €2.9 billion (5¼ months of imports) at end-April 2007.

The pace of financial deepening, a key contributor to growth, is consistent with regional trends, although supervision has weaknesses. After an initial surge, steady private sector credit growth of about 25 percent annually has financed activity and contributed to a gradual increase in the credit-to-GDP ratio. On the supply side, credit expansion is stimulated by competition and consolidation in the banking sector, which is dominated by foreign banks, and financed largely by lending from these banks to their local affiliates. Although bank soundness indicators are good and improving, a number of weaknesses remain in supervision, notably its fragmentation into two Entity-based agencies. While this has not been addressed, the inclusion of individuals in the credit registry in 2007, was a key step toward better risk management.

Fiscal policy has thus far been prudent and public debt low, though the size of the government is large. The VAT introduced on January 1, 2006 generated a surge of revenue, partly due to one-off factors, while the share of expenditures was kept at its 2005 level. The general government thus recorded a surplus of 3 percent of GDP in 2006. At about 50 percent of GDP, the size of the government is large, reflecting inefficiencies and duplication of functions. At the same time, at 23 percent of GDP at end-2006, public debt is low. Even after the planned bond issuance to cover outstanding domestic claims against the government—projected to raise the debt-to-GDP ratio by some 25 percentage points over the next three years—the debt will still be low in net present value terms, as most of it is concessional. The introduction of statutory borrowing ceilings for all levels of government was a major step toward fiscal discipline: though not yet binding, these ceilings could be effective in limiting fiscal deficits in the future.

This good overall picture reflects a benign external environment and the effects of past economic reforms. Growth in Bosnia and Herzegovina's trading partners was strong. World prices of metals—a key export—rose 55 percent in 2005-06. Low world interest rates facilitated the financing of the current account deficit. Although Bosnia and Herzegovina generally lags behind the region in terms of structural reforms, certain reforms in specific sectors have had a sizeable impact: industrial production and exports of key products, such as steel and aluminum, benefited from foreign investment; the successful introduction and administration of the VAT led to the good fiscal outcome in 2006; last but not least, the process of financial deepening was spurred by the privatization and opening of domestic banks to foreign participation.

Executive Board Assessment

Executive Directors welcomed the continued strong growth with low inflation, and the recent marked improvement in the external balance in Bosnia and Herzegovina, which they attributed largely to the effects of past structural reforms in key sectors and the benign international environment, as well as to the benefits of the currency board.

Directors considered that the good economic performance offers an opportunity to tackle long-standing distortions that currently limit the economy's long-term growth potential: the large and inefficient public sector, segmented labor market, and overregulated business environment. While recognizing the institutional complexity for policy making, Directors underscored the need for far-reaching additional reforms. In particular, they encouraged the authorities to improve policy coordination, take steps to put the fiscal position on a sustainable path, strengthen financial stability, and accelerate structural reforms to sustain competitiveness and facilitate private sector development.

Directors expressed concern about the prospects of fiscal deterioration in 2007. They encouraged the authorities to adhere to the original budget spending plans in the Republika Srpska (RS) and to generate savings in the Federation's central government budget in order to offset the deficits likely to arise in the cantons. From a longer-term perspective, Directors welcomed the adoption of the statutory borrowing limits, but cautioned that they would not be sufficient to ensure medium-term sustainability. They stressed that a comprehensive medium-term policy framework is needed, targeting an overall general government balance, in light of the requirements of the currency board and uncertainties regarding the size of government liabilities. In this context, Directors stressed the importance of ensuring that domestic claims against the government, including for financial restitution, are kept at fiscally sustainable levels, and that private-public partnerships are used only once an appropriate institutional framework has been put in place.

Directors welcomed the progress in privatization, noting that the large expected receipts could help finance one-off priority expenses. They endorsed the RS plans to use privatization receipts for pension reform, but several Directors cautioned against financing private business development in strategic sectors.

Directors underscored the importance of improving fiscal policy coordination. They welcomed the authorities' intention to establish a firm legal basis for the Fiscal Council, and recommended that the current draft expand the definition of the general government to cover all public investment and strengthen penalties for noncompliance. Directors emphasized that effective coordination and good fiscal outcomes will not be possible without the political will to cooperate.

Directors noted that recent export trends are reassuring about Bosnia & Herzegovina's external competitiveness position. At the same time, the external balance is dependent on performance of a few key sectors and vulnerable to commodity price shifts. To sustain these export trends, diversify the export base, and safeguard external competitiveness and the viability of the currency board, Directors encouraged the authorities to accelerate structural reforms. In particular, they called for actions to restructure the corporate sector, improve the business environment, make the country more attractive for foreign investment, and deregulate the labor market. Advancing internal integration will require harmonizing corporate income taxation and the system of social contributions, and ensuring portability of pension and health benefits and facilitating labor mobility.

Directors noted that financial sector indicators have remained largely positive. They considered that maintaining financial stability in the presence of rapid credit growth requires further improving credit risk management, closing gaps in nonbank oversight, and unifying bank supervision. Directors favored tightening loan loss classification, raising penalties for noncompliance, and relaxing maturity matching requirements as a way to boost system soundness and weaken the link between credit expansion and foreign borrowing.

Directors welcomed the recent progress in improving national accounts statistics achieved with the help of Fund technical assistance, but noted that major problems remain in the timeliness and coverage of general government statistics and quality of balance-of-payments estimates. Directors encouraged the authorities to step up their efforts to improve data quality, including by leveraging technical assistance from donors and following up on their recommendations.

Bosnia and Herzegovina: Selected Economic Indicators, 2003-07
  2003 2004 2005 2006 2007  
        Est. Proj.  
  (Percent change)

Real GDP

3.5 6.1 5.0 6.0 6.0  

CPI (period average) 1/

0.5 0.3 3.6 7.5 2.5  

Money and credit (end of period)


Broad money

10.0 24.3 18.2 24.7 21.0  

Domestic credit

25.4 31.1 27.7 20.6 22.0  

Of which: credit to the private sector

24.8 27.5 27.5 23.3 25.5  
  (In percent of GDP)

General government budget



50.4 47.5 48.8 50.6 49.0  

Expenditure (on a commitment basis)

52.2 48.1 47.8 47.6 50.4  

Overall balance

-1.8 -0.5 1.0 3.0 -1.4  

External public debt

30.2 27.5 27.5 22.9 20.5  

NPV of external public debt

23.1 21.0 21.0 17.5 15.7  

Total public debt

30.6 27.5 27.5 23.4 39.4  
  (In millions of euros)

Balance of payments


Exports of goods and services

1,939 2,402 2,905 3,575 4,134  

Imports of goods and services

5,313 5,704 6,465 6,495 7,431  

Current account balance

-1,439 -1,482 -1,750 -1,044 -1,357  

(In percent of GDP)

-20.9 -19.7 -21.7 -11.5 -13.4  

Gross official reserves

1,422 1,768 2,145 2,761 3,254  

(In months of imports)

3.2 3.7 4.0 5.1 5.3  

External debt service

289.4 364.0 234.1 318.9 322.0  

(In percent of exports of goods and services)

14.9 15.2 8.1 8.9 7.8  

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)

91.9 90.5 91.1 91.4 ...



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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