March 25, 2022
PRESS OFFICER: Wafa Amr
Phone: +1 202 623-7100Email: MEDIA@IMF.org
Sarajevo, Bosnia and Herzegovina:
The war in Ukraine is casting a pall on the European economy, presenting new challenges for Bosnia and Herzegovina just as it rebounded from the Covid-19 crisis. Prospects for economic activity are further affected by domestic tensions and lack of consensus on reforms to enhance the integration of the economy internally and with international markets. The most immediate economic impact of the war is the large increase in food and fuel prices, which is already hitting hard many households and firms and will last for some time.
The right response is to significantly raise public support for the most vulnerable, while avoiding tax or excise reductions, which are costly and poorly targeted. This is also the right time to further strengthen the financial stability framework, where the recent Sberbank episode has highlighted the need to close gaps. An immediate priority is to set up a single bank resolution fund to facilitate bank restructuring and provide liquidity in exceptional cases. The currency board remains an anchor of stability in an otherwise uncertain environment.
Looking further ahead, structural reforms are critical to improve the business environment, stimulate private-sector employment, and tackle corruption. Work on these reforms needs to resume as soon as possible.
Economic outlook
Bosnia and Herzegovina’s (BiH) economy has recovered from the Covid-19 pandemic. Growth is estimated to have accelerated to 5.8 percent in 2021, fueled by strong external demand, pent-up domestic spending, and a rebound in tourism. Strong economic activity also reflected the authorities’ Covid-related measures and their decision to not impose lockdowns during the Delta and Omicron variants despite a surge in cases amid vaccine hesitancy.
The outlook is highly uncertain given the ongoing war in Ukraine and domestic political tensions. Initial effects of the war were felt in the financial sector and on confidence, as well as on households’ spending on food and transportation. Although direct economic ties with Russia and Ukraine are limited, BiH’s economy is vulnerable to soaring commodity prices, slower economic growth in Europe, and tighter financial conditions as a result of the war. Domestically, political tensions, including regarding the role of state-level institutions, have paralyzed reforms and weighed on investor sentiment. We expect growth to moderate to 2½ percent this year and average annual inflation to accelerate to 6.5 percent, but our forecast is subject to high uncertainty. Delays in government formation after the October general elections could further undermine economic prospects, while the potential emergence of new Covid variants poses another risk.
Fiscal policy
The rebound in economic activity helped restore fiscal balance. The fiscal stance is estimated to have turned from deficit (4.7 percent of GDP) in 2020 to neutral in 2021. Revenues collected by the Indirect Tax Authority reached a record high level, driven by strong private consumption and higher prices. External financing was ample, with financing from the IMF (€306 million SDR allocation) and the European Union (€125 million macro-financial assistance) adding to a €300 million Eurobond issuance by the Republika Srpska. On the expenditure side, the authorities appropriately reduced pandemic-related fiscal support.
Fiscal policy should cushion the impact of high food and fuel prices on the most vulnerable and retain buffers given the uncertain outlook . The economic slowdown will lead to less revenue growth and a larger fiscal deficit. We strongly advise against introducing differentiated VAT rates to address inflation. A reduced rate on essential items is a costly and poorly targeted instrument for providing benefits to low-income households. Moreover, multiple rates would increase opportunities for fraud. The authorities should aim instead to provide temporary, targeted assistance to vulnerable households. Given the inadequate social safety net, a suspension of fuel excises could be considered on a temporary basis. Although also costly and poorly targeted, it is preferable to permanent changes in tax policy. In parallel, the authorities should seek to improve the social safety net to be better prepared for future shocks. Public-sector wages are already competitive and should not be increased further as this would exacerbate inflationary pressures and worsen the composition of public spending.
Available fiscal space should be used to scale up public investment. The country has large and pressing investment needs in road infrastructure and green energy, together with a low debt level. The authorities should use fiscal space to scale up public investment, preferably through low-cost, long-term financing from international financial institutions.
Financial sector policies and currency board arrangement
The banking sector weathered the Covid-19 crisis well. Banks remained well capitalized and profitable, while nonperforming loans continued to decline. The recent European Commission determination that the regulatory and supervisory framework in BiH is equivalent to EU standards is a major achievement of the banking agencies.
But the recent Sberbank event has highlighted the urgent need to close gaps in the financial safety net. A deposit run on the BiH Sberbank subsidiaries took the two banks from healthy to the brink of failure in a few days. Prompt action by the supervisors facilitated the sale of the banks and prevented the deposit run from spreading. The episode highlighted, once again, the urgent need to create a single resolution fund that can facilitate bank restructuring and provide liquidity on an exceptional basis. A stronger financial safety net will also require better collaboration among state- and entity-level authorities. With the outlook highly uncertain, the authorities should step up monitoring and enhance preparedness to deal with future liquidity or solvency pressures.
The currency board continues to serve BiH well. Throughout the pandemic, and more recently during the Sberbank episode, the currency board has provided stability by maintaining public confidence in the currency. The central bank recently enhanced its reserve requirement framework by aligning the remuneration on commercial bank reserves with the opportunity cost of holding foreign assets, which will help strengthen its balance sheet. Calls for the central bank to finance entity budgets or provide liquidity to commercial banks are misguided and threaten the stability of the currency board.
Governance and other reforms
Reforms to public procurement and the AML/CFT framework are critical to improve governance. Governance weaknesses are widespread, contributing to economic inefficiencies and deterring foreign investment. The public procurement framework is inadequate and prone to corruption; the law should be amended, enforcement strengthened, and beneficial ownership information of firms awarded procurement contracts published. To strengthen the AML/CFT framework, the authorities should correct deficiencies in the AML/CFT law and establish a country-wide registry of bank accounts of individuals. Digitalization, including the use of e-procurement, has the potential to enhance transparency and boost productivity.
Broader reforms are needed to reduce the income gap with the EU and transition to a greener economy. Placing BiH on a higher growth path will require political consensus on reforms to improve the business environment, strengthen the single economic space, and integrate BiH more closely into international markets. Broad reforms are also needed to increase private sector employment and bring more efficiency and transparency to public enterprises. A successful transition to a greener energy sector will require phasing out coal, expanding the natural gas market, and exploiting BiH’s ample wind and solar potential. Finally, progress along all these fronts will make the BiH a more attractive place to live for many of its citizens and thereby reduce the steady loss of its people to other European countries.
The mission thanks the authorities and all other counterparts for the constructive and insightful discussions in Sarajevo and Banja Luka.
