Press Release No. 00/82

The International Monetary Fund's (IMF) Executive Board today approved the extension of Bosnia and Herzegovina's stand-by credit by two months to May 29, 2001. This decision was made in conjunction with the completion of the fourth and fifth reviews of Bosnia and Herzegovina's economic program under the stand-by credit, and makes an amount equivalent to SDR 16.16 million (about US$21 million) available immediately.

The stand-by credit, which was approved May 29, 1998, totals an amount equivalent to 94.42 million (about US$122 million), of which an amount equivalent to SDR 64.3 million (about US$83 million) has already been disbursed.

Following the Executive Board discussion on Bosnia and Herzegovina, Stanley Fischer, First Deputy Managing Director and Acting Chairman said:

"Bosnia and Herzegovina has made welcome progress toward macroeconomic stability and country-wide acceptance of the convertible marka, thanks to the policy of fiscal restraint and strict adherence to the rules of the currency board. The authorities have successfully implemented policies, following fiscal slippages earlier in 2000, to partially reverse the unsustainably-high wage and pension increases.

"Nevertheless, Bosnia and Herzegovina faces serious challenges in the period ahead, and it will be important to continue the stabilization effort into 2001. The overall fiscal stance adopted in the draft 2001 budgets is appropriate, and the Fund's Directors strongly supported the reduction of budgeted military expenditure. They also endorsed the authorities' medium-term goal of increasing capital expenditure while lowering the expenditure-to-GDP ratio, noting that this will take on increasing importance in the years ahead, when foreign-financed reconstruction spending declines, as envisaged.

"With regard to structural reforms, Directors warmly welcomed the major efforts made in the financial sector, labor market, and small-enterprise privatization, and the authorities commitment to increase transparency by bringing all military expenditure on-budget in 2002. However, Directors stressed that the Bosnia and Herzegovina authorities need to maintain the reform momentum in order to create an environment conducive to private sector activity. In particular the authorities need to follow through with the end year closure of the payments bureaus, by improving financial management, implementing tax and social welfare reform, completing the financial sector reform, and making significant progress with large-scale privatization." Mr. Fischer said.

ANNEX

Background

Bosnia and Herzegovina's economy is continuing its recovery from the devastation of war and overcoming the adverse effects of the Kosovo conflict with the aid of large inflows of foreign assistance. Real GDP growth is estimated to have been 9 percent in 1999 and, despite the adverse effects of a severe drought on agricultural production, is projected to reach about 10 percent in 2000 and about 14 percent in 2001. Industrial production, which fell in 1999 in the Republika Srpska and showed modest growth in the Federation, has been exhibiting a sustained and broad recovery in the first half of 2000. Nevertheless, production in most traditional industries remains at less than half its pre-war level which, combined with weak legal frameworks for the labor and financial markets, keeps unemployment high. Inflation, which was low in both Entities in the first half of 2000, rose in the third quarter, reflecting the severe drought in the region. In the Federation, inflation over the 12-month period ending in September 2000 was only 3.5 percent. In the Republika Srpska, which has a greater share of GDP devoted to agriculture and was therefore more affected by the drought, the 12-month inflation rate rose to 16.9 percent by September 2000.

The government's main objectives under the program remain to move toward fiscal sustainability through tax and expenditure reform and to foster market development.

Fiscal Policy

Faced with substantial financing gaps under policies implemented during the first half of 2000, both Entities' parliaments approved major revisions of the 2000 budgets in the third quarter. The revised budgets aim to maintain macroeconomic stability while supporting the return of refugees. They are consistent with the injunction not to borrow domestically and to limit external borrowing to loans on concessional terms. Expenditures on wages and goods and services were lowered to make room for increased spending on refugees and displaced persons, foreign debt-service transfers to the State (Federation), and transfers to social funds and war invalids (Republika Srpska). Revenue measures included in the revised 2000 budgets focused on enhancing tax enforcement. Those corrective fiscal measures will close the budget gaps for 2000, while allowing for higher than originally budgeted expenditures on refugees and displaced persons.

Furthermore, the authorities have made some progress in the area of fiscal transparency. They also intensified their efforts to reform the sales tax system and are planning to rationalize operations of the pension funds to bring pension entitlements in line with available resources. In the 2001 budgets, the authorities will focus their efforts on shifting the composition of overall spending away from recurrent and nonproductive expenditure.

Monetary Policy

The evolution of monetary aggregates in 1999-2000 continued to be governed by demand for foreign currencies, in line with currency board rules. Monetary developments in 1999 and the first nine months of 2000 therefore reflected the increasing acceptance of the convertible marka as well as continued slow growth of private sector credit. In 1999, a portfolio shift into convertible marka contributed to a 40 percent growth in broad money and a US$264 million increase in gross reserves. The shift from foreign to domestic currencies has since moderated, and gross reserve growth in 2000 is projected to slow to US$40 million. With continued modest growth in net domestic assets, broad money is expected to increase by only 13 percent by end-year.

Structural Policy

Significant progress was made during the first half of 2000, particularly in overhauling the payments system and strengthening bank supervision, while enterprise privatization gathered momentum. However, reform in some areas continues to be slow. The authorities have intensified their efforts to accelerate enterprise privatization, but the technical complexities involved have slowed progress. Despite high unemployment, major strides have been made in labor market reform. In this regard, the authorities have begun the reform of the social protection system in order to provide social safety net for workers who are vulnerable to retrenchments that will follow the privatization of state-owned enterprises.

In the area of banking, much progress has been made in strengthening bank regulation and supervision. Preparations to close the payments bureaus and transfer their clearing functions to commercial banks are well advanced. However, progress in privatizing or liquidating state-owned banks has been patchy. The authorities also continue to advance in implementing their trade reform program.

Bosnia and Herzegovina joined the IMF on December 14, 1992.The member's quota¹ is SDR 169.1 million (about US$218 million). Bosnia and Herzegovina's outstanding use of IMF credits totals SDR 68.1 million (about US$88million).

Bosnia and Herzegovina: Main Economic and Financial Indicators, 1996-2001 1/   1996 1997 1998 1999   2000   2001         Prel.   Prog.   Proj. Population (millions) ... ... 3.7 ...   ...   ... Nominal GDP (millions of KM)                 BiH 4125 6116 7,141 8,043   9,075   10,609 Federation 3049 4748 5,407 5,833   6,434   7,465 Republika Srpska 1076 1368 1,734 2,210   2,641   3,144 Industrial production (percent change) 2/                 Federation 88 36 24 11   15 7/ ... Republika Srpska 39 27 23 2   12 7/ ... Federation employment (end-period, thousands) 3/ 244 288 336 356   360 7/ ... Wages (KM/month) 4/                 Federation 296 493 524 551   597 7/ ... Republika Srpska 5/ 85 138 ... ...   392 7/ ...   (Percent change) Real GDP (annual average) 86 40 13 9   10   14 CPI (twelve-month average)                 Federation (In KM terms) -25 14 5 0   2 7/ 2 Republika Srpska (In YUD terms) 66 3 38 ...   ...   ... Republika Srpska (DM/KM-based index) 6/ 17 -7 2 14   10 7/ 4   (Change in percent of opening broad money) Money and credit 8/                 Broad money 96 52 31 40   13   17 Foreign assets (net) 60 -11 1 38   -3   6 Domestic assets (net) 36 63 30 2   16   11   (In percent of GDP) Fiscal balances                 Federation                 Revenue 10 13 13 12   13   12 Expenditure 13 14 14 14   16   13 Balance 9/ -3 -1 -2 -1   -3   -2 Republika Srpska 10/                 Revenue 24 15 21 30   26   23 Expenditure 24 15 26 35   30   26 Balance 9/ 0 0 -5 -5   -4   -3   (In millions of U.S. dollars; unless otherwise indicated) External current account balance 11/ 12/ -1,306 -1,482 -986 -1,058   -942   -1,022 Exports 12/ 336 575 697 649   732   877 Imports 12/ -1,882 -2,333 -2,656 -2,502   -2,338   -2,495 CBBH gross reserves 13/                 In millions of U.S. dollars 235 80 175 455   488   538 In months of merchandise imports 1.2 0.4 0.7 2.0   2.3   2.4 External debt 14/                 (In millions of U.S. dollars) 3,620 4,076 2,985 3,095   2,632   2,763 (In percent of GDP) 132 119 74 71   62   61 Short-term debt ... ... ... ...   ...   ... Debt service (in percent of exports of goods and                 nonfactor services) 53 16 -12 -12   -11   -12 Memorandum items:                 Exchange rates (period average)                 Convertible marka (KM) per deutsche mark ... 1.0 1.0 1.0   1.0   1.0 BiH dinar per deutsche mark 15/ 100 100 ... ...   ...   ... FR Yugoslav dinar per deutsche mark 16/ 3.5 3.9 6.4 ...   ...   ...                   Sources: Data provided by the authorities; and IMF staff estimates.               1/ Data refer to the entire country, unless otherwise indicated. Intrayear data refer to flows cumulative in the year unless otherwise noted. 2/ Annual production, percent change over previous year. Figure for 1995 refers to the entire country.           3/ Excludes people formally employed but not working ("waiting"). Data for 1997 and 1998 include military personnel.     4/ Data refer to average of monthly gross wages paid in the year (first eleven months of 1999), not to average earnings in the period; only firms paying wages in a particular month are included in the data. 5/ Until end-1997 FR Yugoslav dinar (YUD) wages converted into DM using the parallel market exchange rate described in footnote 16.Thereafter, reliable estimates are not available owing to problems with exchange rate conversion. 6/ Until mid-1998 prices were observed in YUD and converted into DM/KM at exchange rates described in footnote 16.     7/ Data as of June 2000; industrial growth in the first six months of 2000 relative to same period a year before; employment and wages for the Federation as of May 2000; 12-month inflation as of July 2000. 8/ Country-wide monetary aggregates. In percent of beginning of year broad money stock.           9/ Before grants.                 10/ Excludes municipal government operations. Data for 1996 exclude military expenditures financed by external grants.     11/ Excluding official transfers.                 12/ Data for 1994-99 are rough estimates for the whole territory of Bosnia and Herzegovina.           13/ Excluding earmarked funds and blocked accounts as well as foreign exchange held by Payments Bureaus.         14/ Projected external debt and debt service for 1998 exclude debt relief.               15/ Official rate. Parallel rate not collected by the Central Bank of BiH. The BH dinar was replaced by the convertible marka (KM) in mid-1998. 16/ YUD/DM exchange rate in the parallel market in the Belgrade, as reported by the National Bank of FRY through end-1998.     1A member's quota in the IMF determines, in particular, the amount of its subscription, its voting weight, its access to IMF financing, and its allocation of SDRs.