Bosnia and Herzegovina: Final Statement of the 2022 Mission Services under Article IV
March 25, 2022
A closing statement describes the preliminary findings of IMF staff at the end of an official staff visit (or “mission”), in most cases to a member country. Missions are carried out within the framework of regular (usually annual) consultations under Article IV of the IMF Articles of Agreement, within the framework of a request for the use of IMF resources (borrowing from the IMF), within the framework of discussions on the programs followed by the services or within the framework of other services of surveillance of the economic evolution.
The authorities consented to the publication of this statement. The views expressed in this statement are those of IMF staff and do not necessarily represent the views of the IMF Executive Board. Based on the preliminary findings of this mission, staff will prepare a report which, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
The war in Ukraine casts a shadow over Europe’s economy, presenting new challenges for
Bosnia and Herzegovina as it recovered from the Covid-19 crisis. The outlook for economic activity is further affected by domestic tensions and the lack of consensus on reforms aimed at further integrating the economy within and with international markets. The most immediate economic impact of the war is the sharp rise in food and fuel prices, which is already hitting many households and businesses hard and will last for some time.
The right answer is to significantly increase public support for the most vulnerable, while avoiding tax or excise cuts, which are costly and poorly targeted. It is also a good time to further strengthen the financial stability framework, where the recent episode of Sberbank has highlighted the need to fill the gaps. An immediate priority is to set up a single bank resolution fund to facilitate the restructuring of banks and provide liquidity in exceptional cases. The currency board remains an anchor of stability in an otherwise uncertain environment.
In the longer term, structural reforms are essential to improve the business environment, boost private sector employment and fight corruption. Work on these reforms should resume as soon as possible.
The economy of Bosnia and Herzegovina (BiH) has recovered from the Covid-19 pandemic.
Growth is estimated to have accelerated to 5.8% in 2021, fueled by strong external demand, pent-up domestic spending and a rebound in tourism. The strong economic activity also reflected authorities’ Covid-related measures and their decision not to impose a lockdown during the Delta and Omicron variants despite an increase in cases amid vaccine hesitancy.
The outlook is highly uncertain given the ongoing war in Ukraine and domestic political tensions.
The first effects of the war were felt in the financial sector and on confidence, as well as on household spending on food and transport. Although direct economic ties with Russia and Ukraine are limited, BiH’s economy is vulnerable to soaring commodity prices, slowing economic growth in Europe and tighter financial conditions due to the war. Domestically, political tensions, particularly over the role of state-level institutions, have paralyzed reforms and weighed on investor confidence. We expect growth to slow to 2½% this year and average annual inflation to accelerate to 6.5%, but our forecast is subject to significant uncertainty. Delays in government formation after October’s general election could further undermine the economic outlook, while the potential emergence of new variants of Covid poses another risk.
The rebound in economic activity helped restore fiscal balance.
The fiscal stance is estimated to have shifted from deficit (4.7% of GDP) in 2020 to neutral in 2021. Revenue collected by the administration from indirect taxes has reached a record high, driven by strong private consumption and higher prices. External financing has been abundant, with funding from the IMF (€306 million allocation of SDRs) and the European Union (€125 million macro-financial assistance) in addition to a Eurobond issue of 300 million euros by the Republika Srpska. On the expenditure side, the authorities have appropriately reduced pandemic-related fiscal support.
Fiscal policy should
cushion the impact of high food and fuel prices on the most vulnerable and maintain reserves given the uncertain outlook
The economic slowdown will lead to lower income growth and a larger budget deficit. We strongly advise against introducing differentiated VAT rates to combat inflation. A reduced rate on essential items is an expensive and poorly targeted instrument for providing benefits to low-income households. In addition, multiple rates would increase the possibility of fraud. Authorities should instead focus on providing temporary and targeted assistance to vulnerable households. Given the inadequacy of the social safety net, a suspension of excise duties on fuels could be envisaged on a temporary basis. While also costly and poorly targeted, it is preferable to permanent tax policy changes. At the same time, the authorities should seek to improve the social safety net in order to be better prepared for future shocks. Public sector wages are already competitive and should not be increased further as this would aggravate inflationary pressures and deteriorate the composition of public spending.
The available fiscal space should be used to increase public investment.
The country has significant and pressing investment needs in road infrastructure and green energy, as well as a low level of debt. The authorities should use the fiscal space to increase public investment, preferably through long-term, low-cost financing from international financial institutions.
Financial sector policies and currency board regime
The banking sector has weathered the Covid-19 crisis well.
Banks remained well capitalized and profitable, while nonperforming loans continued to decline. The recent decision by the European Commission that the regulatory and supervisory framework in Bosnia and Herzegovina is equivalent to EU standards is a major achievement of bank branches.
But the recent Sberbank event has highlighted the urgent need to close gaps in the financial safety net.
A deposit run on BiH Sberbank subsidiaries took the two banks from good health to the brink of bankruptcy within days. Swift action by supervisors facilitated the sale of banks and prevented the deposit rush from spreading. The episode highlighted, once again, the urgency of creating a single resolution fund that can facilitate the restructuring of banks and provide liquidity on an exceptional basis. A stronger financial safety net will also require better collaboration between state and entity level authorities. With the outlook highly uncertain, authorities should step up surveillance and improve their preparedness to deal with future liquidity or solvency pressures.
The currency board continues to serve BiH well.
Throughout the pandemic, and most recently during the Sberbank episode, the currency board has provided stability by maintaining public confidence in the currency. The central bank recently improved its reserve requirement framework by aligning commercial bank reserve remuneration with the opportunity cost of holding foreign assets, which will help strengthen its balance sheet. Calls on the central bank to fund 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 key to improving governance.
Weaknesses in governance are widespread, contributing to economic inefficiencies and deterring foreign investment. The public procurement framework is inadequate and prone to corruption; the law must be amended, its enforcement strengthened and information on the beneficial owners of companies that have obtained supply contracts must be published. To strengthen the AML/CFT framework, the authorities should address loopholes in the AML/CFT law and establish a national register of retail bank accounts. Digitization, including the use of e-procurement, has the potential to improve transparency and boost productivity.
Broader reforms are needed to reduce the income gap with the EU and the transition to a greener economy.
Putting BiH on a higher growth trajectory will require political consensus on reforms aimed at improving the business environment, strengthening the single economic space and integrating BiH more closely into international markets. Wide-ranging reforms are also needed to increase employment in the private sector 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 harnessing Bosnia and Herzegovina’s vast wind and solar potential. Finally, progress on all these fronts will make Bosnia and Herzegovina a more attractive place to live for many of its citizens and thus reduce the steady loss of its population to other European countries.
The mission thanks the authorities and all other counterparts for the constructive and instructive discussions in Sarajevo and Banja Luka.
IMF Communications Department
PRESS OFFICER: Wafa Amr
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