Bosnia and Herzegovina

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Bosnia and Herzegovina Economic
ReformAchievements, Challenges and Priorities

• Consultative Group Meeting
• Sarajevo
• September 22-23, 2004

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Outline of presentation

• Main achievements to date and key remaining
  weaknesses
• Major challenges for achieving sustained growth
  and higher employment while increasingly
  integrating into European structures
• Selecting/designing priority reforms for
  achieving these goals

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MAIN ACHIEVEMENTS AND KEY REMAINING
WEAKNESSES
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Significant progress in reconstruction, macro
policy and state-building

• Post-conflict reconstruction supported by large
  aid flows is nearing successful completion.
• The currency board, backed by debt restructuring
  and phased fiscal adjustment (to small surplus in
  2003), laid the foundations for macro stability.
• Recent advances in public financial management
  (expenditure framework, tax policy) and
  state-building, including enhanced internal
  harmonization and state-level coordination.

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and in some important but difficult areas of
structural reform

• Foreign trade extensively liberalized, including
  bilateral FTAs with sub-regional trading
  partners, and enhanced access to EU market (ATMs)
• Developed a largely privatized competitive
  banking system, including enforced regulatory and
  supervisory functions.
• SMEs privatized and faced with hard budget
  constraints.
• Reformed labor code.
• Social protection (first pensions, recently
  veterans benefits).
• MTDS and SAp.

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has already brought important positive results

• GDP trebled since 1995, extreme poverty
  eliminated
• Much enhanced macro stability (inflation,
  reserves and debt indicators, confidence in
  currency)
• Some redirection of trade towards EU and Croatia
• Foreign direct investment doubled from 2000 to
  2003, reaching close to 5 percent of GDP. Total
  FDI since the end of the war over US1.6 billion
• SME sector shows increasing promise (behaving
  commercially, paying on time, creating new jobs)

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However, significant vulnerabilities remain

• Slowing growth, declining aid flows and
  large/persistent current account deficit pose
  risks for sustained growth.
• After a rapid initial burst, export growth has
  stagnated and goods exports remain much too low
  (10 of GDP).
• External/government creditworthiness remains
  elusive.
• GDP still well below pre-war level, with 20
  living below poverty line.
• Some 30 near-poor could slip into poverty were
  the economy hit by a negative shock.

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and reforms are far from complete

• Lost decade of war plus the twin challenge of
  post-conflict reconstruction and transition still
  leave BH quite far behind the most successful
  Central and Eastern European countries.
• Notwithstanding achievements, the track record in
  structural policies is uneven, with partial
  reform in many areas.
• The agenda of integrating into European
  structures lies largely ahead.

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KEY CHALLENGES
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Challenges are well described in the MTDS

• We focus on six
• Deepening macroeconomic adjustment
• Reducing the size/improving the efficiency of
  government
• Accelerating export growth and deepening trade
  integration
• Restructuring the enterprise sector
• Strengthening the business environment
• Improving the functioning of the labor market

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Macroeconomic adjustment needs to be further
deepened

• Overarching challenge is increasing domestic
  savings to cut current account deficit without
  harming investment, economic efficiency
• Public savings can be raised by further
  containing current spending/GDP
• Domestic claims resolution plan needs to be
  implemented within agreed parameters
• In the short-run, increasing private savings
  requires controlling credit growth, primarily to
  household sector
• Medium-term challenge is boosting corporate
  savings, i.e. the profitability of BH companies
• Attracting more FDI/other foreign savings also
  key to external sustainability

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Governments need to become smaller/more efficient

• Despite past gradual reduction, public spending
  still over 50 percent of GDP, one of the highest
  levels in the world.
• Post-DPA political/administrative structure plays
  a role, but much is inefficient spending.
• Need further rationalization targeted at current
  spending, esp. wage bill, making room for
  MTDS/SAp priorities.
• Transfers of responsibilities should be
  revenue-neutral
• Within core public services, e.g. education or
  social protection, expenditure allocation should
  be driven by efficiency/equity considerations.
  Focus on education financing, welfare transfers
  to households.
• Also need to further enhance technical capacity
  and transparency, reduce complexity of
  government, and continue improving coordination
  between various levels of government (e.g. higher
  education reform)

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Further trade integration and private sector
reform are keys to export growth

• Recent disappointing export performance can
  hardly be attributed to a policy of
  liberalization/integration.
• As nothing broken with the trade regime, BH
  should build on initial achievements and
  selectively advance the same agenda.
• Need further progress in removing behind the
  border barriers to using extensive market access
  (technical, veterinary etc. standards product
  certification customs)
• Further developing single economic space will
  also stimulate cross-border trade.
• Key to faster export growth is enterprise
  restructuring, the business environment, and
  labor market (wage competitiveness) which we turn
  to next.

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An extensive remaining agenda of enterprise
sector reforms

• Banking/SME successes not matched in broader
  enterprise sector, esp. SOEs. Early (MVP)
  privatizations led to diluted ownership and weak
  governance, soft budget constraints and weak
  profit drive. Large privatization painfully slow,
  and exit so far rare. Need
• Faster, more transparent privatization to
  strategic owners.
• Changes to encourage concentration of ownership
  in PIFs/MVP firms.
• Range of corporate governance reforms to
  strengthen role of owners, create incentives for
  efficiency gains.
• Remove barriers to effective corporate
  restructuring.
• Implementation of new bankruptcy laws (a major
  positive reform), including active initiation of
  proceedings by government bodies/firms, control
  of subsidies.

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The business environment needs to be
significantly strengthened

• While somewhat improved, it retains high
  barriers to entry and impediments to business
  operation. Priorities include
• Complete new business registration system to
  smooth/lower cost of entry.
• Improve functioning of legal system (esp.
  commercial courts, including backlog) in
  protecting property rights and contracts.
• Reduce economic policy uncertainty and corruption
  as most powerful deterrents to business entry and
  development.
• To reduce administrative barriers, streamline
  business inspection, incl. via clear distribution
  of tasks across levels of government.
• VAT introduction/ITA as particularly crucial with
  far reaching implications also level playing
  field in tax collection, follow by gradual
  reduction of tax wedge on labor.

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The labor market needs to be made more flexible

• Formal labor market is anemic, unemployment high
  (esp. for women and youth), and informal economy
  may be gaining ground.
• Despite relatively flexible labor laws,
  participation remains low, pay/separation
  practices rigid, and wages grow faster than
  productivity.
• Problems compounded by weak firm-level discipline
  (by workers, other creditors, management) and
  corporate governance.
• Role of employers in collective bargaining needs
  to be enhanced.
• A strict incomes policy needs to be applied in
  leading public companies.
• Minimum wage needs reform to promote
  competitiveness and employment of vulnerable
  groups (women, youth).
• Employment institutes/active programs also need
  restructuring.
• Over time, reduce tax burden on labor.

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SELECTING/DESIGNING PRIORITY REFORMS
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Reforms need to be selectively chosen, flexibly
implemented

• The authorities have already taken many
  initiatives to meet the noted challenges.
• BUT envisaged actions are often too numerous to
  be credible, starting with those in MTDS itself.
• The vast scope of challenges calls for
  selectivity, prioritization and sequencing.
• Reforms must in turn be linked to and consistent
  with MTEF and PIP
• There is also a need to flexibly apply 4
  different types of approaches to economic policy

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1. Staying the course

• Means keeping the same policy direction in
  areas where policies are broadly adequate, with
  selective further deepening. For example
• Macroeconomic policy (rely on CBA as solid anchor
  supported by continued fiscal consolidation and
  prudent debt/borrowing policy).
• Trade policy. Increased protectionism would
  backfire, so continue and deepen liberal policies
  and market integration.
• Banking. Continue strengthening of supervision
  while tightening credit policy.

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2. Setting the right incentives for the private
sector

• Accelerating progress on 16 prior requirements
  set forth in the EC Feasibility Study, to open
  negotiations for a SAA (extensive impact on
  business climate).
• Tax reform (VAT, tax on labor) and creating level
  playing field in tax collection.
• Changing privatization/PIF laws to get core
  owners.
• Corporate governance reforms.
• Creating bankruptcy framework.
• More flexible wage determination.

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3. Getting out of the way

• Proposed policies too often see a large and
  active role of government. BUT government cannot
  fix everything and is already big. Large gray
  economy shows entrepreneurial activity which
  could flower if government got out of the way.
  This includes
• Deregulation/streamlining the administrative
  framework around the private sector (e.g.
  business registration, licensing)
• Trade liberalization
• Reducing subsidies
• Labor market flexibility

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4. Intervening smartly in some areas

• Areas where government must act decisively
  include
• Adjusting size/composition of public spending
• Addressing domestic debt overhang
• Creating institutions required to access export
  markets
• Privatization/initiation of bankruptcy for
  companies with large tax and contribution arrears
• Anti-corruption efforts
• Incomes policy for public sector companies
• Reforming education system
• Creating a new, more effective architecture for
  donor coordination

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Summary of key challenges

• Deepening macroeconomic adjustment
• Reducing the size/improving the efficiency of
  government
• Accelerating export growth and deepening trade
  integration
• Restructuring the enterprise sector
• Strengthening the business environment
• Improving functioning of the labor market