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Country Report Bosnia and Herzegovina

Country Report

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Bosnia-Herzegovina faces major socioeconomic challenges in the aftermath of devastating floods and months of violent protests. The upcoming general elections in October are unlikely to improve the situation, but increased IMF support should alleviate possible financial problems.

Strengths (+) and weaknesses (-)

(+)      Likely (Western) donor support

Given the threat of re-emerging ethnically-based violence, EU and IMF financial support is generally available, if needed.

(-)       Political stalemate hinders structural reforms

The complex political system in Bosnia-Herzegovina obstructs the country’s policy making process. Urgently-needed structural reforms to improve the business environment are thereby stalled.

(-)       Vulnerability to social unrest

Widespread frustration with the country’s economic and political stalemate constitutes a source of public unrest, while  reconciliation in the aftermath of the 1990s civil war still has to be completed.

(-)       Weak competitiveness and poorly diversified low-tech export base

Bosnia-Herzegovina’s economy suffers from weak competitiveness and a poor business climate characterized by bloated administrative procedures and widespread corruption. It mainly exports base metals, wood and low-tech produce to a limited number of markets, which contributes to large current account deficits.

Key developments

1. Worst social unrest since the end of the 1990s civil war

Following sizeable demonstrations last year, Bosnia-Herzegovina’s (BiH) fragile social situation was shaken once more early this year by the country’s worst violent protests since the end of its civil war in the 1990s. What started in early February as protests by thousands of employees of five failed privatised companies in Tuzla regarding the payment of years of unpaid wages quickly turned into nationwide protests against the desolate economic and political state of the country. While hundreds of demonstrators and policemen were injured, several government buildings, including the presidential building in  Sarajevo, were set on fire. Given the deteriorated security situation in the capital, the government of the Bosniak-Croat Federation, one of the two constituent entities of BiH, even held its cabinet meetings in Mostar, instead. While the federal government rejected protesters’ demands for its immediate resignation, several regional governments stepped down. Meanwhile, so-called “citizens’ plenum” were formed that demanded the election of a technocratic government, less benefits for government officials, a revision of privatisations and an independent investigation into the violent protests. Even though the months-long protests gradually ebbed and finally lost momentum as Bosnia-Herzegovina was hit by catastrophic floods, they might flare up again, possibly along ethnic lines, as politicians continue to fail to address the underlying causes.

2. Devastating floods weigh heavily on economic outlook

Torrential rainfalls in May caused the flooding of large areas of northern and north-eastern BiH along the river Sava and its tributaries, forcing an estimated 500,000 of the country’s 4m inhabitants to flee their homes, while hundreds of thousands who stayed behind were left without clear drinking water. The inundations wreaked havoc on local infrastructure, as about 50,000 homes were destroyed or severely damaged, flood defences were devastated, and large parts of critical infrastructure like roads, rail and bridges were affected. Meanwhile, clean-up efforts were impacted by dislodged unexploded landmines from the Balkan wars. The damage caused by the floods has been estimated at EUR 2bn (about 15% of GDP), but since international donor loans for reconstruction efforts only amount to EUR 809m and BiH’s very weak economic and fiscal strength limit its access to debt markets, the country’s recovery from the disaster will likely take years. Due to the extensive damage, the European Bank for Reconstruction and Development (EBRD) has cut its growth forecast for this year to 1.1%, down from 2.2%, while local economists even expect an economic contraction of about 0.7%. Reflecting weaker tax revenues and reconstruction expenses, BiH’s budget deficit is expected to increase to 4.1% of GDP this year, while contracting exports and considerably higher imports related to the rebuilding of infrastructure will likely boost the country’s current account deficit to almost 11% of GDP this year. As the widening twin deficit threatens to confront BiH with balance of payments and sovereign funding problems, the IMF once more augmented its 33-month stand-by agreement (SBA) with BiH and relaxed pertaining budget deficit targets, even as the country’s pre-disaster performance under the SBA has been mixed. The IMF’s decision illustrates the ongoing commitment by the international community, which, out of fear of renewed escalating political tensions, feels obliged to prevent a sovereign default or balance of payments problems in BiH. 

Figure 1: Growth performance
Figure 1: Growth performanceSource: IMF
Figure 2: Current account balance
Figure 2: Current account balanceSource: IMF

3. Presidential and parliamentary elections to be held in October 

Political tensions are expected to intensify in the short-term as BiH heads for presidential and parliamentary elections on October 12th, 2014. While politicians blame each other for the local authorities’ poor disaster relief, nationalist rhetoric fuels ethnically-based resentment. Even though the electorate’s frustration with the political elite and its failure to improve living conditions is running high, the elections are unlikely to yield a substantial change of BiH’s entrenched political system. Only in the Bosniak-Croat Federation, a newly-created party may win the elections, while incumbent parties prevail in the Republika Srpska. Meanwhile, the so-called “citizens’ plenums” seem to have failed to reinvigorate BiH’s political life. Consequently, irrespective of the eventual outcome, the elections are unlikely to yield the changes demanded by the public in recent demonstrations. Even worse, they may once more result in months of political paralysis, as politicians struggle to form a coalition in line with the multi-ethnic set-up demanded by the Dayton peace accord. If this risk were to materialize, calls for a dissolution of BiH may once more gain traction, even though the disintegration of the country may result in renewed ethnically-based violence.

Factsheet of Bosnia and Herzegovina
Factsheet of Bosnia and HerzegovinaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

The history of Bosnia and Herzegovina (BiH) is characterized by a devastating three-year war that followed its declaration of independence from the former Yugoslavia in the early 1990s. With the end of the war and the implementation of the Dayton Peace Accords in 1995, two separate entities were established; the Bosniak-Croat Federation of BiH and the Bosnian Serb Republic, Republika Srpska. Both entities, which are subdivided into various cantons, have their own governments, including an own president, government, parliament and police. On top of these two entities, a multi-ethnic, joint government was created. The presidency of this Central Bosnian government is rotating between the three ethnical groups. Besides the two entities, the district of Brčko, constitutes a neutral area under joint authority of the Bosniak, Bosnian Croat and Serb community. Almost a decade after the war, the social situation is very tense, as reconciliation between the ethnic groups is far from complete. While preserving peace so far, BiH’s intricate political structure forms a major impediment to daily policy-making and the implementation of urgently needed structural reforms. Government services constitute one of the main generators of GDP, as private sector development is held back by bloated administrative procedures, widespread corruption and overall low competitiveness. BiH’s currency, the convertible marka, is pegged to the euro. Due to its structural weaknesses, BiH remains dependent on concessional financing. The  mainly foreign-owned financial sector is relatively well-capitalized, but suffers from weak asset quality. BiH is one of the poorest European countries in terms of GDP per capita and human development is low.

Economic indicators of Bosnia and Herzegovina
Economic indicators of Bosnia and HerzegovinaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

 

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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 64053

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