Bosnia Herzegovina

CEEBIC COMMERCIAL GUIDE CEEBIC is a business facilitation program for U.S. firms interested in expanding into the Central and East European markets. Established in 1990 by Congressional legislation under the Support for East European Democracy (SEED) Act, CEEBIC is a one-stop shop and the US Government's clearinghouse for the most recent economic, commercial, and financial information on the 15 countries of Central and Eastern Europe. CEEBIC offers a wide array of services, business counseling, and information products designed to help primarily small- and medium-sized U.S. companies. CEEBIC's Washington-based trade specialists and dedicated overseas staff in 15 countries of the region work together to implement this unique program for U.S. firms. BOSNIA HERZEGOVINA COUNTRY COMMERCIAL GUIDE CHAPTER 1: EXECUTIVE SUMMARY Bosnia-Herzegovina (BiH) has made slow but steady progress over the past year in making the transition to a market economy. At the Federation and state levels, a multi-ethnic, social- democratic coalition (Alliance for Change) has replaced the nationalist parties long viewed as the main obstacles to economic reform. The Alliance has expressed strong commitment to accelerating the pace of economic reform, to building a viable market economy and to creating a more business-friendly investment climate. As signs of that commitment, in early 2002, the Council of Ministers approved an Action Plan aimed at removing barriers to investment; adopted a Poverty Reduction Strategy to create more jobs and increase exports; and initiated an anti-corruption plan to foster greater trust and confidence in the domestic economy. Despite the plans and strategies, Bosnia's complex legal and regulatory framework, weak judicial structures and corrupt public administration system continue to discourage investment. BiH is ranked last in the region in terms of foreign direct investment (FDI). However, BiH authorities are keenly aware of the country's economic shortcomings, recognizing that economic reform and rule of law are crucial ingredients for both growth and poverty reduction. Their action plans are aimed at moving the reform agenda forward more vigorously. BiH's economy is beginning to respond. In 2001, unofficial estimates show foreign direct investment at around $160 million, slightly up from the $150 million in 2000. While dwarfed by the billions in FDI going into neighbors Croatia and Slovenia, Bosnia's FDI is at least moving in the right direction. Official economic statistics present a sobering picture: per capita GDP stands at $1,100 and total GDP of less than five billion dollars represents only half of prewar levels. Unemployment officially averages 35-40 percent, though according to a recent World Bank study, the actual figure may be closer to one-half that value. Exports remain at only about one- third of their pre-war levels, far from adequate to generate the hard currency revenues needed to compensate for projected declines in donor assistance over the next several years. The most recent export figures (January-June 2001) are more encouraging, showing sharp gains in exports of clothing, furniture and leather goods. Leading industrial sectors for U.S. exports include electric power and transmission, telecommunications, rail transport, and pollution control equipment. International financial institutions (the World Bank, the European Bank for Reconstruction and Development, the European Investment Bank) and other co-financiers will continue to support reconstruction and rehabilitation of the country's infrastructure. Approximately US$ 230 million will be provided over the next three years for reconstruction of the electric power system and an additional US$ 17 million will be spent for environmental improvements at the country's four thermal power plants. Furthermore, US$ 20 million will be invested in reconstruction of the railway network including the purchase of track maintenance machines and equipment, and the restoration of the signaling system. The telecommunications sector will continue to generate sufficient revenues to fund further modernization and expansion. Two state-owned telecommunications operators are about to kick-start the countrywide expansion of their GSM networks while continuing to upgrade the fixed networks. The proposed liberalization of the telecommunications sector will ignite private investments in data and non-voice services thus generating demand for the related equipment. CHAPTER 2: ECONOMIC TRENDS AND OUTLOOK Since the signing of the Dayton Peace Accords at the end of 1995, Bosnia and Herzegovina has faced the triple challenge of recovering from the war, merging three ethnically-based economies still influenced by separatist agendas and overcoming 50 years of communist rule. While the post-war reconstruction phase is now largely completed, the economy is still in the midst of a transition that began in 1996. As a result, the economy continues to be heavily dependent on international aid, despite an influx of more than five billion U.S. dollars in aid since the end of the war. A. Macroeconomic Conditions Per capita GDP in 2001 stood at about $1,100 and with a total estimated GDP of less than $5 billion, BiH output is at only about half its prewar level. Strong post-war economic growth reflected more the infusion of donor assistance than increases in domestic production or private investment. As assistance levels have fallen in recent years, GDP has fallen in tandem. In 2001, the IMF estimated economic growth at 5.6 percent, and during the next several years, even assuming more aggressive implementation of economic reforms, GDP is projected to plateau at six percent. With donor assistance decreasing, BiH must necessarily increase private sector investment in order to maintain GDP growth. Inflation is under control in Bosnia and Herzegovina thanks to the adoption of a currency board in 1997 legally mandating that the local currency (the Convertible Mark) be fully backed by hard currency or gold. Deposits in the Central Bank stood at more than one billion German marks in November 2001, reflecting growing confidence in the banking system. Previously, a relatively large inflation differential existed between the two entities, however, because of a faster-than-expected deceleration in inflation in the RS, rates equalized at around two percent in the last quarter of 2001, Official statistics show unemployment at 35 to 40 percent statewide. That figure has fallen significantly from the 70 to 80 percent levels in the aftermath of the war. However, with a significant gray economy, unemployment figures are misleading. Since labor costs for employers are high, many hire employees off the books. According to a recent World Bank study, actual unemployment is likely closer to 20 percent. There is little doubt, however, that the job market remains weak and young people in particular have difficulty finding jobs. Bosnia has run high trade deficits because with low domestic production, imports have satisfied demand for goods. However, the gap between imports and exports has been narrowing steadily. In 1997 the ratio of imports to exports was 4-to-1, but in 2001 the ratio is about 2.5-to-1. For the first half of 2001, exports (led by clothing, furniture and leather goods) rose by twenty percent, while imports fell by nearly five percent. Duty-free access of Bosnian exports to the EU fueled the export growth with sales to Germany up by 40 percent and to Italy by more than 20 percent. In terms of fiscal policy, both entities have faced the challenge of keeping spending under control. At the state level, new expenditures have arisen as BiH builds up its central institutions. At the entity levels, spending pressures grow out of increasing demands to widen the safety net for pensioners and war veterans. With an army to maintain in each entity, military spending is the highest in the region, at 6 percent of GDP. Both entities are taking measures to cut the military, but while this will save resources in the long term, the entities will need to fund expensive severance packages in the short term. On the revenue side, tax collection has been inefficient. Annually, the entities lose 30 percent of their annual revenue from customs evasion. Additionally, unpaid sales tax cost entity governments approximately 1.5 million U.S. dollars per month. Smuggling of cigarettes alone deprives government coffers of an estimated KM 500 million in customs revenues. With assistance from the international community, the entity governments have been taking steps to create more efficient tax administrations and to grant greater powers to officials to collect taxes. B. Government Role in the Economy The public sector continues to maintain a heavy hand in economic activity. Despite several years of attempted market reforms, the private sector's share of the economy is a mere 35 percent. According to World Bank transition indicators, BiH lags behind its neighbors in every category of economic reform: governance and enterprise restructuring, competition policy, trade and foreign exchange systems, and banking reform/interest rate liberalization. Additionally, the pace of large-scale privatization has been disappointingly slow. The election of a moderate multi-ethnic government in November 2000 at the state and Federation levels has given new impetus to the economic reform effort as the Alliance for Change coalition has shown a more concerted effort to tackle the impediments to economic growth. The state government has prepared a variety

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