Documentof The World Bank
FOR OFFICIAL USE ONLY Public Disclosure Authorized
Report No. P-7208-BIH
REPORT AND RECOMMENDATION
OF THE
PRESIDENT OF THE
INTERNATIONAL DEVELOPMENT ASSOCIATION Public Disclosure Authorized
TO THE
EXECUTIVE DIRECTORS
ON A
PROPOSED CREDIT
IN AN AMOUNT EQUIVALENT TO SDR 46.2 MILLION
Public Disclosure Authorized TO
BOSNIA AND HERZEGOVINA
FOR A
PUBLIC FINANCE STRUCTURAL ADJUSTMENT CREDIT
April 27, 1998 Public Disclosure Authorized
This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EOUIVALENTS (as of April 27, 1998) Unit of currency: Konvertible Marka (KM), equivalent to 1:1 to Deutsche Mark
I KM=US$0.56
WEIGHTS AND MEASURES Metric System
ABBREVIATIONS AND ACRONYMS
BiH Bosilia and Herzegovina BHD Bosnia and Herzegovina Dinar CAS Country Assistance Strategy CIFR Commission on Intergovernmental Fiscal Relations DMU Debt Management Unit EBF Extra-budgetary Fund EU European Union GDP Gross Domestic Product IDA International Development Association IFI International Financial Institution IM Initiating Memorandum IMF International Monetary Fund KM Konvertible Marka MFTER Ministry for Foreign Trade and Economic Relations OEDM Office of External Debt Management PHRD Policy and Human Resources Development Fund PFSAC Public Finance Structural Adjustment Credit SBA Stand-by Arrangement SFRY Socialist Federal Republic of Yugoslavia TAC Transition Assistance Credit
FISCAL YEAR January 1 to December 31
Vice President: Johannes Linn Country Director: Christiaan J. Poortman Sector Director: Pradeep Mitra Sector Leader: Frank Lysy Task Team Leader: Sebnem Akkaya FOR OFFICIAL USE ONLY
iii
BOSNIA AND HERZEGOVINA
PROPOSEDPUBLIC FINANCESTRUCTURAL ADJUSTMENT CREDIT
Credit and OperationSummary
Borrower: Bosnia and Herzegovina
Beneficiaries: Bosnia and Herzegovina,Federation of Bosniaand Herzegovina, RepublikaSrpska
Amount: SDR 46.2 million (US$63million equivalent)
Terms: 35 years, includinga 10-yeargrace period
Credit Objectives: To support the establishmentof public finance structures and implementationof reform policies at the State and Entity levels. Specifically, the Credit will support: (i) securing financing of the State through the preparation and adoption of the budgets of the State and the Entity governments and through the development and implementationof a transfer mechanism that would provide a regular and predictable flow of funds to the State budget for meeting its obligations; (ii) development of a debt management capacity in Bosnia and Herzegovina;(iii) administrativereforms to improve efficiency and transparency of government budgetary operations; (iv) initiation of reform and harmonization of tax policies and administration within Bosnia and Herzegovina; and (v) initiation of reform in the pensionsystem.
Credit Description: The Credit will be lent to the State of Bosnia and Herzegovinawhich will in turn onlend in the amount of US$33 million:US$30million to the Federation and Republika' Srpska, at the same terms of the IDA Credit. The Credit will be disbursed in two tranches for budgetary and balance of payments support to Bosnia and Herzegovina. Release of tranches will be linked to policy conditionalityas agreed during the negotiationof the Credit.
Benefits: The proposed Credit will support measures that are crucial for the further development of a new govemment structure at the State and the Entity levels, reintegration of the economy and reorganizationof the public finance system. Establishment of an effective and integrated public finance structure will help Bosnia and Herzegovinato better conduct macroeconomicmanagement, reduce cost to economic transactions, and achieve external creditworthiness. It will support economicand social developmentthat will benefit all people in Bosniaand Herzegovina. By pursuingessential reforms in key public finance institutionsand policies, the Credit will help the Entities correct the medium-term imbalance between revenues and expenditures and set appropriate priorities for public expenditures. By supportingthe creationof a public sector which is more suitable to a market economy,the Creditwill also contributeto private sector development, employmentcreation and povertyreduction.
This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. iv Risks: The two potentialrisks faced by the proposedCredit are: (i) non-implementation of agreed policies and reversal of reform measures; and (ii)diversion of the counterpartfunds of PFSACproceeds for non-priorityuses. To mitigatethe risk of non-implementationof agreed policiesand reversal of reform measures,the Bank requires upfrontfulfillment of conditionsfor tranche releases whenever possible; and will work closely with the IMF, the US Treasuryand othersto jointly promote the implementationof the reformagenda. To reducethe potentialrisk of diversion of the counterpartfunds of the PFSACproceeds for non-priorityuse, PFSAC will support reform measuresto strengthenthe budgetary allocationprocess. It will also be conditional on the formulationof the budgets of the Entities that are inclusiveof the envisagedPFSAC funds.
Poverty Category: Direct impact upon povertywill be effectedthrough provisionof more adequate resources for social protection programs, and improved targeting and distribution of social benefits.
Rate of Return: Not Applicable
Map: IBRD 27708-R
Project ID Number: BA-PE-45546 v
BOSNIA AND HERZEGOVINA
PROPOSED PUBLIC FINANCE STRUCTURAL ADJUSTMENT CREDIT
CONTENTS
I. INTRODUCTION ...... I II. MACROECONOMIC SETTING AND FINANCING REQUIREMENTS...... 1 A. Macroeconomic Setting...... 1 B. Economic Outlook and Financing Requirements ...... 2 III. BACKGROUND AND ISSUES IN PUBLIC FINANCE .4 A. Dayton Rules on Public Finance Structure .4 B. Need to Control the Expenditure Level .5 C. Issues in Public Finance Reform .5 IV. PUBLIC FINANCE REFORM PROGRAM .6 A. Ensuring Financing of the State to Meet its Mandated Obligations .6 B. Establishing a Viable Debt Management Structure .8 C. Reforming Intergovernmental Finances within the Entities .10 D. Reforming and Harmonizing Tax Policies and Coordinating Tax Collection .12 E. Initiating Pension Reform .13 F. Reforming the Budgetary Management System .16
V. THE PROPOSED CREDIT ...... 18 A. Rationale for Bank Involvement ...... 18 B. Credit Amount and Borrower ...... 19 C. Credit Design ...... 19 D. Administrative Arrangements ...... 19 E. Disbursement ...... 19 F. Monitoring Arrangements and Tranche Release Conditions ...... 20 G. Environmental Assessment Requirements ...... 20 H. Benefits and Risks ...... 20 VI. RECOMMENDATION .21
ANNEX I Policy Matrix ANNEX II Letter of Development Policy ANNEX III Statistical Annex REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED PUBLIC FINANCE STRUCTURAL ADJUSTMENT CREDIT (PFSAC) IN THE AMOUNT EQUIVALENT TO SDR 46.2 MILLION TO BOSNIA AND HERZEGOVINA
I . I submit for your approval the following report and recommendation on a proposed Credit to Bosnia and Herzegovina (BiH) in the amount of SDR 46.2 million (US$63 million equivalent) to help finance a Public Finance Structural Adjustment Operation. The proposed Credit would be on International Development Association (IDA) terms, with a 35-year maturity, including a 10-year grace period. This operation follows a more broadly-based structural adjustment operation in 1996, and is the first of two planned operations that focus on public finance reform. The Country Assistance Strategy (CAS) was discussed by the Board of Directors in August 1997. The most recent economic report on BiH (Bosniaand Herzegovina-From Recovery to Sustainable Growth) was published in May 1997. A Public Expenditure Review was completed in October 1997.
I. INTRODUCTION
2 . The proposed PFSAC builds on BiH's achievements to date in establishing the common institutions and governance structure as mandated by the Dayton Accords, and supports further progress in institution- building and policy reforms in public finance. It aims to achieve this objective by focusing on the following areas: (i) development and implementation of a sound transfer mechanism that would provide regular and predictable flow of funds to the State budget; (ii) development of debt management capacity in BiH; (iii) administrative reforms to improve efficiency and transparency of government budgetary operations; (iv) initiation of efforts to reform and harmonize tax policies and administration within the country; and (v) initiation of reform of the pension system. The proposed Credit would provide much needed budgetary and balance of payments support to BiH in 1998. It is proposed that the Credit be disbursed in two tranches.
11. MACROECONOMIC SETTING AND FINANCING REQUIREMENTS
A. Macroeconomic Setting
3. Since the signing of the Dayton Accords in December 1995, Bosnia and Herzegovina has experienced the beginnings of economic and social recovery. While living standards are still very low for many Bosnian families and economic activity is only at about one third of prewar levels, the reconstruction effort has already borne significant fruit. Economic growth, which reached 50 percent in 1996, remained high at 30 percent in 1997. Unemployment has declined from its postwar high of 90 percent to about 40 percent. Many schools and health clinics have reopened, repairs to infrastructure are well underway. Commerce and production are picking up with the help of donor-financed lines of credit. The effects of reconstruction and growth are particularly evident in one of the country's two constituent Entities, the Bosniac-Croat Federation, where much of the international aid has been directed. Recovery in the other constituent Entity, Republika Srpska, began after international sanctions were lifted in March 1996, and has been proceeding at a slower pace than in the Federation. 2
4. Bosnia and Herzegovina's strong recovery in the past two years was also accompanied by macroeconomic stability, which was made possible by substantial donor assistance and recovery of the tax base. It was facilitated by the de facto "Deutsch-Markization" of the economy, which imposed stringent discipline on domestic monetary and fiscal management. Limit in the use of Bosnian dinar (BHD) to only Bosniac-majority areas of the Federation further constrained policy maneuvering space. In the Croat- majority areas and in Republika Srpska, Croat kuna and Yugoslav dinar, in addition to DM, have been in use which limited the scope of debt financing by local fiscal authorities. Although there have been sizable increases in fiscal arrears, cash outlay of the fiscal authorities was limited to available real sources of financing (tax revenue and external support). As a result of these factors, the price level has been broadly stable since early 1996.
5 . Rebuilding of the governance structure has proceeded at a very slow pace. In the Federation, modest progress has been made in establishing key economic institutions such as customs and tax administrations. However, the fiscal system is yet to be fully unified as divergent policies and practices continue for certain aspects of the fiscal system of the Federation. At the country-wide level, tie two Entities have developed only limited institutional linkages and policy coordination, because of a lack of progress in establishing or operationalizing the common institutions at the State level. Country-wide elections took place, after some delay, in September 1996, and the State Council of Ministers was set up in January 1997. Since then, the work of the Council of Ministers has proceeded, but only with great difficulty and at a slow pace. International pressure, coordinated by the Office of High Representative, helped to ensure that the State Parliament adopted, in June 1997, the key legislation needed for setting up a country- wide institutional and policy framework. The legislation includes six essential laws regulating foreign trade, external debt, customs policy, central bank and currency, and 1997 State budget. The challenge now facing BiH is to operationalize and implement these laws.
B. Economic Outlook and Financing Requirements
6. Macroeconomic Policy Framework. Macroeconomic stability has been maintained so far under an economic policy framework developed with the help of the International Monetary Fund (IMF) and the Bank. The prospects for continued stability depends critically on prudent management by the authorities, the pace of further progress in institution building and market reform, and continued international financial and technical assistance. The introduction of a proposed IMF Stand-by Arrangement in 1998 is expected to strengthen the prospects for macroeconomic stability in the medium-term. Understandings on the economic program to be supported under the proposed Arrangement have been reached by the BiH and the Entity Governments and IMF Executive Board consideration is expected in May 1998.
7. The IMF program supports continued economic and social recovery and transition to a market economy while maintaining the current macroeconomic stability and consistency with the currency board arrangement. The program aims to maintain macroeconomic stability through: (i) the use of a fixed exchange rate as a nominal anchor through the currency board arrangement; (ii) fiscal discipline, aimed initially at the avoidance of borrowing by all levels of government from the banking system or the non-bank public; and (iii) large scale external assistance on concessional terms. Structural elements of the program are wide ranging, covering customs tariff reform and trade liberalization; banking reform; enterprise privatization and restructuring; the pension and health system reform, and the strengthening of economic statistics. The program also aims to consolidate the fiscal institutions of the State and the Entities and introduce reforms to make fiscal policy sustainable. In this area, the programs supported under the proposed PFSAC and the proposed IMF Stand-by Arrangement are complementary to each other.
8 . Prospects for Growth. Economic recovery is expected to continue so long as the reconstruction program and the progress in institution building and market reform are continued, dthough it is unlikely that growth in the medium term will be as rapid as in 1996 The growth rate is estimated to remain around 3
30 percent in 1998. As in 1996/97, growth and employment generation in 1998 will be stimulated to a large extent by the donor-financed activities. Beyond 1998, the growth rate for BiH's economy will gradually decline to the more normal range of 8-10 percent. With these assumptions, GDP is expected to reach about two thirds of its prewar level by 2000.
Tablel: Selected Key Economic Indicators", 1995-2000
Estimated Projected Indicator 1995 1996 1997 1998 1999 2000
Gross Domestic Product GDP (USS million) 2157 3328 4456 5956 7485 8635 Real GDP growth (%) 7 50 30 30 22 12 General Government Finance Expenditures (% of GDP) 35 70 68 70 53 40 Tax Revenues2' (% of GDP) 29 43 43 38 35 36 Deficit (-) (% of GDP) -6 -27 -25 -33 -18 -5 External Financing (% of GDP) 6 27 25 33 18 5 Grants 6 19 18 21 12 3 Borrowing (net) 0 8 7 12 6 2 Balance of Payments (US$ million) Financing Requirements 1604 3180 2200 4084 2636 1079 o/w Current Account Deficit3' 953 1620 1590 2177 1698 835 o/w Debt Service (scheduled) 513 573 385 236 186 194 o/w Increase in Foreign Exchange Reserves 138 367 225 175 75 50 Financing Sources 1604 3180 2200 3830 2473 965 o/w Unrequited Net Transfers 1002 1094 772 480 345 281 o/w New Financing for Reconstruction 0 1040 901 1600 1200 410 o/w Arrears Clearance and Debt Reliefe' 0 621 0 1497 679 0 Remaining Financing Gap5' 0 0 0 254 163 114 External Debt Total External Debt6 (in%of GDP) 156 117 100 80 68 62 7 Debt Service / (in % of total exports) 135 87 39 18 11 9
1/ Data refers to estimates for all Bosnia and Herzegovina unless otherwise stated. 2/ Includes small amount of non-tax revenues in the form of fees, fines, etc. 3/ Excluding interest and transfers. 4/ Assumes clearance of arrears to Paris Club and multilateral creditors in 1998, and commercial creditors in 1999. Data reflects clearance of IBRD arrears of 621 million on June 14, 1996; and debt rescheduling with London Club creditors, effective as of December 31, 1997, offering a debt stock reduction equivalent to about 80 percent on a net present value basis. I/ Before balance of payments lending from multiletaral institutions, including the Bank, and bilateral donors. 6/ Of the total debt, 56 percent in 1995,52 percent in 1996, and 54 percent in 1997 are in arrears. 7/ Refers to scheduled debt service. Source: Official data, Bank and IMF staff estimates.
9. Fiscal Outlook The economic recovery boosted tax revenues, which increased from 29 percent of GDP in 1995 to 43 percent in 1996/97. Revenue recovery combined with generous international aid has allowed public expenditures to increase substantially. Public expenditure in 1996/97, inclusive of donor- 4 financed expense, reached almost DM 3 billion, or 70 percent of GDP. In 1998, total public expenditures will remain high. The need for donor financing in the medium term, although declining as BiH's tax revenues continue to recover, will still be significant.
10 . To achieve fiscal sustainability in the medium term, BiH needs to aldress the imbalance between domestic budgetary resources and expenditure responsibilities. Only with adequate fiscal adjustment will BiH be able to gradually stabilize the budget deficit at a noderate level, as shown in Table 1, that would ensure fiscal sustainability and the country's access to external financing in the medium tern.
11. Balance of Payments Outlook. Exceptional external financial assistance has made a major contribution to BiH's balance of payments picture. In addition to generous humanitarian assistance, the international community made commitments during 1996 of US$1.8 billion, mainly on a grant basis, for BiH's reconstruction. Total disbursements of grants and loan aid in 1996 have been estimated at over US$1 billion, equivalent to 33 percent of GDP. For 1997, donors made disbursements of about US$0.9 billion, equivalent to 21 percent of GDP.
12. Considerable additional external financing is needed to normnalizeBiH's relations with external creditors, and to cover the requirements of the reconstruction program. This normalization involves both clearing outstanding arrears and restructuring remaining debts. After having normalized its financial relations with the IMF and the World Bank in 1995 and 1996, respectively, BiHl is expected soon to regularize its relations with other multilateral, bilateral, andcommercial creditors. Towards this end, a debt rescheduling agreement was signed between BiH and the London Club creditors at the end of 1997. The Agreement provides the country with a debt stock reduction equivalent to about 80percent on a net present value basis. Several conditions have to be met for a Paris Club rescheduling to occur, including putting into place the IMF Stand-by Arrangement.
13. Near-term financing requirements consist mostly of reconstruction funding and debt service obligations for those debts that have already been restructured. In 1998/99, total financing requirements are estimated to average US$3.4 billion per year. After taking into account anticipated reconstruction assistance (averaging to US$1.4 billion per year), official and private flows (averaging to US$0.4billion per year), arrears clearance and debt relief to creditors (totaling to about US$2.2billion), there will be a remaining financing gap of about US$0.25 billion in 1998 and US$0.16 billion in 1999 which is expected to be filled by balance of payments support from the IMF, the Bank (including the proposed Credit of US$0.06 billion in 1998), other multilateral institutions and bilateral donors.
III. BACKGROUND AND ISSUES IN PUBLIC FINANCE
A. Dayton Rules on Public Finance Structure
14. The Dayton Accords provide a broad framework for building a new governance structure in BiH. Under the Accords, BiH is a sovereign state consisting of two Entities, the Federation (ofBosniacs and Croats) and Republika Srpska, with a State government responsible for international relations and inter- Entity coordination. Key economic institutions and policies envisaged at the State level include a central bank (organized as a currency board in its first six years) and a new currency, customs and trade policies, international financial relations (including servicing of international debts and debt management) and coordination in telecommunication and transport. Unless mandated otherwise by the State Parliament, the State does not have the capacity to tax or collect customs duties on its own. The budgetary needs of the State are to be met in the proportions of two thirds by the Federation and one thirdby Republika Srpska.
15. The Entity governments have exclusive responsibility in their respective territories over defense, internal affairs (including police), environmental policies, economic and social sector policies (such as 5 agriculture, industry, and health), refugees and displaced persons, reconstruction programs and justice, tax, and customs administration. To canry out these responsibilities, each Entity has ownership of the taxes collected in its territory. But the two Entities have different fiscal structures. The Federation has a three-tier fiscal system: the Federation government, cantons, and municipalities, with major responsibilities resting with the cantons. Republika Srpska has a two-tier structure: the Republika Srpska government and municipalities, with very limited local fiscal authority.
16 . Modest progress has been achieved in establishing the Dayton-mandated public finance structure at the State and the Entity levels since 1996. In the Federation, the customs and the payments systems were reintegrated and the formation of a unified tax administration was initiated. Some progress has also been achieved in unifying tax policies, and in establishing canton-level fiscal administration. However, separate policies and practices are still continuing within the fiscal structure of the Federation. The fiscal system of Republika Srpska has functioned broadly along the lines of the former SFRY system and needs to be strengthened and reformed. At the State level, the legislative framework for establishing Dayton-mandated institutions was adopted only in mid-1997. Due to the difficult political circumstances, its implementation has only just started. In the absence of country-wide institutions and policies, the Entities have had minimal coordination in key areas of economic management.
B. Need to Control the Expenditure Level
17. Public expenditures in 1996/97 totaled about 70 percent of GDP, and will remain high in 1998. While fiscal stability has been maintained thanks to donor support, the present level of public expenditure, as a percent of GDP, is excessive by most norms and is not likely to be sustainable in the medium-term once the extraordinary level of donor assistance phases down. On the other hand, additional pressure on fiscal expenditure is rising rapidly, even in the short run. Chief among these are: (i)return of refugees and the impact this is having on the demand for services such as health care, education and physical infrastructure; (ii) domestic liabilities and claims originating from numerous promises made by various authorities to ex- soldiers, their families, and other socially-disadvantaged groups; and (iii)accumulated stock of foreign debt that, once restructured, will need to be serviced regularly.
18. Clearly, over the longer term, BiH needs to constrain public sector expenditure to the levels appropriate to its stage of development and comparable to those in the region, i.e., in the range of 40-45 percent of GDP. To achieve this, it will need to prioritize expenditure demands among competing claims. This process will be made easier if the economy is recovering rapidly, thereby creating more room to maneuver. Public expenditure can rise in nominal terns even when its share in GDP is to be reduced.
C. Issues in Public Finance Reform
19. Institutional and policy foundations for fiscal management must be firmly laid to prepare BiH for sustainable recovery and growth. Implementation of the blueprint laid out in the Dayton Accords requires a major effort of all parties as well as further elaboration of the design of the fiscal structure. In the Federation, in addition to establishing the canton-level administrative structure,key tasks include: (i) clear assignment of revenue and expenditure responsibilities across the Federation government, cantons, and municipalities, (ii)further integration and full operationalization of the institutions that administer the customs, tax, budget, social security and payments systems, and (iii) promotion of transparency and accountability of government finance. In Republika Srpska, the key task is to reorganize and reorient existing institutions in order to facilitate the development of a market economy and to promote transparency and effectiveness. Together, the two Entities need to develop common policies and procedures ta (i) ensure financing of the State budget; (ii) establish viable debt management and (iii) harmonize tax and customs policies, administrative procedures, as well as enforcement capacity. 6
IV. PUBLIC FINANCE REFORM PROGRAM
A. Ensuring Financing of the State to Meet its Mandated Obligations
Current Situation
20. Based on the parameters set by the Dayton Accords, the Entities agreed on the size and the scope of the new State administration in June 1997. With technical assistance and pressure from the international community, the first State budget was adopted by the BiH Parliament at the end of June1997. However, this budget was not fully implemented during 1997. While the Entities agreed in principle that the administrative part of the State budget should be financed in the proportion of 2/3:1/3 by the Federation and Republika Srpska, and the debt service part of the State budget be financed by the Entities on the basis of the final beneficiaries' principle, the budgets adopted by the Entity Parliaments did not reflect fully these understandings and requirements. Although agreement was reached between the Entity governments to amend their respective Budget Laws in order to provide the State with sufficient funding, these amendments were not actually implemented during 1997.
21 . The organization of the new State administration, along the lines envisaged in 1997 budget, has gained a pace since the beginning of 1998 and is expected to be finalized by the end of June. The 1998 State budget has been formulated taking into account the full expenses associated with running the State administration. The budget includes an allocation of DM 57 million to finance the State's administrative structure (Assembly, Presidency, Constitutional Court and Council of Ministers) and three ministries (Foreign Affairs, Civil Affairs and Communications, and Foreign Trade and Economic Relations) as well as a debt service budget of DM 126 million.
Issues and Actions to be Taken in Ensuring Financing of the State
22. Experience so far shows that a much greater effort will be needed to ensure financing for the State administration to fulfill its responsibilities mandated by the Dayton Accords. To make practical progress on this front, concrete actions are needed in three areas: (i) the budgets of the State and the Entity governments, consistent with each other, need to be fully implemented; (ii) a mechanism for a transfer of funds from the Entities to the State needs to be institutionalized; and (iii)because much of the State's budgetary obligations relates to servicing BiH's external debt, institutional capacity for debt management needs to be developed in order to underpin the process of budget management.
23 . Progress has been made in the formulation of mutually consistent budgets of the State and the Entity governments. The 1998 State budget includes: agreement on the structure, size, staffing, and functions of each organ of the State government; agreement on a burden-sharing formula for financing the administrative cost of the State; and agreement on the principle of financing debt service by the two Entities. To underpin the State budget, the Entity governments have reflected in their budgets the required budgetary contributions to the State in accordance with these agreements. The 1998 budgets for the State and the Entity governments, consistent with these principles, have recently been approved by the respective legislatures.
24. Actual implementation of the State budget will be greatly facilitated by the institution of a transfer mechanism that helps ensure a smooth and regular flow of funds from the Entities to the State. As the experience in 1997 shows, even when the Entities incorporate into their respective budgets the required contributions to the State budget, it is not sufficient to simply rely on the provisions of the budgets to effect such contributions.
25 . The Bosnian authorities have recently completed the design of such a transfer mechanism, and initiated the necessary preparation in order to fully effect the transfer mechanism by the end of June 1998. The key features of the transfer mechanism are as follows: (i) transfer will be made on a monthly basis; (ii) 7 each transfer will be in the amount of 1/12 of the annual budgeted contribution by the Entities to the State's administrative budget, and 1/12 of the annual debt service of the Entities; (iii) transfers for the State administrative budget and for the servicing of extemal debt will be deposited into a general budgetary account and a dedicated debt service account, respectively, in the new Central Bank of Bosnia and Herzegovina (CBBH), with a sub-account for each Entity; and (iv) authorization for transfers by the Entities to the State will be effected automatically through a standing instruction from their respective Ministries of Finance to their payments bureau, without requiring monthly authortization for each transfer.
26. The authorities agree that an enhanced financing mechanism should be designed for the longer term. Such mechanism should meet the following criteria: (i)contributions by each Entity are sufficient; (ii) transfers are predictable and regular throughout the year; and (iii)burden-sharing between the Entities is in conformity with the criteria agreed upon. These objectives are perhaps best met by introducing new State taxes or providing the State with a fixed percentage of specific tax revenues of the Entities, such as customs revenue. There are several advantages of basing such a system on customs revenues: (i) the customs policies will be eventually unified for the entire country under the Dayton Accords; (ii)the customs administrations of the Federation and RepublikaSrpska are working relatively smoothly, with technical assistance and supervision of the EU; and (iii) the trade tax base will be a reasonably broad representation of the economy, making revenues less sensitive to fluctuations in individual markets.
27. Finally, as mentioned earlier, the efficient management of the State's financial obligations will hinge critically on the smooth functioning of the debt management system since much of the State budgetary expenditure is linked to external debt service. To ensure that debt service resources are used for their intended purposes, transparent operating and control procedures must be in place for the operation of the debt service account. Furthermore, to ensure adequate funds for debt service payments, building up reserves and establishing a reserve threshold for the account will also be necessary. The State Law on Foreign Debt adopted in June 1997 lays the foundation for establishing an effective debt management system in BiH, and the Entities are in the process of finalizing their draft Debt Laws in order to implement the provisions of the State Law, as outlined in IV.B below.
Actions to be Supported by the PFSAC
28. The proposed operation will support the design and implementatbn of key measures to ensure financing of the State budget. Prior to Board presentation, the authorities will: (i) have prepared the first drafts of the State and Entity budgets for the 1998 fiscal year; (ii) have agreed on the basic features of the transfer mechanism; and (iii) have established a dedicated State debt service account with the new Central Bank of Bosnia and Herzegovina
29. Prior to second tranche release, BiH will have. (i) adopted the State and Entity budgets that are mutually consistent; (ii) established a general budgetary account with the new Central Bank of Bosnia and Herzegovina; (iii) adopted all the necessary measures regarding operation of the transfer mechanism; and (iv) commenced regular transfer offunds from the Entities to the State.
30. As a further step towards preparing for a longer-term State financing mechanism, the authorities will take steps for the implementation of the uniform foreign trade regime across the country. The recently approved interim Foreign Trade Law and Customs Policy Law provide the necessary framework. The Entities will revise their laws to conform with the State legislation. Similarly, a common external tariff structure will need to be developed and implemented. The draft State customs code, based on the EU customs code, is expected to be ready for presentation to the Council of Ministers by mid 1998. The proposed PFSAC will support the efforts of the authorities and donors through the provision of technical assistance in the design and implementation of the new trade and customs regime for BiH. The assistance which has been provided during the preparation of this Project will continue during implementation. 8
Financing for the technical assistance is being provided through a Policy and Human Resources Development (PHRD) grant.
B. Establishing a Viable Debt Management Structure
Current Situation
31 . Since the outbreak of the war, BiH's outstanding external debt grew rapidly, as no debt service payments were made and arrears and penalties accumulated. At the end of 1997, BiH's debt stood at US$4.4 billion, of which 54 percent were arrears accumulated during the war. The debt burden reached unsustainable levels: in 1997, the debt-to-GDP ratio stood at 100percent, and the scheduled debt service-to- exports ratio at 40 percent. Obligations inherited from the SFRY constitute the majority of the outstanding debt of BiH.
32. Since the signing of the Dayton Accords in December 1995, BiH achieved some progress in resolving its debt problem and establishing debt management institutions: arrears to the Bank and the IMF were cleared, allowing the start of reconstruction assistance and debt rescheduling negotiations; the Entities agreed on the principles for the allocation of the old debt; a debt unit was established in State Ministry for Foreign Trade and Economic Relations (MFTER); the State Law on External Debt was adopted; and both Entities initiated preparatory work on their own Laws on External Debt. In December31, 1997, an Agreement was signed with the London Club on the rescheduling of BiH's external debt to commercial banks. The Paris Club is expected to proceed swiftly with the rescheduling of BiH's debt owed to official creditors, once the Stand-by Arrangement with the IMF is approved.
Issues and Plans in Creating a Debt Management System
33 . BiH's access to external financing, including eventual access to capital markets will be determined to a large extent by an early resolution of its existing debt problem and the effectiveness of new borrowing arrangements. This requires clarifying the responsibilities for foreign borrowing between the State and the two Entities and ensuring the automaticity and transparency of external debt servicing through efficient legal and institutional arrangements.
34. The State Law on External Debt defines the responsibilities of the State and the Entity institutions in external debt management and the coordination mechanisms between them. It qualifies the State's external obligations as the only category of sovereign debt in BiH, giving it seniority over external borrowing by the Entities. The State is allowed to borrow on behalf of the Entities or, with Parliamentary approval, on its own, and to issue payment guarantees for the borrowing of its constituent Entities or any other public or private sector institution in BiH. The State is the obligor for BiH's portion of the old SFRY debt and a member of International Financial Institutions (IFIs). Since the State has practically no independent fiscal base, the legislation provides for the cross-indemnification of State borrowing by the Entities. The Entities are also allowed to borrow by themselves, but such borrowing has subnational status, like any other local government borrowing.
35 . The immediate challenge is to implement the provisions of the State Law. The separation of borrowing, debt servicing responsibility, and fiscal authority creates potential for afree rider problem whereby if one Entity defaults, both the State's and the other Entity's ability to borrow could be jeopardized. The free rider problem may be contained only through credible and transparent institutional arrangements between the parties concerned in ensuring a smooth flow of resources to the State for external debt servicing. To provide the State with adequate funds on a regular basis, the Entities are committed to move rapidly in implementing the State finance mechanism as described in the previous section. 9
36. Further steps must be taken to create the institutional setup outlined by the State Law on External Debt. The Law provides for the establishment of a State Office of External Debt Management (OEDM), that should perform the following functions: (i) loan negotiation; (ii) monitoring of utilization and repayment of government and govemment-guaranteed loans; and (iii)debt policy formulation and forecasting. A special debt management office exists at the State level since 1996. The effectiveness of this office will be enhanced if its mandate and organizational structure within the State MFTER is clarified. To this effect, the MFTER is currently developing the functional responsibility of the office. Likewise, Entity Ministries of Finance need to strengthen their more recently established debt management units (DMUs), to assure a smooth flow of debt service payments to the State and to control their own borrowing. With external assistance, including that from the Bank, the Entities have initiated this work.
37. To facilitate the implementation of the State Debt Law, the key principles of the law should be complemented by the preparation and implementation of the Entity Debt Laws, and the following regulations: (i) the Statutes of the State OEDM and the Entities' DMUs that would detail their functions and work processes; (ii)the Coordination Agreement between the three agencies, that would clarify the information-sharing and decision-making procedures; and (iii)the Agent Agreement between the State MFTER and the CBBH that would establish clear operating procedures for the State debt servicing account. As a first step towards this end, the Agent Agreement was concluded in April 1998 while the other two regulatory arrangements are expected to be finalized by July 1998. In addition, to ensure the quality of information used for sovereign decision-making and to build trust between the parties, a unified public debt database (the Central Debt Ledger of BiH) must be created, and minimum disclosure/debt reporting standards agreed upon between the State OEDM, the Entities' DMUs, and other relevant agencies. The establishment of such a database that will link the State OEDM, the Entities' DMUs, and the CBBHhas been initiated in February 1998.
38 . Further, a long-term borrowing policy needs to be developed that would harmonize the State and the Entities' borrowing plans with the country's ability to service external debt. To this end, the State Debt Law provides for the establishment of a high-level Debt Advisory Committee with representation from all State and Entity agencies involved in managing external debt of BiH. This Committee's prototype was created in 1996, which has since tackled the most urgent matters of preparing legislation and debt renegotiation. As relations with external creditors are regularized, this Committee shall become the main instrument for policy coordination, ensuring that BiH keeps its borrowing operations within fiscally prudent and sustainable limits.
39. Improvement of BiH's debt management capacity requires significant investment in its human capital. Currently, BiH has a very modest national debt management cadre. The State debt management office and the Entities' DMUs must be further strengthened with staff professionally trained in accounting, legal, and macroeconomic aspects of external borrowing and debt servicing. The authorities have asked the World Bank to continue to provide its assistance in this area under the proposed PFSAC.
Actions to be Supported by PFSAC
40. The proposed operation will support the development of a strong external debt management capacity in BiH. The most immediate requirement for achieving this is to implement the provisions of the State Law on External Debt as regards the creation of a debt servicing mechanism and institution-building. Board presentation will be conditioned on the operationalization of a special debt service account at the State level with the transparent operating procedure adopted by the State MFTER Additionally, it is also expected that the work on the preparation of the Entity debt laws will have been finalized.
41. Before the second tranche release, the Entity Parliaments will have adopted and started the implementation of the Entity Debt laws. It is also expected that by the second tranche release: (i)debt information flows between the State and the Entities have been regularized, including the adoption of the 10
Coordination Agreement; (ii) the Statutes of the debt management agencies have been adopted; and (iii) a program has been developed by both the State and the Entities to strengthen their respective debt management capacity.
42. The technical assistance which has been provided during the preparation of this operation will continue during implementation. The proposed operation will assist the recently established debt management units in the State MFTER and the Entities' Ministries of Finance to clarify their mandates in transaction management and policy formulation; to elaborate procedures for interagency coordination; to help prepare an Agency Agreement between the State debt management office and its agent bank; and to help develop job descriptions for the debt offices' staff. The proposed operation will also focus on the technical tasks that would ensure the robustness of debt servicing arrangements, assisting the Bosnian authorities in establishing the Debt Ledger of BiH and developing procedures for monitoring and reporting external debt of BiH.
C. Reforming Intergovernmental Finances within the Entities
Current Situation
43. The Dayton Accords envisage different intergovernmental arrangements in the Federation and Republika Srpska. In the Federation, the canton level administration is being developed as the major instrument of government to accommodate different demands for services and to allow for greater local control over setting service levels. A more centralized approach is operating in Republika Srpska.
44. Some progress in establishing the cantonal structures has been achieved in the Federation since the adoption of the law creating cantons in June 1996. All cantons now have governors and cantonal assemblies; first budgets were formulated and adopted by all cantons in 1997, including for the two mixed cantons; and 1998 budgets have been prepared by the majority of the cantons. The adoption of the Law on Allocation of Federation Revenues in January 1997 facilitated this process. The revenue and expenditure assignments, both in 1997 and 1998, have generally followed the structure laid out in the new Federation Constitution. Customs and excise tax revenues are assigned to the Federation Government and the remainder of the revenues, mainly from sales, profits, and wage taxes, are assigned to the cantons and municipalities. The Federation budget anticipates relatively little service delivery responsibility for the Federation government. Cantons have responsibility for education. Service delivery for functions such as health, social assistance and police is mostly a cantonal responsibility, with each canton determining the relative role to be played by the canton versus the municipalities. Cantons will receive about 60percent of total public revenues and municipalities will receive about 20percent of the revenues from canton taxes to meet their expenditure responsibilities.
45 . Republika Srpska uses a tax sharing system with its municipalities that is similar to the one between the Federation cantons and municipalities. The Republika Srpska municipalities receive about lOpercent of tax revenues (mainly from sales, wages and profit taxes) and the remaining revenues go to the central Republika Srpska budget. The Republika Srpska government essentially delivers all services while the municipalities are responsible for limited functions such as solid waste collection, and for utility services that are delivered through off-budget companies.
Issues and Plans in Reforming Intergovernmental Financial Arrangements
46. Further clarification is needed in determining intergovernmental expenditure responsibility and revenue ownership for the Federation and Republika Srpska. Due to the Federation's more complicated structure, issues in intergovernmental finance are relatively more significant in the Federation than in Republika Srpska. I
47. The actual degree of expenditure devolution in the Federation remains unclear. Particularly in health, education, defense, and social welfare, agreement must be reached on the respective responsibilities of the Federation government and cantons. Most health services will be provided by the cantons, but the role and the financing sources of large health care units remain unclear in the existing budget. Similarly, education is mostly a cantonal issue, but the sources of financing for higher-education institutions still need clarification. The problem is more significant for defense and social welfare, in part because a portion of their financing remains off-budget. Defense, although assigned to the Federation government, is also being financed by some cantons and municipalities. Social welfare, where joint responsibility is established by the Federation and the cantons, is also being financed by municipalities in some instances. Responsibility for these expenditures must be clarified, and expenditures properly accounted for so that the full costs to the public sector can be appropriately reflected.
48. There exists a large mismatch between revenue capacity and expenditure responsibility. For example, the current system allocates significant revenue to the Federation, but holds the cantons responsible for most service delivery. A mechanism needs to be put in place to reconsider revenue assignments every several years to ensure that revenue availability is consistent with expenditure responsibility. A related issue is which level of government should be responsible for meeting costs of reconstruction and refugee return. Some parts of the Federation suffered more severe damage than others and face higher burdens in rebuilding public infrastructure and in providing services for the returning refugees, while revenue capacities to provide those services differ widely among cantons and municipalities.
49. Federation tax laws assign tax revenues to cantons on an origin basis, e.g., wage taxes are paid where the worker is employed, profits taxes are paid where firms are headquartered, and sales taxes are paid where the sale occurs. Significant imbalances in revenue across areas thus result because of wide differences in economic activity. Low activity places are able to deliver fewer services, and may be forced to pay lower public sector wages. To limit the degree of these imbalances, the Federation government needs to develop mechanisms for redistributing some limited tax revenues. The Federation amended, in October 1997, the Sales Tax Law by shifting the sales tax collection on excisable commodities from the import/manufacturing point to where the first buyer, after the importer/manufacturer, is located. Another step would be to develop a set of situs rules that share the revenues between jurisdictions in cases where some component of the taxable activity takes place in more than one jurisdiction. This could be done, for example, by sharing the profits tax for businesses operating across multiple cantons. The Federation government is presently considering developing such an approach.
50 . Changes in the revenue allocation rules alone will be unable to bring balance between expenditure responsibilities and revenue capacity across all municipalities and cantons. As a result, large differences in service availability can be expected at the local level since the Federation provides only a small pool of revenues that can be used to offset the most egregious differences. Increasing the size of the Federation's pool for intergovernmental transfers can help reduce these imbalances.
51 . The Republika Srpska government has initiated a new system for revenue allocation which provides municipalities with a slightly higher share of tax revenues, depending on the characteristics of the municipalities. The allocation of revenues is higher for municipalities that are on the border, have high social problems, have significant damage from the war, or have large numbers of refugees. These adjustments are a step towards limiting the occurrence of imbalances at the local level, but further changes may be necessary. There is also a need to consider decentralizing some service functions, especially in primary education and health clinics. Additional assignment of revenues to the municipal level would follow any changes in expenditure responsibility. 12
Actions to be Supported by PFSAC
52. The proposed operation will support the authorities' efforts in developing a sustainable intergovernmental fiscal structure across BiH. Key issues described above will be the focal point of discussion. The technical assistance which has been provided through previous operations and during the preparation of this operation will continue through implementation.
D. Reforming and Harmonizing Tax Policies and Coordinating Tax Collection
Current Situation
53 . Tax policy in both Entities is characterized by high and distortionary rates, particularly on wages and foreign trade, and by numerous, arbitrary tax exemptions that have substantially eroded the tax base. Further, the base and rates for important taxes, such as wage, excise, sales and profit taxes are different between the two Entities. The differences create incentives for tax avoidance and tax competition. Both Entities have initiated limited tax reforms aimed at improving policies and strengthening administration, and some progress has already been achieved in a number of areas.
54 . The Federation government has evaluated the steps needed to harmonize tax rates, bases, and other policies and has begun the process of revising tax laws. Federation wage, sales, and excise tax laws have been adopted, and the new profit and personal income tax laws are under development. The wage tax rate has been reduced significantly through decreases in pension contributions and in wage withholding taxes. Exemptions from social contribution payments, previously granted to a number of state-owned firms, have been eliminated. The Federation Tax Administration has been formed to coordinate tax collection in all cantons. Efforts are underway to build coordination and cooperation between cantonal offices, which carry out most administrative functions, and to develop Federation-wide reporting systems.
55. The Republika Srpska government has also achieved some progress towards reducing the wage tax through a reduction in pension contributions and in the wage withholding tax. Further, it has formed a commission to study the potential for sales tax reform in 1998. The Republika Srpska tax administration continues to operate as a single institution with offices in each municipality. Several initiatives have also been taken to improve tax collection and strengthen administration. Tax stamps were introduced for excisable goods, including alcohol and cigarettes. The responsibility for customs administrations and the financial police was centralized under the Ministry of Finance. The Ministry of Finance is updating the taxpayer registry and is planning to issue new taxpayer identification numbers in 1998.
Issues and Plans in Tax Reform
56 . Further progress in tax reform is essential to creating an environment that is conducive to growth and private sector expansion. The most urgent reforms are: (i) continuing to reduce the combined wage taxes to a level compatible with international standards; (ii)reducing trade taxes by adopting and implementing BiH-wide low tariff rates; (iii)broadening tax bases to replace the revenue loss that might have resulted from tax rate reductions; and (iv)harmonizing and coordinating tax policies and administration between the Entities.
57 . Ways to broaden the wage tax base include capturing a greater part of employee compensation in the tax base by closing legal loopholes used to shift compensation to nonwage benefits, eschewing exemptions, and improving enforcement. Legislation broadening the wage tax base to include some benefits, such as per diems and food and commuting allowances, above the minimum amount set in the Law on Wages, was passed by the Federation Parliament in October 1997. This was subsequently followed by the preparation of the necessary regulations by the Ministry of Finance for the implementation of the 13 amendments. Similar legislation to broaden the wage tax base is expected to be developed and submitted to the Republika Srpska Parliament during 1998.
58. Sales tax legislation, passed by the Federation Parliament in October 1997, has improved the sales tax system by reducing the number of sales tax rates (from five to four), lowering the tax rate on business purchases of fuel, exempting interest on bank loans, and allocating receipts from sales taxes on excisable commodities to the first buyer's location. However, continued use of exemptions from sales tax for items such as home heating and food products (to reduce tax burdens on the low income groups) creates difficulties in administration and introduces distortionary effects on consumption.
59. Taxation of imports is excessive in both Entities, due in large part to the very high excise levy assessed on imports. Harmonizing excise taxes on imported goods with those levied on domestic goods should be considered. To remove distortion and safeguard revenue, the large number of tax exemptions should be significantly reduced. The Federation adopted, in late 1997, legislation removing most exemptions in the Federation customs law, such as for automobiles and furniture. Republika Srpska is considering to remove these types of exemptions in the near future.
60. Among the other measures being considered by the Entities for improving tax policies during 1998 is to incorporate wage withholding into the personal income tax. The corporate income tax is also to be revised to equalize the tax rate with the top marginal rate under the personal income tax. Further, the Federation is considering to reduce the number of sales tax rates to a maximum of two, and to adjust the sales tax on services in line with the maximum sales tax on goods. Finally, the Entities must cooperate to prevent double taxation, tax avoidance, and distribute inter-Entity excise and sales tax revenues on the basis of consumption location.
61 . Coordination between the two Entities on tax policies and tax and customs administration is critical. Harmonization of tax bases, tax rates and collection points is essential to limiting tax competition and encouraging free trade. The planned change in Republika Srpska that moves the collection point for the sales tax on excisable goods from the retail to the wholesale level is a significant step in this direction and would facilitate coordination with the Federation, which already collects the taxes at this level. Definition of tax bases for the wage and profits taxes also must be harmonized across the Entities. Administrative cooperation between the Entities is essential to collecting tax liabilities from taxpayers operating in multiple jurisdictions. To achieve this, information sharing systems should be developed between the tax administrations in the two Entities.
Actions to be Supported by PFSAC
62. The proposed operation will support the continued development and implementation of tax reforms across BiH that will address the key issues described above. As an initial step in this direction, by Board presentation, Republika Srpska will have prepared the amendments to its Sales and Excise Tax Law; and by the second tranche release: (i) Republika Srpska will have adopted the amendments to its Sales and Excise Tax Law; and (ii) the Federation will have implemented the amendment to its Wage Tax Law.
E. Initiating Pension Reform
63. Fundamental reforms in the existing social protection programs for the elderly, the poor, the sick, and the war veterans and their families are needed in BiH in order to balance resources with the needs of poverty alleviation, as donor assistance is being phased out. The proposed operation supports the Entities' efforts to develop a fiscally viable social safety net system, particularly in pension administration which is facing the most severe crisis. 14
CurrentSituation
64. Three pension schemes currently operate in Bosnia and Herzegovina: two separate schemes in the Federation, covering Bosniac- and Croat-majority areas, and a Republika Srpska scheme. In the Federation, the Bosniac pension fund is the administrative successor to the prewar Bosnian pension fund and has maintained the recordkeeping link between past and present. In 1997, the fund was receiving contributions equivalent to 24.5 percent of gross wages from approximately 200,000 workers and paying pensions to around 185,000 pensioners. De facto, the scheme continues to operate under the former Yugoslav legislation with various exceptions. The pension fund operating in the Croat-majority area receives contributions equivalent to 17.5percent of gross wages from about 45,000 workers and pays pensions to almost the same number of pensioners. This scheme has been regulated by a series of decrees and pays a flat pension. The pension scheme of Republika Srpska collects a payroll tax of 22 percent of gross wages from about 145,000 workers and pays pensions to roughly the same number of pensioners. The actual number of contributors is far less than this given the fact that many finns do not pay taxes and have accumulated significant arrears.
65 . During 1996, rapid increase in wages and employment boosted pension revenues in the Bosniac- majority area, more than compensating for a full seven percentage point reduction in the earmarked pension tax in March of 1996. In addition, the Federation transferred DM 26 million from the proceeds of donors' budgetary support to pension funds. Consequently, average net pensions in the Bosniac-majority area rose from around DM 11 in 1995 to above DM 55 and eventually converged to levels in the Croat-majority area which remained steady at around DM 75. The average pension in the Federation further increased to more than DM 100 in 1997. In Republika Srpska, wages and employment and, therefore, the pension tax base, remained stagnant at low levels due to its relatively slow economic recovery. Pension levels in Republika Srpska fell further behind those paid to Federation pensioners: the average net pension during 1996 was about DM 25 and during 1997 was about DM 70. The fund covering the Bosniac-majority area, which maintains the prewar benefit rules, has the highest ratio of maximum to minimum pension (morethan 8:1 in 1996/97) while the ad hoc benefit formula employed in Republika Srpska also has resulted into a relatively wide range of pensions (5:1). In the fund covering Bosniac-majority areas, a significant part of the revenues are being directed to a small number of high-level pensioners, leaving more than half of the elderly in need of food and other basic assistance.
66. In both Entities, pension spending was the single largest cash transfer program. In 1997, spending in the Federation and Republika Srpska represented 5.8 and 3.9 percent of GDP, respectively. Adjusted for the demographic structure, actual pension spending in BiH, in terms of percentage of GDP, is slightly more than what international patterns show. This would have been even higher if legally prescribed benefits had been paid. However, since the beginning of the war, pensioners in the Bosniac-majority areas have received benefits below the legally prescribed amounts leading to an accumulation of claims (arrears) for unpaid pensions. Estimates of arrears reached over DM 300 million in the Bosniac majority areas, i.e., more than the entire amount of the fund spent in 1997. In Republika Srpska, the pension fund accumulated liabilities on current pension payments occasionally in 1996/97 due to lack of sufficient revenues and, therefore, pension payments were only made with two-three months lags.
Issues and Plans in Pension Reform
67 . Pension policy in BiH faces several challenges in the short term. The immediate challenge is to achieve fiscal sustainability by preventing systemic accumulation of arrears. Policies which might exacerbate the situation, such as relaxing eligibility criteria for certain special groups (e.g.,soldiers) must be avoided. This can only be achieved through legislation which redefines legal benefit rules so that statutory benefits match the benefits actually paid in a particular month. The balance of accumulated arrears must be 15 handled without undermining the already tight recurrent budgets. There is also an immediate need to move the elderly out of welfare by raising minimum pension levels.
68. With the assistance of the Bank and the IMF, the Management Board of the Bosniac pension fund adopted a decision in September 1997 that limits the legal entitlement of pension benefits to what is actually paid, thus eliminating continued accumulation of pension arrears. Further, to improve the targeting of pensions, the Board decided to flatten the benefit payments by increasing the minimum pension, while reducing the ceiling on maximum pension. As a result, the pension payment ratio between the highest and the lowest has been recently reduced from 8:1 to 6:1. In addition, the Federation Ministry of Social Protection and the two pension funds have been working together on a new Federation Pension Law. The new Law incorporates a number of reform measures in addition to legalizing the earlier Board decision on limiting the legal entitlement to what is actually paid. They include: (i) an increase in the retirement age to 65 by the year 2003; (ii) an increase in the minimum service period required to retire from 15 to 20 years; (iii) an increase in the number of consecutive years used as the assessment base for pension calculations from 10 to 15 years; (iv) an improvement in the indexation method to tie pension adjustments to the availability of regular pension resources; (v) tightening of eligibility rules related to survivors; and (vi) tightening of the rules regarding partial disability claims. The Federation government has submitted this new Law to its Parliament in April 1998 and expects the adoption of the Law to take place by June 1998. Furthermore, in the Federation, both pension funds have recently completed a new registration campaign to eliminate fictitious pensioners and to tighten eligibility criteria. As a result, about 10,000 entitlements were removed, saving over DM 12 million a year.
69. In Republika Srpska, the pension fund has always succeeded in limiting legal entitlements to what is actually paid, thus avoiding accumulation of arrears. Furthermore, in order to target pension payments to the appropriate individuals, the Republika Srpska pension payments have been effected only through direct cash payments to those entitled, thus avoiding potential payments to fictitious pensioners. However, the levels of pensions for most pensioners are extremely low, and payments are often postponed.
70. The decentralized state of public pension provision presents another important challenge. In order to minimizes the costs associated with having multiple schemes in a small country (highadministrative costs, potential barriers to labor mobility, limited risk pooling etc.) greater coordination must be achieved both on the policy and on the administrative level.
71 . In the Federation, a Working Group was formed to begin the process of harmonization and, eventually, the unification of the two Federation pension funds. The Group is expected to produce a detailed plan by the end of August 1998 after which unification is expected to take place by June 1999. Inter-Entity coordination will also be necessary. Communication between the pension funds operating in the Federation and the one operating in Republika Srpska has been minimal. There is an immediate need to provide all pension funds with pension information as contained in the prewar computer database of the BiH Pension Fund, and, generally, to establish a broader level of cooperation between the Republika Srpska Fund and the Federation Pension Funds.
72. In the medium term, more comprehensive pension reforms will have to be considered in BiH. Reform options such as the introduction of privately funded pensions will have to be studied carefully. The design of such new system should be based on a careful quantitative assessment of its fiscal and distributional impact. The governments of both Entities have asked the World Bank to continue to provide technical support in the process of designing a comprehensive pension reform. Such reform would, in due course, be supported by future structural adjustment operations. 16
Actions to be Supported by PFSAC
73. The proposed operation will support the Entity governments' efforts to design and implement pension policies that will contribute to attaining fiscal sustainability, better targeting of the most vulnerable pensioners, and greater harmonization of pension policies and administration across the country. Continuing dialogue between the governments and the Bank is expected in designing short-term pension policy and preparation for medium-term reform. Prior to Board presentation, the Federation government will have submitted to its Parliament the new Federation Pension Law which will be adopted and be under implementation by the time of second tranche release.
74. Technical assistance will be provided during the implementation of this operation. In particular, technical assistance by the Bank will: (i) advise the Entity governments on short-term pension policy, (ii) support the establishment of a Federation Pension Agency which will facilitate coordination of pension provision across the entire Federation; and (iii)assist and advise the Entity governments in preparing a comprehensive pension reform program.
F. Reforming the Budgetary Management System
Current Situation
75. Some initial steps have been taken by the authorities in improving budget preparation and management since 1996. The 1997 State and Entity budgets were adopted and those for 1998 were prepared broadly in accordance with the principles laid out by the new Constitution. Within the Federation, progress in defining revenue assignment, establishment of budget departments in cantons and municipalities, and adoption of essential accounting information systems all helped to improve budgetary management. Budgetary reporting and execution in Republika Srpska also improved, although only marginally, as compared to the previous year's practices.
76. Despite this progress, the formulation of clear rules and practices for budget planning, classification, coverage, reporting, auditing, and evaluation remains an important issue to be addressed at all levels of government. Certain categories of public outlays--such as those with respect to social funds, donor contributions and military spending--remain off-budget. Recording and accounting for arrears is generally poor. Furthermore, budgetary frameworks differ widely across governments in BiH.
Issues and Plans in Reforming Budget Management
77. In order to support the development of a sound fiscal system in BiH, introduction of new budgetary processes in the following areas is required: (i) defining and classifying public revenues and expenditures in a consistent and transparent manner; (ii) bringing earmarked and extra-budgetary revenues, particularly from donor financing, into the budget; (iii)limiting the number of extra-budgetary funds and regulating their operation by legislation; (iv)implementing adequate reporting standards for spending commitments and expenditures, and reducing unfunded public expenditure commitments; (v)establishing practices for expenditure prioritization; (vi)clarifying, and consistently using, improved budget preparation, execution and reporting practices; (vii) establishing sound procurement practices; and (viii)establishing audit offices, with sufficient authority and resources. In addition, each government should establish a treasury department and more advanced budgeting systems to ensure better execution, control and evaluation of budget outcomes.
78. As a first priority, revenues and expenditures, including foreign financing, need to be clearly defined, classified and recorded in the budget at all levels of government. This requires, on the one hand, addressing the issue of extra budgetary funds (EBFs) and, on the other hand, developing a harmonized framework for budget classification. The classification framework needs to be harmonized across the 17 governments and must be transparent. The Federation and its cantons have been developing a uniform classification framework across the Entity. As part of the new framework, the Federation authorities have brought foreign financing into the budget and will be recording externally financed expenditures in fiscal year 1998. Republika Srpska already reflects foreign financing in its budget.
79. Similarly, there is an urgent need for developing a framework within which government commitments would be systematically recorded, reported and controlled. Budget execution laws specify sanctions for overspending on a cash basis. However, the requirements for government institutions to record and report their commitments are weak and arrears are not systematically recorded. Accounting and budgeting procedures at all levels of government should be revised to include the recording of commitments and should be brought more into line with internationally accepted accounting principles. The Entity governments are considering to improve accounting standards in order to better control expenditure commitments and to obtain more timely and relevant information.
80. Within the budget process, arrangements for planning, approving, execution, reporting and evaluation must be improved and institutionalized in BiH. Budgetary planning should start with a thorough evaluation of the available resources and of the results of the previous year's budget implementation. It should be based on better estimates of revenues and expenditures and be closely related to government policy objectives during the budget period. To provide guidance to the budgetary institutions about spending priorities and desirable work programs, a clear system of strategic expenditure prioritization should be introduced, including the use of extra budgetary funds. At the sub-Entity level, particularly in the Federation, a clearer definition of fiscal responsibilities is crucial to budget preparation and to improving financial control. In particular, the nonbudget resources of budget-funded agencies (fees, receipts and other income) should be disclosed at the time of budget preparation, recorded during budget execution and more tightly controlled.
81 . The Federation is undertaking a comprehensive review of budget management to bring it in line with international practices. This includes preparing a new organic budget law and improving coordination in budget preparation and execution between the Federation and cantonal Ministries of Finance. Republika Srpska, which has a more unified government structure and budget, plans to prepare a new organic budget law in 1998.
82. To achieve more efficient use of budget resources, all governments will need to introduce procurement practices based more on the principle of open competition. The Federation is drafting a new procurement law reflecting such practices. Republika Srpska has also recently initiated drafting of an improved law bringing its current procurement procedures more closely into line with international norms.
83 . Reporting and auditing systems also need to be developed for each level of government including public disclosure to facilitate information sharing. A first step will be the establishment of an audit office for each government which would review government finances and report to Parliament. In addition, each Ministry of Finance would appoint its own inspector in charge of internal audit. Both the Federation and Republika Srspka are presently considering necessary legislation for establishing external auditing institutions. Regarding internal audits, the legislatures of both Entities have proposed the appointment of a budget inspector for their respective Ministries of Finance. The terms of reference for these positions are expected to be developed and appointments to be made by July 1998.
84. It is necessary to establish a Treasury Department in each government to improve budget control and cash management. The treasury, when established, will maintain the exclusive authority for transfer and spending. The treasury system will also provide core accounting functions for each government. The Federation government intends to establish a treasury department within the Ministry of Finance and will gradually introduce a treasury single account and a government financial management information system. 18
In the interim, the Federation Ministry of Finance should have access to all the information of the funds held by public bodies in the payments bureau. Similar arrangements are being considered by Republika Srpska.
Actions to be Supported by PFSAC
85. The proposed operation will support the initial design and implementation of a comprehensive program for improving budget management. The aim of the overall program is to support the achievement of a better controlled, better managed, more transparent and more accountable system of public financial management at all levels of government. During the period of PFSAC implementation, the program will focus on the following aspects: (i) incorporating into the budget of external resources and related expenditures; (ii) adopting improved budget classification schemes; (iii) recording of arrears on a more systematic basis; (iv) a review of extra budgetary funds for better budget coverage; and (v) preparatory work for establishing a treasury system and external government audit. As an initial step toward reforming budget preparation and reporting, by second tranche release, (i) the State and the Entity governments will have prepared 1998 budgets that incorporate external cash grants and borrowing for general budgetary purposes with corresponding expenditures also registered; and (ii) the Federation will have adopted and started the implementation of the new organic Budget Law and Republika Srpska will have drafted a new organic Budget Law.
86. Thereafter, implementation of budget reform should be continued in the following areas: (i) improving the Entity Ministry of Finances' control over all nonbudget revenues of budget-funded agencies, including access to the payment bureau or agent bank accounts held in the name of these agencies; (ii) establishing a Treasury Department; (iii) introducing improved government accounting standards, including commitment accounting and stricter controls on arrears; (iv)bringing EBFs within the budget where appropriate; (v) developing a medium-term expenditure framework to improve budget planning; and (vi) establishing internal and external government audit.
87. The assistance which was provided during the preparation of this operation will continue during implementation. It is also expected that parallel, donor-financed, technical assistance will be continued during PFSAC implementation. The Bank intends to initiate the preparatory work for the Second Public Finance Reforn Project that will focus primarily on these issues.
V. THE PROPOSED CREDIT
A. Rationale for Bank Involvement
88. The Bank Group's assistance strategy during FY98/99--as outlined in the Country Assistance Strategy dated July 31, 1997--aims at assisting BiH in moving from immediate postwar reconstruction towards sustainable recovery and growth. The key objectives of this strategy are: (i)strengthening the institutions of macroeconomic management; (ii)initiating structural reform measures, particularly in privatization and banking reforms; and (iii) carrying forward physical reconstruction of the country.
89. Particular emphasis will be placed on support for developing economic institutions and policies. Key among these efforts are reforms in fiscal management, including, inter alia, rationalization in assignment of revenue and expenditure responsibilities, sound external debt management, and establishment of a sustainable social assistance framework for the most vulnerable. As noted in the CAS, the FY98/99 program includes two public finance reform operations. The proposed PFSAC is the first of these two operations. It is designed to help BiH implement initial priority refofrmmeasures in fiscal management and to prepare the ground for more comprehensive reforms under a second public finance reform operation. 19
B. Credit Amount and Borrower
90. The proposed IDA credit, in an amount equivalent to US$63 million (SDR 46.2 million), will be lent to Bosnia and Herzegovina (the State) for a period of 35years, including a 10-year grace period, on standard IDA terms. The State will onlend, through subsidiary agreements, US$33million equivalent of the Credit proceeds to the Federation and US$30 million equivalent of the Credit proceeds to Republika Srpska, on the same terms of the IDA Credit. The beneficiaries would be Bosnia and Herzegovina (the State), the Federation and Republika Srpska. Funding for technical assistance required for the preparation of this operation is being provided through a PHRD grant.
C. Credit Design
91 . The proposed Credit would provide quick-disbursing funds for fiscal and balance of payments assistance in support of the government's efforts to reform public finance institutions and policies. The main elements of the program supported by this operation include: (i)preparation and adoption of the budgets of the State and the Entity governments, and the development and implementation of a transfer mechanism that would provide regular and predictable flow of funds to the State budget for meeting its obligations; (ii) development of debt management capacity in BiH; (iii)administrative reforms to improve efficiency and transparency of government operations; (iv) initial steps to reform and harmonize tax policies and administration within the whole BiH; and (v)initial reform of the pension system. In view of the critical importance of the establishing a functioning fiscal system for the entire country, this operation puts its main emphasis on assisting Bosnians in implementing the set of laws, adopted in June 1997, that governs the functioning of BiH as a unified country. Conditionality (as specified in section F) is mostly linked to institutional, budgetary management and debt management aspects required for the functioning of the country as a unified State. Other substantive reforms discussed in the previous sections are clearly important for the operation of an efficient public finance system in the longer term. The Bank intends to support these reforms in a planned follow-up operation.
D. Administrative Arrangements
92. The State MFTER is responsible for overall administration of the Credit on behalf of Bosnia and Herzegovina, the borrower. Each Entity's Ministries of Finance is responsible for administering the pre- allocated amount of funds of the Credit. Based on the discussions with government authorities, it is understood that the counterpart funds of the proposed Credit would be used to support fiscal expenditures of the State and Entity governments, in particular, contributions of the Entities to the 1998 State budget for debt service obligations, essential social expenditures such as pension payments and minimum income support, and costs related to institution-building efforts in the areas of debt management, budget management and tax administration.
E. Disbursement
93 . The Credit will be disbursed in two tranches to the deposit account of the State at the Central Bank of Bosnia and Herzegovina. The first tranche (US$33 million equivalent, with Republika Srpska share of US$18 million and Federation share of US$15 million) would be available upon Credit effectiveness. The second tranche (US$30 million equivalent, with Federation share of US$18 million, and Republika Srpska share of US$12 million) would be available upon satisfactory review by the IDA of the implementation of the adjustment program as a whole and the fulfillment of the specific second tranche conditions as described in the following section. 20
F. Monitoring Arrangements and Tranche Release Conditions
94. Implementation of the policy program will be monitored by a Committee composed of the representatives of the State MFTER and the Entity Ministries of Finance. The Committee will have responsibility for monitoring and evaluating progress under the various components of the program with input from participating ministries/institutions. IDA will monitor implementation with the help of the Committee's reports, and through supervision missions.
95. Specific conditions for Board presentation of the Credit are as follows:
(a) Preparation of the draft 1998 State budget, the Federation budget, and Republika Srpska budget which are satisfactory to the Bank;
(b) Agreement on a specific mechanism for automatic transfer of funds from the Entities to the State;
(c) Establishment and operationalization of a State debt service account with clear operating procedures;
(d) Republika Srpska government to prepare the amendments to its Sales and Excise Tax Law; and
(e) Federation government to submit to its Parliament the new Federation Pension Law.
96. Specific conditions for the second tranche release are as follows:
(a) Adoption by the respective Parliaments of the 1998 State and Entity budgets and commencement of their implementation;
(b) Commencement of regular transfers of funds from the Entities to the State budget;
(c) Adoption by the Entity Parliaments of the Entity debt laws;
(d) Federation to implement amendments to its Wage Tax Law; and Republika Srpska to adopt and implement the amendments to its Sales and Excise Tax Law;
(e) Federation to adopt and implement the new Federation Pension Law; and
(f) Federation to adopt and implement the new Organic Federation Budget Law and Republika Srpska to draft a new Organic Budget Law.
G. Environmental Assessment Requirements
97. In accordance with the Bank's Operational Directive on Environmental Assessment (OD4.01, Annex E), the proposed operation has been placed in Category "C" and does not require an environmental assessment.
H. Benefits and Risks
98. Benefits. The proposed operation will support the measures crucial for further development of a new government structure at the State and Entity levels, reintegration of the economy, and reorganization of public finance system. Establishment of an effective and integrated public finance structure will help BiH to 21 conduct sound macroeconomic management, reduce cost to economic transactions, and achieve external creditworthiness. By pursuing essential reforms in key public finance institutions and policies, the operation will help the Entities to correct the medium-term imbalance between the revenues and expenditures and set appropriate priorities for public expenditures. By supporting the development of a public sector which is more suitable to a market economy, the operation will also contribute to private sector development, employment creation and poverty reduction.
99. Risk Management. There will be risks associated with BiH's process of peace and reconciliation, as has been demonstrated so far since the signing of the Dayton Accords in December 1995. The two potential risks faced by the proposed PFSAC are a function of this environment: (i) non-implementation of the agreed measures and reversal of the adopted reforms; and (ii) diversion of the counterpart funds of PFSAC proceeds for non-priority uses.
100. Non-implementation of Agreed Measures or Reversal of Adopted Reforms. Several measures supported by the proposed PFSAC are subject to significant political debate within the country. Particular among them are the transfer mechanism for State financing, and the argument, by some parties, for a complete allocation of old debts as a precondition for implementing the external debt law. To mitigate these risks, the Bank requires the upfront fulfillment of conditionalities whenever possible and will work closely with the IMF, the US Treasury and others to jointly promote the implementation of the reform agenda. Technical assistance for debt management and fiscal support provided under the PFSAC is expected to help reduce any tension between the parties and remove potential bottlenecks to the implementation of the reform program.
101. Allocation of PFSAC Counterpart Funds for Non-priority Uses. The PFSAC will be the Bank's second structural adjustment operation in BiH, after the 1996 Transition Assistance Credit (TAC). One lesson learned under the TAC concerns the use of the counterpart funds from the Credit proceeds by the government, a portion of which was channeled to industrial enterprises, a non-priority use of these funds. Building on the lessons of this experience, in order to mitigate the risk of counterpart funds being used for non-priority expenditures, PFSAC funds will be included in the 1998 budgets of the Entities and allocated strictly in line with agreed budgetary priorities.
VI. RECOMMENDATION
102. I am satisfied that the proposed Credit complies with the Articles of Agreement of the Association, and I recommend that the Executive Directors approve the proposed Credit.
James D. Wolfensohn President
by Caio Koch-Weser
Attachments
Washington, D.C. April 27, 1998
23
SCHEDULEA
BOSNIAAND HERZEGOVINA
PROPOSEDPUBLIC FINANCE STRUCTURAL ADJUSTMENT
TIMETABLE OF KEY PROJECT PROCESSING EVENTS
1. Time taken to prepare: three months
2. Project prepared by: Government with IDA assistance
3. Identification Mission: March/April 1997
4. Preparation Mission September/October 1997
5. Appraisal Mission: November 1997
6. Negotiations: December 1997
7. Planned Board Presentation: May 1998
8. Planned Effectiveness: May 1998
9. Expected Project Completion: Not applicable
10. Relevant SAR: Not applicable 24
SCHEDULE B
BOSNIA AND HERZEGOVINA PROPOSED PUBLIC FINANCE STRUCTURAL ADJUSTMENT CREDIT
STATUS OF BANK GROUP OPERATIONS IN BOSNIA-HERZEGOVINA
STATUSOF BANKGROUP OPERATIONS IN BOSNIA-HERZEGOVINA
A. STATEMENT OF BANK LOANS a/ (As of March 31, 1998)
US$ Million Loan Fiscal (Less Cancellations) No. Year Borrower Project Loan Undisbursed
Loans/Credits/Grants
IBRD b/ 4038-BOS 1996 Bosnia and Herzegovina Consolidation Loan A 28.6 0.0 4039-BOS 1996 Bosnia and Herzegovina Consolidation Loan B 284.9 0.0 4040-BOS 1996 Bosnia and Herzegovina Consolidation Loan C 307.1 0.0
Total 620.6 0.0
Of Which: Repaid 24.9 Total Now Held by the Bank: 595.7 TFBHCI(Under Disbursement) TF-0240301996 Bosnia and Herzegovina Emergency Recovery Credit 45.0 1.2 TF-024031 1996 Bosnia and Herzegovina Emergency Farm Reconstruction 20.0 0.0 TF-0240321996 Bosnia and Herzegovina Emergency Water Supply 20.0 0.5 TF-0240331996 Bosnia and Herzegovina Emergency Transport 35.0 5.8 TF-0240341996 Bosnia and Herzegovina Emergency District Heating d/ 20.0 1.4 TF-024035 1996 Bosnia and Herzegovina Emergency War Victims Rehabilitation 5.0 0.0 TF-0240401996 Bosnia and Herzegovina Emergency Education Reconstruction 5.0 0.0
Total 150.0 8.9
IDA 2897-BOS 1996 Bosnia and Herzegovina Emergency Education Reconstruction 5.0 0.6 2896-BOS 1 996 Bosnia and Herzegovina Emergency War Victims Rehabilitation 5.0 5.0 2902-BOS 1996 Bosnia and Herzegovina Emergency Housing Repair 15.0 1.3 2903-BOS 1997 Bosnia and Herzegovina Emergency Power Reconstruction 35.6 3.3 2904-BOS 1997 Bosnia and Herzegovina Emergency Public Works and Employment 10.0 1.7 2905-BOS 1997 Bosnia and Herzegovina Emergency Landmines Clearance 7.5 0.9 2906-BOS 1997 Bosnia and Herzegovina Emergency Demobilization and Reintegration 7.5 3.7 2914-BOS 1997 Bosnia and Herzegovina Transition Assistance Credit 90.0 0.0 N001 -BOS 1997 Bosnia and Herzegovina Emergency Industry Re-Start Guarantee 10.0 0.5 N002-BOS 1997 Bosnia and Herzegovina Emergency Microenterprise/Local Initiatives 7.0 2.6 N003-BOS 1997 Bosnia and Herzegovina Essential Hospital Services 15.0 11.4 0320-BOS 1997 Bosnia and Herzegovina Transport Reconstruction II 39.0 30.0 0350-BOS 1997 Bosnia and Herzegovina Education Reconstruction II 11.0 9.5 3028-BOS 1997 Bosnia and Herzegovina Reconstruction Assistance Project 17.0 15.7 3029-BOS 1997 Bosnia and Herzegovina Emergency Natural Gas 10.0 10.0 Total 284.6 96.2
a/ The statusof theseprojects is describedin a separateTeport on all Bank/IDA financedprojects in execution,which is updatedtwice yearly and circulatedto theExecutive Directors on April 30 andOctober 31. ConsolidationLoans A, B, and C wereapproved on June13, 1996and became effective on June 14, 1996. C' Trust Fundfor Bosniaand Herzegovina. di Disbursementsto dateare from the ProjectStart-Up Advance (of which US$2million is disbursed for Gas). 25
B. STATEMENT OF IFC INVESTMENTS (As of November 30, 1997) Gross Commitments ------US$ Million------Fiscal Year Obligor _ Type of Business Loan Equity Total
1977 Tvornica Kartona I Ambalaze Cazin Timber, Pulp and Paper 3.79 0.0 3.79
1985 Sour Energoinvest Industrial Equipment and Machinery 8.82 0.0 8.82
1997 Horizonte BiH Enterprise Fund SME Investment 0.0 2.00 2.00
1997 Microentreprise Bank Microcredit 0.0 0.57 0.57
1997 Sarajevska Pivara Brewery 8.04 0.0 8.04
Total Gross Commitments 20.65 2.57 23.22 Less: Participations, Cancellations, Terminations, Exchange Adjustments, Repayments, Write-offs and Sales 23.50 2.60 26.10 Total Commitments Now Held by IFC 20.65 2.57 23.22 Total Undisbursed 5.01 2.00 7.01 Total Outstanding 15.64 0.57 16.21 26 Bosnia and Herzegovina at a glance SCHEDULE C
Bosnia Europe & POVERTYand SOCIAL and Central Low- Herzegovina Asia Income Developmentdlamond, Populationmid-1996 (millions) 4.1 479 1,125 GNPper capita1996 (USS) 750 2,180 1,750 Life expectancy GNP1996 (bilbmsUS$) 3.1 1,043 1,967 Average annual growth, 1990-96 Popuiation(%) 0.3 1.4 GNP 7 Gross Laborforce (%) 0.5 1.8 per / 7~primary Most recent estimate (latestyear avaiablesince 1989) capita \ / enrollment Poverty:headcount index (% of population) Urbanpopulation (% of totalpopulaton) 49 65 56 Life expectancyat birth(years) 71 68 67 infant mortarity(per 1,000fiv bhiths) 19 26 41 Accessto safewater Childmalnutriton (% of chidrenunder 5) Accessto safewater (% of populatin) .. .. 78 ileracy (% of populatonage 15+) . Bosniaand Herzegovina Grossprimary enroliment (% of schoolagepopulation) 97 104 Low-incomegrwp Male .. 97 105 tp Ferale .. 97 101
KEYECONOMIC RATIOS and LONG-TERMTRENDS 1976 1986 1996 1997
GDP(billons USS) .. .. 3.3 4.5 Econoi ratios Grossdomestic investmenVGDP .. Exportsof goods & non-factorservFes/GDP .. .. 19.8 22.4 Opennessof economy Grossdomestic savings/GDP .. Grossnational savings/GDP ..
Currentaccount balance/GDP .. .. -22.5 -23.5 Interestpayments/GDP ...... Savings Inve Total debUGDP .. .. 116.7 99.6 Total debtservice/exports .. .. 87.1 38.6 Presentvalue of debtGDP .. Presentvalue of debt/exports .. .. Indebtedness
1976-86 1986-96 1996 1997 1997405 (averageannual growth) Bosnia andHerzegovina GDP .. .. 49.8 30.0 14.1 GNPper capita .. .. 57.0 29.0 .. Lowfincomegroup Exportsof goodsand non-factorserv .. .. 67.7 47.2 19.2
STRUCTUREof the ECONOMY 1976 1991 1996 1997 (% of GDP) Agriculture *- 9.5 19.1 19.7 Growthrates of outputand investmnnt (%) Industry .. 43.0 23.1 24.0 s- Manufacturing ...... o I Services .. 47.5 57.8 56.3 9t 92 93 94 95 96 97
Privateconsumption ...... G -- GDP Generalgovemment consumption .. Importsof goodsand non-factor services .. .. 68.5 58.1
1976486 1986-96 1996 1997 (averageannual growth) Agriculture ...... Growthrates of exportsand imports (%) Industry 100 Manufacturing ...... 5 Services II : o- I I Privateconsumption ...... 91 92 93 94 95 99 97 Generalgovemment consumption .. Grossdomestic investment .. .. 55.5 29.9 Exports t-O-Imports Importsof goodsand services .. .. 65.8 10.2 Grossnational product ..
Note:1WI data are preliminaryestimates. Largeproportion of dataare missingdue to scantand partial data in case of Bosniaand Herzegovina at present,early, stage of post-warera. The diamondsshow fourkey indicatorsin the country(in bold) comparedwith its income-groupaverage. If data are missing,the diamondwill be incomplete. 27 Bosnia and Herzegovina
PRICESand GOVERNMENTFINANCE Domestic prices 1976 1986 1996 1997 Inflatt% (% change) Consumerprices '11 -25 14 20 Implici GDPdeflator ...... -20 92 93 Govemnmentfinance -40 {X of GDP) Currentrevenue excluding grants .. .. 43.0 43.0 - GDPdef. CPI Currentbudget balance .. Overallsurplustdeficit .. .. -8.0 -7.0
TRADE 1976 1985 1996 1997 (mllions US$) Exportand importlevels (nill. USS) Totalexports (fob) .. .. 336 570 n.a. 2,500 n.a...... 2,000 Manufactures ...... Tolal imports(cil) .. .. 1,882 2,198 1,000 Ji Food .. ... W Fuel and energy .. .. _soo____ Capitalgoods e9 92 93 94 Sa 9 97 Exportprice index (1987=100) .. Importprice index (1987=100) ...... * Exports a Imports Termsof trade (1987=100) .. .. _.._..
BALANCEof PAYMENTS 1976 1986 1996 1997 (millionsUSS) Exportsof goodsand non-factorservices .. .. 658 997 Currentaccount balance to GDPratio (%) Importsof goodsand non-factorservices .. .. 2,278 2,587 -21 _ l _ l Resourcebalance .. .. -1,620 -1,589 91 92 93 94 95 Net factorincome ' .. .. -222 -228 -22 Netcurrent transfers .. .. 1,094 772 l i Currentaccount balance, -23 after officialcapital transfers .. .. -748 -1,046 Financingitems (net) .. .. 1,115 1,271 -24 Changesin net reserves .. .. -367 -225 Memo: Reservesincluding gold (mill. US$) .. Conversionrate (AocalUS$) ..
EXTERNALDEBT and RESOURCEFLOWS 1976 1986 1996 1997 (millionsUSS) Total debt outstandingand disbursed .. .. 3,884 4,439 IBRD 596 596 Compositionof totaldebt. 1997(nill. USS) IDA .. .. 204 364 Totaldebt service .. .. 573 385 A IBRD .. .. 37 39 596 IDA . .. 0 1 Compositionof net resourceflows F 03; Officialgrants ...... 2427 7 Officialcreditors .. E Privatecreditors 940 Foreigndirect investment .. Portfolioequity .. World Bankprogram Commitments . .. .. A- IBRD E- Bilateral Disbursements ...... B- IDA D - Othermultilateral F - Private Principalrepaymnents ...... C - IMP G- Short-term Net flows Interestpayments .. Net transfers
11Data refersonly to the Federationof BiHt.In RepublkaSrpska, annual percentage change in CPI was66 in 1996and 3 in 1997. IntemationalEconomics Department ANNEX I
Public Finance Structural Adjustment Credit to Bosnia and Herzegovina
April 27. 1998
Mr. J. Wolfensohn President World Bank 1818 H Street NW Washington, D.C. 20433 U.S.A.
LETTER OF DEVELOPMENT POLICY
Dear Mr. Wolfensohn:
As you know, Bosnia and Herzegovina (BiH) has been experiencing the beginnings of economic and social recovery since the signing of the Dayton/Paris Peace Agreement in December 1995. While living standards are still low for many families and economic activity is still atonly about one third of the prewar levels, the reconstruction effort has already yielded significant results with signs of the increased production and trade, reduced unemployment, restored services, and improved infrastructure.
Although we consider no less important the establishment of a new governance structure and state level institutions, our progress in these areas has been modest. Following the countrywide elections in September 1996, we established the State Council of Ministers in January 1997. Since then, work of the Council of Ministers has proceeded, but only slowly. With a long delay, we adopted, in June 1997, the Quick Start Package (QSP) which contains six laws needed for establishing a countrywide institutional framework for economic management. These laws govern formulation and implementation of the State budget, management of external debt, foreign trade, customs policy, and the central bank and currency. Because of political difficulties that we experienced in the summer of 1997, we have not been able to implement these laws. Our urgent task now is to operationalize and implement these laws.
Public finance reform is a key element of the QSP and the cornerstone for establishing a new governance structure in Bosnia and Herzegovina. To this end, we intend to focus our efforts in the immediate future to implementthe provisions of the relevant economic laws of the QSP to effect the new public finance structure and to implement fiscal policies that are more appropriate to the development objectives of the Bosnian economy. Specifically, we intend to: (i) clarify the financing arrangement for the State administration through the adoption and implementation of the 1998 budgets for the State and the Entity governments, and of the administrative mechanism for the transfer of funds from the Entities to the State government; (ii) establish an effective debt management system through the setting-up and operationalization of a special State debt service account at the Central Bank of Bosnia and Herzegovina with a subaccount for each Entity; the adoption and implementation of the Entity debt laws; andthe establishment and operationalization of the State Office of External Debt Management and the Debt Management Units in the Entity Ministries of Finance; (iii) reform further the inter-governmental fiscal relations within the Entities by clear assignment of revenue and expenditure responsibilities; (iv) reform and harmonize the Entity tax systems through the adoption and implementation of a customs tariff law, amendments to the existing sales and excise taxes, and preparation of new corporate income and personal income tax laws; (v) control pension expenditures by adopting measures to eliminate continual accumulation of arrears and tightening eligibility criteria; and, importantly, (vi) introduce budgetary reforms to enhance transparency and accountability in government finance through introduction of a new budgetary classification scheme and improving the process for budgetary preparation and implementation, and through better internal control and external auditing. The following sections of this letter describe in more detail the Government's planned reform actions in each of these areas.
Ensuring Financing of the State Budget
We recognize that providing stable financing for the State is a prerequisite to establishing a functioning State administration and a new governance structure in Bosnia and Herzegovina. In June 1997, we adopted, for the first time, a budget for the State government. However, his budget was never implemented because of a number of difficulties. Among them was the lack of financing sources for the State budget. In the absence of regular provision of funds to the State administration, financing of the State expenditures in 1997 was mostly on an ad hoc basis.
To ensure a more stable financing for the State in 1998 and beyond, first, we initiated preparation of mutually consistent budgets for the State and the Entities in 1998. In particular, we ensured that the State budget has the full backing of the Entity budgets in that the expenditure obligations of the State are fully covered by the contributions of the two Entities' budgets. We have completed the preparation of the 1998 draft budgets for the State and the Entity governments, consistent with each other, and have submitted these budgets to the respective legislatures for approval which is expected to take place by no later than May 1998.
Secondly, to ensure regular provision of funds from the Entities to the State administration, we have agreed on the specific arrangements as well as the principle of automatic transfer of funds from the Entities to the State budget. These arrangements specify that:
(i) Transfers to the State budget shall be made on a monthly basis. Each transfer shall be in the amount of 1/12 of the annual budgeted contribution by the Entities to the State's administrative budget, and 1/12 of the debt service obligations of theEntities. This system will be implemented as follows:
* Transfers to the State Budgetary Account through this mechanism will be initiated upon the establishment of the necessary accounts in the Central Bank of Bosnia and Herzegovina (CBBH) and specification of the underlying operating procedures (see item (ii) below). Until decisions and agreements to this effect are finalized, the Entities will transfer their monthly contributions--equivalent to 1/12 of the annual amount in accordance with the 1998 Budget Execution Laws of State of BiH--to the State administrative budget according to their existing practices;
2 * Transfers to the Entity subaccount in the State Debt Service Account will cover debt service obligations to all creditors with whom there has been a normalization of external debt,as well as for the new obligations. At this stage, the Entities are in the process of exchanging information and documentation with the State Ministry of Foreign Trade and Economic Relations (MFTER) to clarify the 1998 payment schedule for these creditors. This information and documentation is currently available only for the World Bank and the IMF for which automatic monthly payments have been started as of April 1, 1998. The debt service obligations for the other creditors will be included in the new system of monthly payments as similar information and documentation is collected and accepted by the Entities. We shall have finalized this work by no later than the end of June 1998;
(ii) Transfers for the State administrative budget and for the servicing of external debt shall be deposited into the general State Budgetary Account and into the dedicated State Debt Service Account, respectively, in the CBBH, with sub-accounts for the Entities. As a first step towards this end, we have created, in March 1998, a dedicated State debt service account in the CBBH with a subaccount for each Entity. To ensure transparency and effectiveness, we have also agreed on a set of operating procedures for this account and concluded an Agent Agreement between the State MFTER and the CBBH in April 1998. We will have created a similar, general State budgetary account with a subaccount for each Entity by June 1998. The accounts in the Central Bank will be subject to regular auditing by independent auditors; and
(iii) The Entity Ministries of Finance shall provide a standing instruction to their respective Payments Bureau to make monthly transfers from their budget account held in the Bureau into their respective subaccounts in the CBBH automatically, without requiring subsequent monthly authorization for each transfer.
In the longer term, we would seek to further improve the State financing system to ensure a more stable financing of the State budget. We would explore all options to achieve this objective.
Establishing a Viable Debt Management Structure
We have made progress in resolving the debt problem inherited from the past and in establishing sovereign debt management institutions. Arrears to the World Bank and the IMF were cleared, allowing the start of reconstruction assistance and debt rescheduling negotiations. A State Law on External Debt was adopted in June 1997. Other achievements to date include: (i) agreement by the Entities on the principles for the allocation of the old debts; and (ii) the signing of an Agreement with the London Club creditors on the rescheduling of BiH's commercial bank debts, which gave Bosnia and Herzegovina a debt reduction of more than 80 percent of its net present value.
The immediate challenge that we face is to implement the provisions of the StateLaw on External Debt. As indicated in the previous section, we have already initiated this process by establishing a special debt service account at the CBBH, with subaccounts for the Entities, into which the Entity governments will channel resources and from which debt service payments will be made. This account will be operated with a clear set of operating, control and auditing procedures, as specified by the Agent Agreement between the State MFTER and the CBBH. We are also preparing a Federation Debt Law and a Republika Srpska Debt Law, that incorporate the debt management mechanisms and the procedures for automatic revenue transfer for the purpose of external debt
3 service. The Governments of the Federation and Republika Srpska will begin implementing the laws by no later than the end of June 1998.
Another immediate challenge we face is to establish and operationalize the institutional setup for debt management. At this time, the State Ministry of Foreign Trade and Economic Relations has three Departments that deal with aid and debt management. To be fully effective, the State's debt management mandate must be consolidated within one office and streamlined. To this end, we will consolidate the existing departments and establish a central State Office of External Debt Management (OEDM), as mandated by the State External Debt Law. By July 1998, we shall have prepared a statute for this office that will detail its functions and work processes. Likewise,by July 1998, both Entities shall have strengthened the Debt Management Units (DMUs) in their respective Ministry of Finances (MOFs) and shall have prepared their Statutes. A regular exchange of detailed information between the Entities and the State on debt will also need to be instituted. To ensure consistency and quality of external debt data, we have initiated, in February 1998, the establishment of a unified public debt database (Central Debt Ledger) that will link the State OEDM, the Entities' DMUs, and the CBBH. This Debt Ledger is being established on a common system platform. In addition, we will conclude, in June 1998, a Coordination Agreement specifying the procedures for information sharing and policy coordination among the parties concerned. Finally, we recognize that the debt management system needs a critical mass of specialists to perform legal, accounting and macroeconomic work for efficient borrowing and debt servicing. By July 1998, we shall have adequately staffed all three debt management offices and shall have arranged debt management training through specialized courses, internships and study tours.
The State External Debt Law provides for the establishment of a high-level Debt Advisory Committee that would bring together for policy discussions all State and Entity agencies involved in managing sovereign external debt. In 1996 we have already created a prototype of this Committee, that focuses predominantly on the renegotiation of the external debt inherited from the Socialist Federal Republic of Yugoslavia (SFRY). As the relations with external creditors are regularized, this Committee will serve as a forum for borrowing policy consultations, assuring that BiH as a whole and each Entity in particular keeps its borrowing operations within fiscally prudent and sustainable limits. We are planing to proceed with the creation of the Debt Advisory Committee by July 1998. The Committee will subsequently initiate the formulation of a long-term policy framework for external public borrowing.
Reforming Intergovernmental Finance Within the Entities
The Dayton Agreement envisages different intergovernmental arrangements in the Federation and Republika Srpska. In the Federation, the canton structure is being developed to allow for greater local control over setting service levels. A more centralized approach is operating in Republika Srpska. Due to the Federation's more complicated structure, issues in intergovernmental finances are relatively more significant in the Federation than in Republika Srpska.
The Federation Government has made progress in establishing its new governance structure since the adoption of the law creating cantons in June 1996. The basic canton structure has been established with the appointment of governors and cantonal assemblies. In 1997, all cantons, including the two mixed cantons, adopted their first budgets. Adoption of the Law on Allocation of Federation Revenues in January 1997 facilitated this process. Most of the cantons have prepared their draft 1998 budgets which are expected to be adopted before the end of May 1998. Revenue and expenditure assignments, both in 1997 and 1998 budgets, generally follow the structure laid out in the new Constitution.
4 We recognize the need for further clarifying intergovernmental expenditure responsibility, particularly, in education, health, defense and social welfare. As an initial step in this direction, we recently clarified education as a cantonal responsibility in accordance with the Constitution. The next step will be to clarify, during 1998, the sources of financing for higher-education, so that cantonal expenditures can be set appropriately. We will follow a similar approach in determining the role and the financing sources of large health care units to enhance the health service capacity of cantons. We are also considering clarifying respective responsibilities of the Federation and cantons in defense and social welfare, so that the full costs of these services to the public sector are made explicit and suitable priorities for overall expenditures are set in the respective budgets.
As a further aspect of reform efforts to support the development of a sound Federation fiscal system, we anticipate developing a mechanism to reconsider revenue assignments every several years with a view to ensuring that revenue availability to cantons is consistent with their expenditure responsibility. A particular issue we intend to address in 1998 is to determine allocation of responsibilities and revenues for meeting costs for refugee return and reconstruction. Some parts of the Federation face higher burdens in rebuilding public infrastructure and in providing services for the returning refugees, while revenue capacities to provide those services differ widely among cantons and municipalities. We recognize the need for limiting this imbalance by introducing necessary measures as the new fiscal structure evolves.
In addition, we plan to improve the distribution of tax revenues among cantons in order to make it more consistent with the principle of attributing revenues to where the actual economic activity takes place. To this end, we already amended, in October 1997, the Sales Tax Law by shifting the collection point of sales tax to the cantons where the first buyer, after the importer/manufacturer, is located. We further plan to develop a set of situs rules that will govern the sharing of revenues between the jurisdictions in situations where taxable activity takes place in more than one jurisdiction. Efforts are underway to initiate this work on the profit tax in 1998.
In Republika Srpska, we changed the rules on revenue allocation to provide municipalities with a larger share of tax revenues, with specific shares in each region set on the basis of the needs and characteristics of the individual municipalities. We are also considering the possibility of decentralizing provision of some services. Any changes in expenditure responsibility will be matched by assignment of adequate revenues to the appropriate level.
Reforming and Harmonizing Tax Policy and Coordinating Tax Collection
In tax policy and tax administration, we need to reduce taxes on wages and foreign trade, strengthen administration in both Entities, and initiate and enhance cooperation between the two Entities in tax policy and administration for mutual benefits. The Federation Government has taken significant steps to harmonize, within the Federation, tax rates, bases, and policies, and has begun the process of adopting or revising all major tax laws. The Federation laws on wage tax, sales tax, and excise tax have been adopted; the Federation laws on personal income tax and corporate income tax are being prepared and are expected to be adopted in 1998. With the introduction of these laws, the Federation will have a unified framework for taxation among all ten cantons. In the Federation, the tax rate on wages has been reduced and exemptions granted to large firms for social contribution payments have been eliminated. More recently, the Federation also reduced the number of sales tax rates (from five to four). A unified Federation Tax Administration has been created by merging the old Croat and Bosniac tax collection systems. Efforts are underway to enhance coordination and cooperation between cantonal offices, which carry out most administrative functions, and to develop
5 Federation-wide reporting systems. Additional ongoing efforts include amendments to the wage tax law to reduce the number of social benefit payments eligible for wage tax exemption.
In Republika Srpska, wage tax was also reduced through a reduction in pension contributions and in the wage withholding tax. The government formed a commission to study the potential for sales tax reform in 1998. Several initiatives have been taken to improve tax collection and strengthen tax administration, including the use of tax stamps on excisable goods such as alcohol and cigarettes. The Republika Srpska Ministry of Finance is updating the taxpayer registry and plans to issue new taxpayer identification numbers by July 1998. The Government has recently reorganized the management of the customs administration and the financial police, and placed them under the Ministry of Finance.
Coordination of tax policies and tax administration between the two Entities is critical to avoiding harmful tax competition and tax evasion. Harmonization of tax bases, tax rates, and collection points is one means of limiting tax competition and encouraging free trade. Republika Srpska has recently prepared amendments to its Sales and Excise Tax Law that will move the collection of excise and sales taxes on excisable goods from retail to the import/wholesale point, which will facilitate coordination with the Federation. Republika Srpska plans to adopt this new system before the end of May 1998. A similar effort is needed in drafting the personal income and company profit taxes of the two Entities, and in harmonizing excise and sales tax rates and exemptions. There is also the immediate need to address taxation on inter-Entity sales by designing a revenue allocation system that will distribute appropriately the tax revenues on the basis of consumption location, and that will prevent double taxation or tax avoidance. As a first step in this direction, a working group has been established to study the necessary amendments to the Entity sales tax laws. Finally, administrative cooperation between the Entities' revenue collection agencies is essential to collect tax liabilities from taxpayers operating in multiple jurisdictions. To achieve this, we expect to develop information sharing systems between the respective tax administrations in the near future.
Reforming the Pension System
Three pension schemes currently operate in BiH - two separate schemes in the Federation, covering Bosniac- and Croat-majority areas, and a third scheme in Republika Srpska. Together, pension schemes in the Federation receive contributions from about 245,000 workers and pay out pensions to about 230,000 pensioners. The Republika Srpska scheme receives contributions from about 145,000 workers and pays out pensions to about the same number of pensioners. Contribution rates on gross wages range from 17.5 percent in the Croat-majority areas to 24.5 percent in Bosniac- majority areas, with rates at 22 percent in Republika Srpska. The average pension in the Federation's two pension schemes has been increasing in the last two years, to more than DM 100 per month at the present time. Pension payments in Republika Srpska have recently averaged about DM 70 per month per person.
The existing pension schemes face several challenges in the short term. First, despite the rapid increase in the average pension level for some parts of the country, a significant number of the pensioners in both the Federation and Republika Srpska still receive pensions that are below the minimum required for subsistence living. Second, owing to financial difficulty, both the Republika Srpska pension fund and the Bosniac pension fund in the Federation have been late for several months in making payments to pensioners. Third, the Bosniac pension system which has, until recently, maintained in its bookkeeping the legally prescribed pension amounts for each pensioner, has experienced an accumulation of arrears for unpaid pensions, totaling over DM 300 million.
6 The immediate challenge in this area is to achieve fiscal sustainability, to better target the most vulnerable pensioners, and to initiate cooperation in pension policies and administration across the country. Efforts have been made in both Entities to address the pension problems.
In the Federation, both pension funds have recently completed a new registration campaign to eliminate fictitious pensioners and to tighten the eligibility criteria. As a result, about 10,000 entitlements were removed, saving over DM 12 million a year. The Management Board of the Bosniac pension fund also adopted and has started implementing a decision in September 1997, that limits the legal entitlement of pension benefits to what is actually paid, thus eliminating continued accumulation of pension arrears. Further, to improve the targeting of pensions, the Board decided to flatten the benefit payments by increasing the minimum pension, while reducing the ceiling on maximum pension. As a result, the pension payment ratio between the highest and the lowest has been reduced from 8:1 to 6:1. Finally, the Federation Ministry of Social Protection and the two pension funds have been working together on a new Federation Pension Law. The new Law incorporates a number of reform measures in addition to legalizing the earlier Board decision on limiting the legal entitlement to what is actually paid. They include: (i) an increase in the retirement age to 65 by the year 2003; (ii) an increase in the minimum service period required to retire from 15 to 20 years; (ii) an increase in the number of consecutive years used as the assessment base for pension calculations from 10 to 15 years; (iv) an improvement in the indexation method to tie the pension adjustments to the availability of the regular pension resources; (v) tightening of eligibility rules related to survivors; and (vi)tightening of the rules regarding partial disability claims. The Federation Government has submitted this new Law to its Parliament in April 1998 and expects the adoption of the Law to take place before the end of May 1998.
In Republika Srpska, the pension fund has always limited legal entitlement to what is actually paid, thus avoiding accumulation of arrears. Furthermore, in order to target pension payments efficiently, the Republika Srpska pension payments have been effected only through direct cash payments to those entitled, thus avoiding potential payments to fictitious pensioners. However, the levels of pensions for most pensioners are extremely low, and payments are often postponed.
The decentralized structure of public pension provision presents another challenge. To minimize the costs associated with having multiple schemes in a small country (e.g., high administrative costs, potential barriers to labor mobility, limited risk pooling),the two Entities intend to improve and enhance coordination between pension schemes in both policy and administration. The Federation has already started this process by forming a Working Group to facilitate the process of harmonization and, eventually, the unification of the two Federation pension funds which is expected to take place by June 1999. While communication between the pension funds in the Federation and in Republika Srpska has been limited so far, we intend to improve cooperation and coordination through a tripartite agreement between the three pension funds and make available to all pension funds information as contained in the prewar computer database of the Bosnia and Herzegovina Pension Fund.
Reforming the Budgetary Management System
As part of the process of establishing new governance structures across BiH, we have made progress towards improving budget management since 1996. The 1997 budgets for the State, Entities and sub-Entity budgets in the Federation were adopted and those for the 1998 were drafted in broad accordance with principles laid out by the new Constitution. The Federation has established the legal basis for providing revenue assignments between the Federation government and the cantons, establishing budget departments in each canton and mnunicipalityfor budget preparation and
7 execution, and creating essential accounting information systems to support the budget process. Budgetary reporting and execution in Republika Srpska also improved as compared to the previous year's practices.
We recognize the need for improved budget systems to help us to allocate scarce resources more effectively, and to support and control the operations of government. We, therefore, intend to review budget management at all government levels, and where necessary to make changes. The development of adequate budgetary systems will be crucial to the maintenance of financial stability and to the viability of new governance arrangements. However, the budgetary framework differs widely across governments in BiM. Therefore, the speed and content of reform will differ from case to case.
Improving Budget Classification. We have identified several areas where initiating actions are called for. Chief among these areas are the improvement of budget classification and coverage. The Federation has already initiated a program to address these issues by developing a new classification scheme, consistent with the IMF's Government Financial Statistics (GFS) framework, which has been introduced by the Federation and most cantonal governments in the preparation of the 1998 budgets. In addition, the Federation has drafted comprehensive amendments to its organic budget law which is expected to be adopted by July 1998. Republika Srpska wishes to continue to use a budget classification scheme similar to that used in the former Yugoslavia in the 1998 fiscal year, while considering to initiate the design of a GFS classification scheme in June 1998 with the assistance from international agencies. For the State, a preliminary identification of budget management needs appears in the law on 1998 budget execution. However, a need for a fuller organic budget law is recognized and drafting this law will be given priority.
Enhancing Budget Coverage. We see extra-budgetary funds (EBFs) and off-budget funds as potential problem areas, requiring review and subsequent action with the objective of optimizing the use of budget resources. We appreciate that EBFs are needed to the extent that they can be properly justified. Even then, they need to be self-financing. In some cases, they will have to be further regulated by legislation. A key aspect of that legislation will be to ensure that government will not cover any deficits incurred by EBFs. We will initiate drafting such legislation to limit the number of and regulate the EBFs in July 1998. Off budget funds also threaten budget coherence and pose. problems of control. Their inclusion in the budget will reduce these problems. An important priority is, therefore, to include public sector revenues along with related expenditures, which are not adequately recorded in budgets at present. Chief among these are foreign financing and the special resources of budget entities. As a first step towards enhancing the coverage of our budgets, we have initiated the process of recording external cash grants and general budgetary borrowing in the 1998 State and the Entity budgets, along with the related expenditures. In parallel, we intend to initiate preparation of a capital budget by July 1998, including externally financed projects.
Controlling Commitments. We have experienced serious problems during budget implementation. Revenues sometimes fail to meet expectations and expenditures have to be reduced. We wish to find a better means of cutting expenditure than across the board cuts. To address this issue within the budgetary process, we plan to initiate measures designed specifically to prioritize strategic expenditures and to reduce lower priority expenditures when revenue shortfalls occur. As one aspect of these policies, during 1998 fiscal year, we will undertake quarterly budget reviews to monitor actual expenditures against the budget and to reallocate resources as necessary.
8 Also, due to our resource constraints, at times we have been unable to meet expenditure commitments. This has resulted in the accumulation of payment arrears. However, due to our existing budgetary practices, whereby budgets are prepared on a cash basis rather than on a commitment basis, arrears have not been systematically recorded in our budgets. To address this problem, we intend to take the following steps in the short term: as a first step, we have made necessary arrangements to record arrears more precisely in 1998 budgets; as a second step, we will initiate design of a system of commitment accountingand reporting standards by July 1998; and as a third step, we will initiate, by July 1998, development of necessary procedures to control arrears which will largely prevent the over commitment of budget allotments. In addition, we will maintain our policy of settling accumulated areas within the context of the overall arrears settlement policy through privatization without creating any pressure on the already tight recurrent budgets.
Establishing Regulatory Framework for Procurement. For better use of budget resources, we consider no less important the establishment of procurement practices based more on the principle of open competition. Strengthening procurement, including the establishment of appropriate institutions and procedures and the training of staff, will take some time. It is nevertheless important to initiate early actions in this important area if our resources are to be used more efficiently. To face this challenge in the shortest possible time, the Federation is already drafting a new Procurement Law reflecting international practices which is expected to be finalized by July 1998. Republika Srpska has also recently initiated drafting of an improved law bringing its current procurement procedures more closely in line with international norms.
Instituting Auditing Procedures and Practices. Another immediate challenge we face is to achieve greater transparency and accountability. For this we are considering actions to improve reporting, including public disclosure of information about budget implementation and auditing. This would facilitate information sharing within and across the Entities and the State and would strengthen accountability. We plan to establish or strengthenthe institutions responsible for auditing and to develop audit procedures by the end of 1998. Establishing an external audit office for each government which would be independent of the rest of government and would report to Parliament, will be an effective means of achieving stronger accountability. In addition, each Entity's Ministry of Finance plans to appoint its own inspectors who would conduct internal audits and report to the Minister of Finance. The State is in the course of defining its functional organization which is expected to be finalized by June 1998. In this context, the State will also consider an audit office to develop transparency and trust on the part of the Entities which will fund it.
Establishing Treasury System. Our near-term aim is to establish a treasury department and a government accounting system using a single treasury account at each level of government. This would greatly improve the reliability, relevance and timeliness of financial information available to each level of government. It would also make cash management far more efficient and improve budget controls generally at the State and the Entity levels. The Federation intends to initiate establishment of a treasury system in 1998. Republika Srpska is also expected to consider it in 1988. Likewise, the State will consider the establishment of its own treasury system in the shortest possible time.
Actions Planned to Further the Budgetary Reforms. Over the next eighteen months period, we plan to extend our reform efforts by building on the above mentioned preparatory actions. More specifically, we plan to: (i) improve the controls by Ministry of Finance over nonbudget revenues, in particular by giving it access to full details of accounts held by the payments bureaus and banks in
9 the name of budget funded entities; (ii) bring extra budgetary funds into the budget where this is appropriate and introduce enhanced controls on EBFs; (iii) introduce improved government accounting standards, includingcommitment accounting; (iv) introducea medium-termexpenditure frameworkto improve budget planning;and (v) establish effective internal and external government audit services.
We hope that the above elaboration of the program for the reform of our public finance systems has clearly expressed our commitmentto modernizing our economy and putting it on a sound and sustainablepath to growth and prosperity. The continuedcontribution of the WorldBank together with other agencies is an essentialpart of this difficult endeavor.
Mr.Mirsad KUrrt?vic Minister ForeignTrade and Economic Relations Bosniaand Herzegovina
Mxw-FWemBicackik Mr. Milorad Dodik Prime Minister Prime Minister F cration of snia andHr na Reptli Srpska
Mr.Drago Bilandzija Mr. Novak Kondic Deputy Ministerand Minister Minister R ublika Srpska FederationMinistry of Finance Isty of Fin `71 ' b
10 ANNEX 11 page 1 of 10
BOSNIA AND HERZEGOVINA PUBLIC FINANCE STRUCTURAL ADJUSTMENT CREDIT - POLICY MATRIX (Items in italic and bold are conditions for tranche releases)
POLICY AREASAND ACHIEVEMENT/MEASURES MEASURESPRIOR TO THE MEASURESPRIOR TO THE SECOND LONGER-TERMTASKS OBJECTIVES ALREADYINTRODUCED FIRST TRANCHE DISBURSEMENT TRANCtIE DISBURSEMENT (MAY1998) (AUGUST1998) I. Maintaininga Stable Macroeconomic Framework
MonetaryPolicy
* Establishinginstitutional * ApprovedCentral Bank Law; * Agree on the currency design; * Progressin implementationof * Issue the new currency; frameworkfor monetary * AppointedCentral Bank * Inauguratethe CentralBank; the CentralBank Law; * Continuedimplementation management. Governorand the Governing * Concludeauditing and of the CentralBank Law; Board members; liquidationplan of NBBH.
* Linkedthe two separate * Strengthenthe managementof * Integratepayments systems paymentssystem in the the Federationpayments under the new currency. Federation; system; * Establisheda clearing mechanismbetween the Entities' paymentssystems.
* Maintainingpolicies * Hasrestored and maintained * Maintainquasi-currency board * Continuedsatisfactory * Continuedsatisfactory conduciveto monetary monetarystability since late principles,and abstainfrom implementationof the implementationof the stability. 1994; extendingcredits to the public monetarypolicies by the monetarypolicies by the sector or the bankingsystem; monetary authorities; new centralbank; Fiscal Policy
* Maintaininga fiscalpolicy * Has maintainedbudgets that * Balancebudgets on a cash * Continueto balancebudgets on consistentwith the are balancedon a cash basis basis; abstain from borrowing a cash basis, abstain from monetarypolicy. and abstainedfrom from the nonbank and banking borrowingfrom the nonbank borrowingfrom the domestic sector; and prevent and bankingsector; and bankingsector. accumulationof arrears. prevent accumulationof arrears. ANNEX II page 2 of 10
POLICYAREAS AND ACHIVMNtMEASURESEASE R TOT MEASES PAIORTO TE S L ER-TERMlTA OBJECTIVES ALED NTOUE IRTTACIEDSUSEET TANIEDSURSEMENT
II. Ensuring Financing of the State Administration
Operationalization of a * Approved 1997 State Budget * Preparation of the draft 1998 * Adoption and implementation viable State finance Law; State and Entity Budgets; of mutually consistent 1998 mechanism. State and Entity Budgets;
* Completed the division of old * Agreement in principle on the * Commencement of * Smooth operation of State debt owed to the World Bank mainfeaturesfor the mechanismfor automatic finance mechanism. and the Paris Club creditors operation of a mechanismfor transfer offunds. between the Entities and is automatic transfer offunds proceeding with the division from Entity to the State. of debt owed to London Club creditors.
* Strengthening the customs * Approved BiH Foreign Trade * Draft amendments to the * Adopt and implement revenue collection and Law and Customs Policy existing Entity Customs Laws amendments to the existing customs administration Law; to harmonize them with the Entity Customs Laws; across BiH. BiH level Customs and Trade Laws;
* Drafted the Interim BiH * Adopt the Interim BiH * Finalize the permanent BiH * Implement; Customs Tariff Law. Customs Tariff Policy Law; Customs Code and Tariff Law;
* Strengthen the EU's customs * Develop a plan to harmonize * Adopt and implement. monitoring mission in and improve cooperation of the Republika Srpska. Entity customs administrations. ANNEX II page 3 of 10
POLICYAREAS AND ACHIEVEMENT/MEASURES MEASURESPRIOR TO THE MEASURESPRIOR TO THE SECOND LONGER-TERMTASKS OBJECrIVES ALREADYINTRODUCED FIRSTTRANCHE DISBURSEMENT TRANCHiEDISBURSEMENT (MAY1998) (AUGUST1998) III. Establishinga Viable Debt Management Structure
Developing debt * Started debt service * Operationalize a special State management capacity to payments, although often debt service account with the enhance the efficacy and with delays, on rescheduled transparent operating effectiveness of the debt; procedure adopted by the State external borrowing and to MFTER; facilitate the reintegration * Approved State External of BiH into the Debt Law; international capital markets. * Started drafting Entity Debt * Complete the draft Entity Debt * Adopt and implement the Laws; Laws; Entity Debt Laws;
* Established Debt * Draft the statute of the State * Adopt the respective statute for * Maintain an effectively Management Unit in the State Debt Management Office, and the State and the Entities; working State Debt MFTER; statutes of the Entity Debt * Strengthen the capacity of debt Management Office and * Established Debt Monitoring Monitoring Units; management agencies by new effectively working Debt Units in the Entities; recruits, training and Monitoring Units in the computerization; Entities;
* Established a Working Group * Create the Debt Advisory on debt management policy. Committee and ensure its effective functioning. * Conclude an agreement * Implement the Agent Bank between the State Debt Agreement. Management Unit and its Agent Bank.
* Creating mechanisms of * Conclude Coordination * Implement Coordination * Establish a unified public coordination among the Agreement between the State Agreement and regularize the debt database that will link State and Entity debt and the Entities and initiate debt information flows State and Entity debt management units. information sharing and between the State and the management bodies. coordination. Entities. ANNEX II page 4 of 10
POLICYAREAS AND T U AuES PI -. TO EAHIEVEMESES OR THES.coNLO GERE TSIS OBJECTIVES AREADYV0INTRDUCED . FI^ TRNH EDISBURMN T-NH DSBURSMEN
IV. Reforming Inter- governmentalFinances
* Providinga sound * Agreedunder Dayton on the * Agree on the specificfeatures * Operate a State finance foundationfor the basic frameworkfor division for a State financemechanism. mechanism(see Section II). emergingpublic finance of fiscalresponsibility structure. betweenthe State and its two constituentEntities. -InFederation:
* Clear assignmentof public * Basicgovernance structure * Clarifyresponsibilities for * Adopt and implementthe functionsto Federation, has been establishedacross health, education,social agreed changesin expenditure canton and municipal Federationincluding welfare and defense spending and revenue assignments. governments. adoptionof the Law on the for the fiscal year 1998;and revenueand expenditure reviewand revise the Law on assignment.Certain areas Allocationof Federation (e.g. health, defense,social Revenuesto conform with welfare),however, left with assignmentin expenditure less clearerassignment. responsibility. * Adoptedlaws on health insuranceand health protection.
* Efficientassignment of * Initiatework to determine * Adopt and Implement. revenues compatiblewith revenue allocationin such the servicesfor which situationswhere some Federation,cantons and componentof the activity takes municipalitiesare place in more than one responsible. jurisdiction. ANNEX II page 5 of 10
POLICYAREAS AND ACHIEVEMENT/MEASURES MEASURESPRIOR TO THiE MEASURESPRIOR To THESECOND LONGER-TERMTASKS OBJECTIVES ALREADYINTRODUCED FIRSTTRANCHE DISBURSEMENT TPRANCHEDISBURSEMENT (MAY 1998) (AUGUST1998) V. Reforming and HarmonizingTax Policy and Coordinating Tax Collection
* Harmonizing tax policies * Republika Srpska initiated * Prepare the amendments to * Adopt and implement the between the Entities and drafting amendments to the the Sales and Excise Tax Law amendments to the Sales and improving tax collection Sales and Excise Tax Law to of Republika Srpska Excise Tax Law of Republika and coordinationto levysales tax on excisable Srpska; discouragetax avoidance goods at the wholesalelevel. and evasion. Federationalready collects * Entitiesto review the tax rates * Continuethe effort to the salestax at this level. and definitionof the base for harmonizetax policies; the wage, income,profits and sales and excise taxes; and prepare proposalsfor better harmonization;
* Promotingcoordination * Entities to review * Implementprograms to betweentax administrativestructures, establishcoordination and administrationsof the two forms and contentsof cooperationbetween Entities Entities. informationrequirement of tax tax administrations. payers, collectionand auditing procedures; * Entitiesto developcooperative arrangementsto address tax on inter-entitysale; In Federation:
* Reformingtax systemto * AdoptedFederation wage, * Drafting of Federationpersonal * Furtherreduce the number of * Adopt and implement; (i) reintegratethe tax sales and excise taxes. incomeand corporateprofit tax sales tax rates to two and adjust * Initiatework, in coordination policiesand administration laws. the salestax on servicesto the with RepublikaSrpska, on across Federation; maximumsales tax on goods; State value added tax to (ii) enhancethe revenue * Define, on a more permanent replace sales tax; collection;and (iii) better basis, the role of Cantons in tax facilitateprivate sector policies. expansion. ANNEX II page 6 of 10
POLicy AREAsAND AcHIEVEMENT/IMMEASURES ME S O O OBJECTIVES ARAYITOUE IS RNH IBREET TACEDSUSMN
* Draft amendmentsto the * Adopt and implement. Excise Tax Law to equalize the excise tax rate between domesticallyproduced and importedgoods.
* Reducedpayroll tax rates, * MoF to finalizethe necessary * Implement amendments to the and amendedthe WageTax regulationsto implementthe Federation Wage Tax Law. Law to restrict non-wage amendmentsto the Wage Tax benefits in wage tax Law. exemptions.
* Mergedthe separatetax * Develop a systemfor reporting * Implementthe reporting collectionsystems under the between cantonaltax offices system. FederationTax and the central tax office. Administration. In RepublikaSrpska:
Reformingtax system to * Reducedthe wage tax rates * Draft amendmentsto Wage * Adopt and implement; enhancethe revenue througha reduction in Tax Law to restrict tax collectionand to facilitate pensioncontributions and exemptionstatus of nonwage growth and privatesector wage withholdingtax; benefits; expansion. * Preparingamendments to * Adopt and implement * Initiatework on State value Salesand Excise Tax Law amendmentsto the Sales and added tax to replace sales tax requiringpayment of excise ExciseTax Law. in coordinationwith the taxes at border and use of Federation. customs stampsfor excisable goods;
* Began updatingtaxpayer * Prepare for issuingnew * Adopt and implement. registry. taxpayer identification numbers. ANNEX II page 7 of 10
POLICY AREAS AND ACHIEVEMENT/MEASURES MEASURES PRIOR TO THE MEASURES PRIOR TO THE SECOND LONGER-TERM TASS OBJECTlVES ALREADY INTRODUCED FIRST TRANCHE DISBURSEMENT TRANCHE DISBURSEMENT (MAY 1998) (AUGUST1998) VI. Establishing Efficient and Equitable Social Safety Net
Reforming PensionSystem
* Achievingfiscal * FederationGovernment * Submit the new Federation * Adopt and implement the new sustainabilityand draftedthe legislationto (i) Pension Law to the FederationPension Law; improvingequity among prevent accumulationof FederationParliament; pensioners. pensionarrears; (ii) gradually increasethe retirementage; and increasethe minimum serviceperiod requiredfor retirement;(iii) tighten eligibilitycriteria; * The Management Board of BosniacPension Fund improvedtargeting by flatteningthe benefit payments;
* Improvingcoordination in * FederationGovernment * Establishintra-Federation pensionpolicy and draftedthe legislationto coordinationmechanism administration. establish intra-Federation throughthe FederationPension policy and administrative Agencyor other arrangement. coordination; * Make availableto all pension * Establishingan inter-Entity funds informationas contained coordinationmechanism in the pre-warcomputer data- through a tri-partite base of the BiH pensionfund; agreementbetween the three pension funds.
* Begin to developproposals for * Undertakepension reform. * Comprehensivemedium- medium-termreforms in both term pensionreform. Entities. ANNEX II page 8 of 10
POLICYAREAS AND ACHIEVEMENT/MEASURES MEASUEtS PRIOWTO THE M OBJECTIVES ALREADYINTRODU CED FRSTRNEDSBJSMT TANE lSREET
Other Socialprograms
* Improvingand targeting * Federationgovernment * Clarifythe mandate of the * Prepare a study of veteran * Comprehensivereform of financial sustainabilityof establishedthe Federation FederationDirectorate for programsin both Entitiesto: social safety net. social programs. Administrationfor Veterans Veterans; (i) analyzewhether and DisabledSoldiers Affairs * Initiatea survey of the commitmentsare affordablein and initiateda survey of beneficiariesunder veteran the immediate-and medium- beneficiariesto formulate programs in RepublikaSrpska; term; (ii) clarify permanent benefits policies; * Initiatea comprehensive entitlementsversus one-time reviewof existing social compensations;and (iii) bring welfareprograms to improve benefitsto veteransand effectiveness,sustainability veteran familiesmore in line and targeting. with the other social groups.
* Improvingthe scope and * Initiatethe preparation of a * Continuewith the preparation * Adopt and implementthe effectivenessof labor new EmploymentLaw, and of the new law; new law. programs. refrain from creatingan Design and implementa unemploymentinsurance in the transitionalpolicy for covering absenceof financial resources. the unemployed. VII. ReformingBudget Management
* Establishing * Establishedbasic budgetsat * Use the new classification * Initiatepreparation of a GFS * ImplementGFS comprehensivebudgets, all levelsof governments; scheme for preparingthe 1998 classificationscheme for classificationin Republika includingall revenuesand * Federationhas drafted a Federationand Canton RepublikaSrpska budget; Srpska; expenditures,for each classificationscheme which budgets; levelof governmentand conformswith the GFS * Record external cash grants * Establisha comprehensive improvingbudget definitionand intendsto and borrowingforgeneral revenue and expenditure classification. introduce it across budgetarypurposes and recording system inclusive Federation. correspondingexpenditure in of externalfinancing for the 1998 budget; general budget and for specificprojects;
* Draft Legislationto limit the * Adopt and implement; number of and to regulatethe EBFs; ANNEX II page 9 of 10
POLICYAREAS AND ACHIEVEMENT/MEASURES MEASURES PRIORTO THE MEASURES PRIOR TO THE SECOND LONGER-TERM TASKS OBJECTIVES ALREADY INTRODUCED FIRST TRANCHE DISBURSEMENT TRANCHE DISBURSEMENT (MAY1998) (AUGUST 1998)
* Initiatepreparation of capital * Incorporatecapital projects, budget, includingall externally includingthose which are financedprojects; externallyfunded in the budget.
* Developinga frameworkto * Developplans for settlingall * Develop rules on expenditure * Establishcommitment better report record,and accumulatedarrears within the commitmentsby public accountingand reporting control all government contextof overall restitution institutions. standards. liabilities. policy.
* Developingclear rules for * Introducedbasic budget * Plan for establishinga budget * Implement; budgetplanning, preparationand execution evaluationfunction within approving,execution, laws at all levelsof MoF budgetdepartment; evaluationand public governments; disclosure. * Entitiesrevised their organic * Enact revised Federation BudgetLaws. Federation Organic Budget Law; MoF is preparinga new, * Draft a new Organic Budget * Enact the revised Budget comprehensiveBudget Law. Law of Republika Srpska; Law of RepublikaSrpska;
* Initiatedevelopment of * Develop a multi-year necessaryprocedures for financial planning process on linkingbudget programswith the basis of macro-economic macroeconomicand fiscal forecastand policies; policiesand priorities;
* Entitiesto take initialsteps to * Adopt and implement; establishthe audit officesand * Public disclosureof auditingprocedures; informationabout budget implementationand regular reportingof audit results.
_ ~~~~~~~~~_J ANNEX II page 10 of 10
POLICYAREAS AND ACHIEVEMENT/MEASURES MEASURESPRIOR TO TIIE MEASURES PRIO TOTHE SECOND LONGER-TE TAS;S OBJECTIVES ALREADY INTRODUCED FIRST TRANCHE DISBURSEMENT TRANCIIEmDISURSEMENT (MNAY1998) (AGUST 1998)
* Initiatepreparation of a new * Finalizedraft Federationlaw * Adopt and implement; Federationlaw on public on procurement; procurement. * Initiatepreparation of the law * Adopt and implement; on public procurementin RepublikaSrpska;
Developingan effective * Began preparatorywork on * Draft and pass legislation for controlover the budgetby establishinga Treasury establishingthe Treasury establishingTreasury Departmentat each MoF Department;and operate the Departmentand a Treasury responsiblefor: (i) budget Treasury Departmentsand SingleAccount in the executionand financial Treasury Single Account. respectiveministries of the planning;(ii) accountingand State and Entities. reporting;and (iii) cash and debt management. Annex III page 1 of 9
Table 1: Bosnia and Herzegovina - Key Economic indicators
Actual Estimat Projected Indicator 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
National accounts (as % GDP at current market prices)
Gross domestic product toi 100 100 Agriculture I 0 19 20 Industry 43 23 24 Services 48 58 56 -
Exports (GNFS)a 21 24 10 18 20 22 22 23 25 Imports(GNFS) 18 19 53 62 68 58 59 46 34
Memorandum items Gross domestic product 10633 8670 . 1964 2157 3328 4456 5956 7485 8635 (US$ million at current prices)
Real annual growth rates (%, calculated from 1995 prices) Gross domestic product at -23 7 50 30 30 22 12 market prices
Real annual per capita growth rates (%, calculated from 1995 prices) Gross domestic product at -23 12 50 30 30 22 12 market prices
Balance of Payments (USSm) Exports(GNFS)' 2188 2120 194 381 658 997 1328 1720 2141 Merchandise FOB 91 152 336 570 822 1127 1451 Imports(GNFS)a 1953 1673 1040 1334 2278 2587 3505 3418 2977 Merchandise FOB 894 1082 1882 2198 3007 2985 2670 Resource balance 235 477 -846 -953 -1620 -1589 -2176 -1698 -835 Net current transfers 879 1002 1094 772 480 345 281 (including official current transfers) Current account balance -177 -193 -748 -1046 -1815 -1453 -656 (after official capital grants)
Net private foreign direct 0 0 0 0 100 200 200 investment Long-term loans (net) -258 -271 -107 55 259 197 57 Other capital (net, including 429 602 1222 1216 1631 1131 448 errors and omissions) b Change in reserves 6 -138 -367 -225 -175 -75 -50 (continued) Annex III page 2 of 9
Table 1: Bosnia and Herzegovina - Key Economic indicators (Continued)
Actual Estimate Projected Indicator 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Memorandum items Resource balance (% of 2 6 .. -43 -44 -49 -36 -36 -23 -10 GDP at current market prices) Real annual growth rates (1995 prices) Merchandise exports .. . 63 115 65 40 33 25 (FOB) Merchandise imports 18 69 13 33 -4 -13 (CIF)
Public finance (as % of GDP at current market prices)c Total revenues ...... 35 62 61 59 47 39 Tax revenues ...... 29 43 43 38 35 36 Grants .. .. 6 19 18 21 12 3 Total expenditures ...... 35 70 68 70 53 40 Budget deficit (-) ...... 0 -8 -7 -11 -6 -1
Foreign financing ...... 0 8 7 12 6 2 Memorandum items Budget deficit excluding grants (-) -6 -27 -25 -33 -18 -5
Monetary indicators M2/GDP (at current market ...... 18 23 22 .. prices) Growth of M2(%) ...... 8 96 25 ..
Price indices( 1995 =100) Consumer price index (% average growth rate) Federation .. 114 .. 780 -4 -25 14 .. RepublikaSirpska .. 114 .. .. 1061 118 66 3 ..
a. "GNFS" denotes "goods and nonfactor services." b. Includes use of IMF resources. c. General Govemment Source: Official data and staffestimates. Annex III page3 of 9
Table 2: Bosnia and Herzegovina - Key Exposure indicators
Actual Estimate Projected Indicator 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Total debt outstanding and disbursed (TDO) (US$m)" 2586 2809 3013 3360 3884 4439 4745 5102 5331
Net disbursements (US$m) .. 215 458 378 239
Total debt service (TDS) (USSmy' .. ., 287 485 547 513 573 385 236 186 194
Debt and debt service indicators (%) TDO/XGS" ...... 1553 882 590 445 357 297 249 TDO/GDP ...... 153 156 117 100 80 68 62 TDS/XGS ...... 282 135 87 39 18 11 9 Concessional/TDO ......
IBRD exposure indicators (%) IBRD DS/public DS ...... 26 19 26 6 10 16 21 22 Preferred creditor DS/public DS (%)' ...... 28 20 28 23 16 24 30 31 IBRD DS/XGS ...... 54 36 4 4 3 2 2 IBRD TDO (USSm)d .. .. 415 483 546 623 596 596 596 606 646 Share of IBRD portfolio (%) .. .. 0.4 0.5 0.5 0.5 0.5 0.6 0.6 0.6 0.6
IDA exposure indicators (%) IDA DS/public DS ...... 0.0 0.4 1.4 2.2 2.3 IDA DS/XGS ...... 0.0 0.1 0.3 0.2 0.2 IDATDO (USSm) ...... 204 364 464 554 614
IFC (lJS$m) Loans ...... 15 15 8 Equity and quasi-equity' ...... 0 0 0
M IGA MIGA guarantees (US$m) 0 0 0 0 0 0 0 0 ..
a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-term capital. After debt rescheduling. bh "XGS" denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA. the regional multilateral development banks, the IMF. and the Bank for International Settlements. d. Includes present value of guarantees.
Source: Official data and staff estimates. Annex III Page4 of 9
Table 3: Bosnia and Herzegovina - State Revenues and Expenditures, in millions of KM/DM, 1996-98
State 1996 1997? 1998'
TOTAL REVENUES 78 136 173
TAXES 0 0 0 NONTAX REVENUES AND GRANTS 78 136 173 Consular Fees 14 20 20 Support for Salaries from the World Bank 2 Grants " 21 Transfers from Entities 42 116 153
TOTAL EXPENDITURES 127 136 183 Wages, Salaries and Employee Contributions 30 17 40 Material Costs/Running Costs 23 14 8 Debt Service Payments 19 96 126 Expenditures not Otherwise Classified d' 51 4 4 Reserves 4 4 6
BUDGET BALANCE -49 0 -10
NET FINANCING 49 0 10
FOREIGN CREDITS (net) ' 45 0 10
DOMESTIC CREDITS (net) 4 0 0 a/ Based on the State Budget Law of June 1997 which is only partially executed. The data on 1997 budget realization is highly incomplete. b/ As adopted by the Council of Ministers of Bosnia and Herzegovina c/ In 1996 includes World Bank IDA credit which is cofinanced by the Netherlands Govemment and provided for budgetary support d/ In 1996 includes expenditures financed by proceedings of the IDA Credit and Dutch Grant; in 1998 includes separation package for those State employees to be laid off Source: Official data and staffestimates Annex III page 5 of 9
Table 4: Bosniaand Herzegovina- CentralGovernment Revenues and Expendituresin Draft 1998 for Federation and Republika Srpska, in millions of KMIDM. Federation Republika Srpska
TOTAL REVENUES 822 365
TAXES 766 347 Sales Tax 0 140 Excises 390 19 Customs 376 92 Personal Income Tax 0 11 Profits Tax 0 36 Other Taxes 0 50 NONTAX REVENUES AND GRANTS 56 18
TOTAL EXPENDITURES BY ECONOMIC CLASSIFICATION 917 468 Wages and Contributions 88 107 Goods and Services 33 38 Military 343 86 Reconstruction Expenditure 30 14 Transfers to Households 303 113 Transfers to the State Government 95 60 Administration 20 50 Debt Service 75 10 Transfers to Cantons or Municipalities 7 12 Expenditures not Otherwise Classified 18 39
BUDGET BALANCE -95 -103
NET FINANCING 95 103
FOREIGN CREDITS (net) 80 103
DOMESTIC CREDITS (net)" 15 0 a/Budget figures represent only the central government revenues and expenditures, excluding cantonal budgets for Federation and municipal budgets for Republika Srpska bh For the Federation budget indicates expected privatization revenue Source: Official data from the Federation and the Republika Srpska Ministries of Finance and staffestimates Annex III page6 of 9
Table 5: Bosnia and Herzegovina - General Government Revenues and Expenditures in the Federation, in millions of DM, 1994-97
1994 1995 1996 1997 Consolidated Consolidated Consolidated Consolidated Consolidated
Federation w/ Donor w/o Donor Federation Sub-level W/ow/ Donor Federation Sub-level hI
TOTAL REVENUES 401 855 2,497 1,661 329 1,442 2,100 623 1,495
GENERAL FUND REVENUES 331 659 2,041 1,205 329 985 1,552 623 947 TAXES 236 436 1,115 1,115 312 803 1,395 565 850 Customs 50 95 201 201 163 38 281 286 0 Excises 4 118 205 205 149 56 264 279 0 Sales Tax c/ 166 117 485 485 0 485 581 0 581 Wage Tax 13 50 117 117 0 117 140 0 140 Personal Income Tax 0 0 0 0 0 0 0 0 0 Profits Tax 2 10 31 31 0 31 37 0 37 Other Taxes 1 46 76 76 0 76 91 0 91
NONTAX REVENUES AND GRANTS 96 223 926 90 17 182 157 58 97 Fees 0 0 16 16 0 16 60 15 19 Fines 0 0 3 3 I 3 6 3 3 Consular Fees 0 0 0 0 0 0 0 0 0 Special Fees 0 0 20 20 2 20 49 22 24 Support for Salaries from the World Bank 0 0 3 3 3 0 2 2 0 Grants 76 169 847 11 11 0 0 13 0 Transfers from Other Levels of Govemment 0 0 0 0 0 110 0 0 10 Other Revenues 20 54 36 36 0 34 40 4 40
SOCIAL FUND CONTRIBUTIONS v 70 196 457 457 0 457 548 0 548 Health 0 0 188 188 0 188 226 0 226 Pensions 0 0 210 210 0 210 252 0 252 Education 0 0 22 22 0 22 27 0 27 Unemployment 0 0 21 21 0 21 25 0 25 Other 0 15 15 15 18 0 18
Continued Annex III page 7 of 9
Table 5 (continued): Bosnia and Herzegovina - General Government Revenues and Expenditures in the Federation, in millions of DM, 1994-97
1994 1995 1996 1997 Consolidated Consolidated Consolidated Consolidated Consolidated Federation w/ Donor w/o Donor Federation Sub-level w/o Donor Federation Sub-level TOTAL EXPENDITURES 420 854 2,839 1,751 420 1,441 2,096 641 1,494 GENERAL FUND EXPENDITURES BY FUNCTION 350 684 2,511 1,423 409 1,124 1,719 641 1,117 General Public Administration 0 0 174 121 33 89 132 40 92 Defense 215 374 74 74 5 70 318 254 64 Public Order and Safety 7 19 295 212 11 201 211 35 176 Education, Culture and Sport 22 56 345 267 2 266 295 10 290 Health 0 0 274 201 7 195 177 1 170 Social Protection 0 0 259 185 100 85 274 192 92 Urban Planning, Utilities, Housing and Environment 0 0 119 46 1 45 49 1 49 Energy, Mining, Industry and Economic Development 0 0 394 83 31 52 59 2 57 Transportation, Communications and Information Media 5 5 216 68 10 58 81 21 61 Agriculture, Forestry and Water System 0 0 90 13 11 2 13 11 2 Reconstruction, SFOR, War Criminals and Int'l. Coop. 0 0 44 11 3 8 8 0 8 Expenditures not Classified by Major Group 101 230 157 72 55 17 27 23 17 Contributions to the State of BiH 0 0 29 29 29 0 17 30 0 Contributions to Cantons and Municipalities 0 0 0 0 110 0 0 4 0 Interest Payments 0 0 0 0 0 0 0 0 0 Reserves 0 0 41 41 4 37 57 17 40 o/w goods reserves 0 0 24 24 0 24 26 0 26 SOCIAL FUND EXPENDITURES 70 171 328 328 11 317 377 0 377 Health 0 0 46 46 0 46 55 0 55 Pensions 0 0 223 223 11 212 252 0 252 Education 0 0 4 4 0 4 27 0 27 Unemployment 0 0 40 40 0 40 25 0 25 Other 0 0 15 15 0 15 18 0 18 BALANCES TOTAL BUDGET BALANCE -20 0 -341 -90 -91 1 4 -18 1 General Fund Balance -19 -25 -470 -219 -80 -139 -167 -18 -170 Social Fund Balance -1 25 129 129 -11 140 170 0 170 BALANCE AFTER FINANCING 0 0 0 0 0 0 0 0 0 NET FINANCING 20 0 341 90 91 -I -4 18 -1 FOREIGN CREDITS (net) 0 0 341 90 91 -1 -4 0 -1 DOMESTIC CREDITS (net) 20 0 0 0 0 0 0 18 0 a! Includes World Bank IDA credit, cofinanced b) the Dutch government and provided as a budgetary support b/ Estimated based on available official data c/ Includes some excise taxes, 1994 d/ "Social security contributions", 1994 and 1995 Source: Official data and staffestimates Annex III page 8 of 9
Table 6: Bosnia and Herzegovina - General Government Revenues and Expenditures in Republika Srpska, in millions of DM, 1994-97
1994 1995 1996 1997' Total Total Republika Total Republika Republika Srpska w/ Donor w/o Donor Srpska Municipal w/o Donor Srpska Municipal
TOTAL REVENUES 211 188 447 365 338 27 465 259 26
GENERAL FUND REVENUES 139 140 362 280 254 27 357 259 26 TAXES 131 138 243 243 216 27 346 241 26 Customs 13 16 91 91 91 0 117 77 0 Excises 0 0 13 13 13 0 41 12 0 Sales Tax 3' 85 84 48 48 37 12 65 111 16 Wage Tax 32 27 50 50 35 15 35 27 10 Personal Income Tax 0 0 7 7 7 0 9 7 0 Profits Tax I 10 I I 0 0 1 1 0 Other Taxes 0 0 33 33 33 0 78 247 0
NONTAX REVENUES AND GRANTS 8 2 119 38 38 0 11 18 0 Fees 0 0 1 1 1 0 6 15 0 Fines 0 0 1 1 1 0 2 2 0 Consular Fees 0 0 0 0 0 0 0 0 0 Special Fees 0 0 4 4 4 0 0 0 0 Support for Salaries from the World Bank 0 0 0 0 0 0 0 0 0 Grants 0 0 105 23 23 0 0 0 0 Transfers from Other Levels of Govemment 0 0 0 0 0 0 0 0 0 Other Revenues 0 0 8 8 8 0 3 1 0
SOCIAL FUND CONTRIBUTIONS hI 72 48 85 85 85 0 108 0 0 Health 0 0 37 37 37 0 45 0 0 Pensions 0 0 47 47 47 0 63 0 0 Education 0 0 0 0 0 0 0 0 0 Unemployment 0 0 0 0 0 0 0 0 0 Other 0 0 0 0 0 0 0 0
Continued Annex III page9 of 9
Table 6 (continued): Bosnia and Herzegovina - General Government Revenues and_Expenditures in Republika Srspka, in millions of DM, 1994-97 1994 1995 1996 -_____- -__ 1997" Total Total Republika Total Republika Republika Srpska w/ Donor w/o Donor Srpska Municipal w/o Donor Srpska Municipal TOTAL EXPENDITURES 248 197 448 366 341 24 463 209 24 GENERAL FUND EXPENDITURES BY FUNCTION 181 150 340 258 233 24 354 209 24 General Public Administration 0 0 43 38 31 6 46 25 6 Defense 120 88 57 57 55 2 89 73 2 Public Order and Safety 0 0 22 22 20 2 52 40 2 Education, Culture and Sport 16 14 33 30 26 4 39 0 4 Health 0 0 0 0 0 0 0 0 0 Social Protection 0 0 43 35 33 2 62 21 2 Urban Planning, Utilities, Housing and Environment 0 0 7 3 1 2 3 0 2 Energy, Mining, Industry and Economic Development 0 0 34 8 8 0 2 2 0 Transportation, Communications and Information Media 5 2 18 15 12 3 15 12 3 Agriculture, Forestry and Water System 0 0 9 1 1 0 2 2 0 Reconstruction, SFOR, War Criminals and Inftl. Coop. 0 0 28 25 25 0 0 9 0 Expenditures not Classified by Major Group 40 47 25 1 0 1 1 1 1 Contributions to the State of BiH 0 0 0 0 0 0 18 0 0 Contributions to Cantons and Municipalities 0 0 0 0 0 0 0 1 0 Interest Payments 0 0 0 0 0 0 0 0 0 Reserves 0 0 23 23 20 3 25 22 3 o/w goods reserves 0 0 20 20 20 0 22 22 0 SOCIAL FUND EXPENDITURES 67 47 108 108 108 0 108 0 0 Health 0 0 45 45 45 0 45 0 0 Pensions 0 0 63 63 63 0 63 0 0 Education 0 0 0 0 0 0 0 0 0 Unemployment 0 0 0 0 0 0 0 0 0 Other 0 0 0 0 0 0 0 0 0 BALANCES TOTAL BUDGET BALANCE 211 188 447 365 338 27 465 50 26 General Fund Balance -42 -11 22 23 20 2 2 50 2 Social Fund Balance 5 2 -23 -23 -23 0 0 0 0 BALANCE AFTER FINANCING 248 197 448 366 341 24 463 50 24 NET FINANCING 37 9 1 1 3 -2 -2 -50 -2 FOREIGN CREDITS (net) 0 0 1 0 0 0 0 2 0 DOMESTIC CREDITS (net) 37 9 1 1 3 -2 -2 -52 -2 a/ Includes some excise taxes, 1994 and 1995 b/ "Social security contributions", 1994 and 1995 ct "Social organizations", 1996 and 1997 d/ Includes some health expenditures et 1997 level assumed to be fixed at 1996 level, no data was directly available f/ Budget estimates for 1997 are highly incomplete due to lack of adequate information, particularly the foreign exchange revenues Source: Official data and staff estimates MAP SECTION IBRD 27708R 16'I j <_ ToZagreb 18' TOOsijek
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