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COUNTRY REPORT

Bosniaand Hercegovina

August 2001

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

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Bosnia and Hercegovina 1

EIU Country Report August 2001 © The Economist Intelligence Unit Limited 2001

Contents

3 Summary

4 Political structure

6 Economic structure6 Annual indicators7 Quarterly indicators

8 Outlook for 2001-028 Political outlook9 Economic policy outlook

10 Economic forecast

13 The political scene

20 Economic policy

24 The domestic economy24 Output and demand25 Employment, wages and prices

29 Foreign trade and payments

List of tables

10 International assumptions summary12 BiH: forecast summary20 BiH: central state budget22 Federation: entity budget22 Republika Srpska: entity budget24 BiH: industrial production27 BiH: labour statistics28 BiH: retail prices29 Federation: foreign trade, Jan-Mar30 Federation: trading partners, Jan-Mar

List of figures

12 BiH: gross domestic product12 BiH: current-account balance27 BiH: wage growth28 BiH: retail prices



Summary

August 2001

The Economist Intelligence Unit expects the politically volatile situation inBosnia and Hercegovina (BiH) to persist over the forecast period, but the rulingAlliance for Change should manage to hold on to power. Its allies from theRepublika Srpska (RS) entity represent the greatest current threat to thecoalition’s survival, for although at the state level they provide it with a smallparliamentary majority, they oppose Alliance attempts to strengthen thecentral state. Macroeconomic stability is likely to remain the focus of thegovernment’s economic policy over the forecast period, and a weak fiscalposition could undermine the stability achieved so far. We expect real GDPgrowth in 2001 of around 6-7%, on the assumption that BiH continues tobenefit from international assistance, following a fall in the growth rate in2000 to single digits for the first time since 1995. In 2001-02 the current-account deficit is likely to remain large, driven by a substantial trade deficit.

Proposals from the Alliance to reform the BiH government have been opposedby its Bosnian Serb allies, and the draft election law has been rejected, leadingto the replacement of the BiH prime minister by Zlatko Lagumdzija, the headof the Social Democratic Party (SDP). The main Bosnian Croat party has endedits boycott of government institutions, as their self-rule project has lostmomentum. Riots in RS in protest against the rebuilding of mosques haveembarrassed the RS government, and it has backed a bill to co-operate with theInternational Criminal Tribunal for former Yugoslavia (ICTY) in The Hague.

BiH has negotiated a new IMF stand-by facility, although this might quickly bereplaced by a three-year poverty reduction and growth facility (PRGF). Thecentrepiece of the PRGF will be a programme of structural reform to establish astable and transparent business environment, which would be more conduciveto attracting foreign direct investment (FDI).

Industrial output has remained strong in the Federation, but has fallen sharplyin RS. Federation manufacturing employment has increased as idle “waitinglist” workers have come off the register. Wage growth has subsided. Retail priceinflation has slowed in both the Federation and RS.

Export performance lags that of imports in both entities. Exports toSwitzerland have plummeted. RS has diversified its trade away from Yugoslavia.The large trade deficit in BiH is resulting in a widening of the current-accountdeficit. More effort is needed to attract foreign investors. Agreement has beenreached on dividing up the assets of former Yugoslavia.

Editors: Michael Taylor (editor); Gavin Gray (consulting editor)Editorial closing date: August 8th 2001

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2001-02

The political scene

Economic policy

The domestic economy

Foreign trade andpayments

4 Bosnia and Hercegovina


Political structure

Bosnia and Hercegovina (BiH) has legal existence within the boundaries of the formerYugoslav republic of the same name. It comprises two entities: the Federation of Bosniaand Hercegovina (which is often referred to simply as the Federation), set up by theWashington Treaty of March 18th 1994, and Republika Srpska (RS)

BiH has the following limited responsibilities under the Basic Principles agreed inGeneva and New York in September 1995, and confirmed at Dayton, US, onNovember 21st: the establishment of a Constitutional Court, a Commission forDisplaced Persons, a Human Rights Commission, a central bank, public corporations tomanage and operate transport and telecommunications, a Commission to PreserveNational Monuments, and a system of arbitration between the two entities. Foreigntrade is also supposed to be managed by the government of BiH

BiH has a bicameral parliament comprising the House of Representatives and the Houseof Peoples, two-thirds of whose members are elected from the Federation and one-thirdfrom RS. A valid majority requires the support of at least one-third of the membersrepresenting each entity. The Federation and RS have their own parliaments

November 11th 2000. Next elections: parliamentary, November 2002; presidential, byOctober 2002

BiH has a rotating collective three-member presidency: Jozo Krizanovic (Croat; electedMarch 30th 2001; current chairman), Beriz Belkic (Muslim; elected March 30th 2001)and Zivko Radisic (Serb; elected September 13th 1998)

The Council of Ministers comprises six ministers, one of whom is appointed chairman(prime minister) on a rotating basis for eight months at a time. The current governmentwas formed on February 22nd 2001. The entities have their own governments

Social Democratic Party (SDP), Party for BiH (SzBiH), New Croatian Initiative (NHI), BiHPatriotic Party (BPS), List for Progress (List), Party of Democratic Action (SDA), CroatianDemocratic Union of BiH (HDZ BiH); Serb Democratic Party (SDS), Party of DemocraticProgress (PDP), Party of Independent Social Democrats (SNSD), Democratic SocialistParty (DSP), Serb People’s Alliance (SNS), Serbian Radical Party of Republika Srpska(SRSRS), Socialist Party of Republika Srpska (SPRS)

The Dayton agreement called for the appointment of a high representative, a seniorforeign diplomat charged with monitoring the implementation of the agreement andco-ordinating the activities of international organisations operating in BiH. The highrepresentative is advised by the Peace Implementation Council (PIC), which includes allthe signatories to the Dayton agreement. Since December 1997 the high representativehas been able to impose decisions in cases of disagreement and to dismiss officials whoobstruct the Dayton agreement

Chairman & foreign affairs Zlatko Lagumdzija (Muslim)Civil affairs & communications Svetozar Mihajlovic (Serb)European integration Dragan Mikerevic (Serb)Foreign trade & economic relations Azra Hadziahmetovic (Muslim)Human rights & refugees Kresimir Zubak (Croat)Treasury Ante Domazet (Croat)

Peter Nicholl

Wolfgang Petritsch

Official names

Form of state

Legislatures

National elections

Head of state

National government

Main political parties

International involvement

National government

Central Bank governor

High representative



President Karlo Filipovic (SDP)Vice-president Safet Halilovic (SzBiH)Prime minister Alija Behmen (SDP)Deputy prime minister & minister of finance Nikola Grabovac (NHI)

Agriculture, water & forestry Behija Hadzihajdarevic (SzBiH)Defence Mijo Anic (NHI)Education, science, culture & sports Mujo Demirovic (SDP)Energy, mining & industry Hasan Becirovic (SDP)Environment Ramiz Mehmedagic (SzBiH)Interior Muhamed Besic (SzBiH)Justice Zvonko Mijan (SDP)Social affairs & refugees Sefer Halilovic (BPS)Trade Andrija Jurkovic (SDP)Transport & communications Besim Mehmedic (SzBiH)Veterans’ affairs Suada Hadzovic (SDP)

President Mirko SarovicVice-president Dragan CavicPrime minister Mladen Ivanic

Agriculture Rajko LatinovicDefence Slobodan BilicFinance Milenko VracarForeign economic relations Fuad TuralicHealth & social security Milorad BalabanInterior Dragomir JovicicJustice Biljana MaricRefugees & displaced persons Mico MicicTrade & tourism Zeljko TadicWar veterans’ & soldiers’ affairs Dragan Solaja

Federation

Key ministers

Key ministers

Republika Srpska



Economic structure

Annual indicators

1996 1997 1998 1999 2000a

GDP at market prices (KM bn) 4,125 6,116 7,336 8,323 9,115

GDP (US$ bn) 2,741 3,526 4,169 4,540 4,305

Real GDP growth (%) 86.0 37.0 10.0 10.0 5.0

Retail price inflation (%; av) Federation –20.1 10.8 5.2 –0.7 1.2b

Republika Srpskac 17.2 –6.8 2.0 15.1 13.6b

Population (m) 4.16 4.20 4.23 4.28 4.32

Exports of goods fob (US$ m) 106 303 593 635 1,070b

Imports of goods fob (US$ m) 1,256 1,643 2,723 2,707 2,798b

Current-account balance (US$ m) –352 –642 –747 –788 –970

Reserves excl gold (US$ m) 235 80 175 455 485b

Total external debtd (US$ bn) 3.6 4.1 3.0 3.1 2.6

Exchange ratee (KM:US$; av) – – 1.76 1.83 2.12b

July 27th 2001 KM2.24:US$1; KM1.96:€1

Origins of gross domestic product 1998 % of total Components of gross domestic product 1998 % of total

Agriculture, fisheries & forestry 16.0 Public & private consumption 100.4

Industry & utilities 22.4 Gross investment (incl stockbuilding) 38.0

Construction 5.7 Exports of goods & services 35.1

Services 55.8 Imports of goods & services –73.5

Total 100.0 Total 100.0

Principal exports 2000 % of total Principal imports 2000 % of total

Federation FederationIndustrial products 26.9 Machinery & transport equipment 24.8Miscellaneous manufactures 24.8 Industrial products 17.6Crude material excl fuels 23.9 Food & live animals 15.1Machinery & transport equipment 9.6 Miscellaneous manufactures 11.9

Main destinations of exports 2000 % of total Main origins of imports 2000 % of total

Federation FederationItaly 17.2 Croatia 28.3Switzerland 16.8 Slovenia 16.5Germany 16.0 Germany 11.8Croatia 11.0 Italy 9.0

Republika Srpska Republika SrpskaYugoslavia (Serbia-Montenegro) 38.5 Yugoslavia (Serbia-Montenegro) 23.4Italy 32.2 Slovenia 13.7Germany 4.1 Germany 7.2Slovenia 3.0 Croatia 7.1

a EIU estimates. b Actual. c KM-based index. d Source: IMF, Country Report, January and July 2001. e Convertible marka (KM) introduced in June1998 and fixed at KM1:DM1.



Quarterly indicators

1999 2000 20012 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

Financial indicators

Exchange rate

KM:US$ (av) 1.852 1.867 1.885 1.984 2.097 2.164 2.252 2.121

KM:US$ (end-period) 1.894 1.867 1.885 1.984 2.097 2.164 2.252 2.121

Interest rates (%; av)

Deposit 10.99 79.38 9.07 16.40 14.70 15.12 14.67 16.50

Lending 24.29 24.29 24.29 30.50 30.50 30.50 30.50 30.99

M1 (KM m; end-period) 429 594 1,149 1,193 1,253 1,362 1,463 1,420

% change, year on year 55.4 74.7 199.2 202.8 192.1 129.3 27.3 19.0

M2 (KM m; end-period) 1,815 1,929 2,326 2,279 2,368 2,437 2,564 2,523

% change, year on year 28.5 18.3 27.5 30.6 30.5 26.3 10.2 10.7

Foreign tradea (US$ m)Exports fob 145 150 172 145 163 179 199 n/aImports cif –635 –678 –720 –583 –692 –698 –717 n/aTrade balance –490 –528 –548 –438 –529 –519 –518 n/a

Foreign reserves (US$ m)Reserves excl gold (end-period) 203 242 452 419 432 422 497 478

a DOTS estimates.Source: IMF, International Financial Statistics.



Outlook for 2001-02

Political outlook

The Economist Intelligence Unit expects the politically volatile situation inBosnia and Hercegovina (BiH) to persist over the forecast period, but the rulingAlliance for Change should manage to hold on to power. The crisis in whichthe Alliance has found itself—unable to pass the proposed election law or to seethrough changes to the workings of the BiH state government—is notunexpected. When the coalition took control of the government of BiH andone of its two entities, the Federation, in early 2001, it was clear that the newadministration would not find it easy to implement its election pledges. TheAlliance embraces ten parties of different political profiles and is held togetherby a single motive—to fend off the nationalist parties whose rule has preventedthe country from returning to normal following the 1992-95 war. Pressure fromthe international community to create a moderate political block to countervarious nationalist groupings was another important factor in its formation.Both internal differences and constant pressure from the West to push on withreform will continue to pose a challenge to the unity of the Alliance.

At the same time the forces of ethnic nationalism are regrouping, reinforcingthe message that throughout the region ethnic nationalism still enjoys strongsupport, thus adding to the strain of holding the government of BiH together.In the short term, however, the greatest threat to the survival of the Alliancecomes from the Party of Democratic Progress (PDP) and the Party ofIndependent Social Democrats (SNSD) from Republika Srpska (RS), BiH’s otherentity. Although at the state level the two parties provide the Alliance with asmall parliamentary majority, there are major differences between them andthe Social Democratic Party (SDP), the leading Alliance party, regarding therelationship between the central state and the entities. It is around this issuethat the proposed changes to the election law and to the BiH governmentstructure revolve. There seems to be growing resentment among RS deputiesthat the outgoing BiH prime minister, Bozidar Matic, as well as his successor,Zlatko Lagumdzija, who is also the leader of the SDP, have tried to impose theirvision of the future of the country in the short time they have been in office.

The political outlook therefore remains unsettled. The international communitywill be decisive in determining the future direction of events. Time has beengained by the postponement of the deadline for passing the election law, whichis a condition for admission into the Council of Europe. There is a danger that bytrying to keep the lid on the internal coalition differences, the Alliance may failto deliver on its election promises, which could undermine its prospects ofwinning another term. Since the next elections are due towards the end of 2002,the Alliance does not have much time in which to convince the electorate that itdeserves another spell in power. Provided that it can show that progress has beenmade, especially on the economy, we believe that the Alliance should be able towin re-election, but there are risks to this forecast, not least because of the dangerthat institutional paralysis will prevent it from taking any decisive action.

Domestic politics

Coalition stability



Recent violence in RS, as well as problems in the functioning of the new govern-ment, suggest that the international presence in BiH will remain essential for anumber of years to come. BiH still lacks its own capacity to provide security toits people. In this respect, the reassurance in July from George W Bush, the USpresident, that the US would not withdraw unilaterally from its militarycontribution to the NATO-led Stabilisation Force (SFOR), is a factor for stability.The RS government is making some effort to co-operate with the InternationalCriminal Tribunal for former Yugoslavia (ICTY) in The Hague, even if this seemsto be motivated by self-interest, given its need for Western aid.

The integration of BiH into international structures is high on thegovernment’s agenda, as it believes that this will act as a safeguard against theresumption of violence and a guarantee of long-term security. Membership ofthe Council of Europe remains an immediate priority. At the same time thegovernment is making an effort to meet the demands of the EU “road map” tomembership, which is a precondition for the start of the process leading to astabilisation and association agreement (SAA).

Economic policy outlook

The preservation of macroeconomic stability is likely to remain the principalfocus of the government’s economic policy over the forecast period. Adherenceto the currency board rules and firm control over public finances will remainthe key conditions for securing the continued support of the IMF, which hasurged the government to devote more resources to capital investment. The newstand-by facility, due to come into effect in late 2000, may soon be replaced bya poverty reduction and growth facility (PRGF). In preparation for the PRGF, afour-year economic development strategy document has been drawn up. Inorder to speed up economic reform, which received a setback from a slowdownin growth in 2000, the government envisages much higher levels of investmentover the period of the plan, at US$800m per year, or about 20-25% of GDP. Thegovernment is hoping to obtain the required resources from privatisationproceeds, foreign direct investment (FDI), government investment andreinvestment of enterprise profits, but it is unlikely to meet its target.

The weak fiscal position of BiH continues to threaten macroeconomic stability.The entity governments seem determined to step up their efforts to improve taxcollection and stamp out tax evasion by reforming the tax and customs regimes,and an effort is being made to cut expenditure, which involves an overhaul ofthe pension, health and education systems. The entity governments have largepension and invalidity benefits arrears, as well as debts to the pre-war holders offoreign-currency accounts, and there is a dispute over how to settle these debts.In addition, some 20,000 soldiers are to be made redundant, which will requireextra severance funds. Fiscal sustainability has so far depended on foreign grants,which may decline. The Federation planned to use some of the proceeds fromthe sale of state utilities for this purpose, but the international agenciessupervising privatisation have allowed for the sale of only 15% of the govern-ment’s utility stakes in 2001, and the sale of the electrical utilities has beenpostponed. We therefore expect the Federation budget to be revised later in 2001.

International relations

Policy trends

Fiscal policy



The currency board is expected to remain in place in 2001-02, helping topreserve price and exchange-rate stability. According to Peter Nicholl, thegovernor of the Central Bank of BiH (CBBiH), the local currency, theconvertible marka (KM), is becoming more acceptable abroad, which confirmsthe growing confidence in its stability. Although under the Dayton agreementthe foreign head of the CBBiH was to remain in place for six years, there seemto be no plans to replace Mr Nicholl with a local governor, which givesadditional reassurance that the currency board rules will be adhered to.

Economic forecast

International assumptions summary(% unless otherwise indicated)

1999 2000 2001 2002

Real GDP growthOECD 3.1 4.0 1.4 2.4EU 2.5 3.4 2.0 2.5

Exchange rates (av)US$:€ 1.07 0.92 0.88 0.96

Financial indicators€ 3-month interbank rate 2.97 4.48 4.54 4.39US$ 3-month commercial paper rate 5.18 6.32 4.04 4.75

Commodity pricesOil (Brent; US$/b) 17.9 28.5 26.9 25.5Food, feedstuffs & beverages (% change in US$ terms) –18.6 –6.1 1.2 15.0Industrial raw materials (% change in US$ terms) –4.6 13.4 –3.5 3.8

Regional aggregate GDP growth rates weighted using purchasing power parity exchange rates.

The world economy is experiencing a severe deceleration, and global realGDP growth (weighted using purchasing power parity exchange rates) isexpected to slow from 4.9% in 2000 to 2.7% in 2001. The US will be close torecession and Japan is continuing to weaken. The euro zone is also slowingsharply, particularly in Germany (an important market for BiH), which isexpected to grow even more slowly than the US in 2001; however, Italy, BiH’sleading market, is expected to make the average EU growth rate of 2% in2001. EU economic performance in general is expected to be better (but not bymuch) than in the US this year. Our central forecast is for monetary easing inthe US that will generate a moderate pick-up there—from 1.5% growth in2001 to 2.5% in 2002—which should feed through into higher global growthof 3.7%, although there are risks to the forecast, such as US vulnerability to acrisis in an important emerging market such as Argentina.

The marka will share the fortunes of the euro (to which it is linked via theD-mark) against the US dollar, which we now expect to remain weak for sometime, appreciating slowly to US$0.91:€1 by end-2001, and not reaching parityuntil late 2002. This will keep US dollar-denominated oil prices high for BiHcustomers; prices are expected to remain stable for the rest of 2001 and to stayabove US$25/barrel throughout 2002, moderating only a little from the

International assumptions

Monetary policy



US$28.5/b average for 2000. As a metals exporter, BiH may be hit by aweakening in the prices of industrial raw materials; base metals prices areexpected to decline by 5.3% in 2001, although prices for aluminium, a majorexport, are only expected to fall by 2.2%, and to revive to a similar extent in2002, on the assumption of a moderate world recovery.

We expect real GDP growth in 2001 to remain at around 6-7%, on theassumption that BiH will continue to benefit from international assistance. In2000 BiH’s growth rate fell to single digits for the first time since the ending ofthe war in 1995 and the beginning of the post-war reconstruction programme.For most of this period large injections of international assistance, estimated atan average of US$1bn a year, fuelled a strong recovery—although this hasfallen short of returning BiH to its pre-war economic position. GDP in 2000has been estimated to have reached 46% of its 1991 level. Much of industry,which was once the core economic sector, remains dormant, and expansion inother sectors has failed to compensate for that loss. By mid-2001 industrialoutput in the Federation was estimated at around 40% of its pre-war level, andsharp oscillations in RS industrial output suggest that growth there is notstrongly rooted either. Nor has agriculture completely recovered yet: land hasgone out of cultivation, in part because of uncleared landmines, and flocks andherds are still being replenished after the destruction of wartime.

Over the forecast period wage growth is likely to continue decelerating becauseof persistently high unemployment. This in turn will hold back privateconsumption, although local spending by large numbers of international staffand substantial remittances from BiH’s citizens abroad will compensate to someextent. Some pick-up in both foreign and domestic investment is expected, butwill not be sufficient to boost economic growth. The investment environmentremains unattractive, because of cumbersome bureaucratic procedures and aweak financial sector. A number of initiatives to boost the small and medium-sized enterprise (SME) sector are under way, but unless local financialinstitutions become able to sustain the financing needs of local businesses, andunless a more palatable regulatory and legislative environment is created, mostof these projects will remain isolated undertakings. Growth in exports is likelyto continue, as confirmed by anecdotal evidence, but its contribution togrowth will be only moderate. In value terms, BiH still exports modest amountsof goods, as its productive capacity remains restricted by unresolved problemsof post-war reconstruction, economic restructuring and reform.

Retail price inflation is likely to remain moderate over the forecast period. Thereare indications that inflation is easing off in the Federation, following on fromthe high year-on-year figures seen since September 2000. The rate in RS willcontinue to surpass that in the Federation, but should stay within a 7-8% band.

Since its introduction in 1998 the marka has been fixed at parity with theD-mark and has therefore followed the pattern of the German currency againstthe US dollar, depreciating strongly in 1999-2000. The marka is likely todepreciate against the US dollar from an average of KM2.12:US$1 in 2000 toKM2.23:US$1 in 2001, before rallying to KM2.03:US$1 in 2002.

Exchange rates

Economic growth

Inflation



In 2001-02 the current-account deficit is likely to remain large, driven by asubstantial trade deficit. BiH lacks the capacity to respond more robustly to theopening trade opportunities. Recently a Memorandum of Understanding onthe liberalisation and simplification of regional trade between BiH, Bulgaria,Romania, Croatia, Macedonia and Yugoslavia (Serbia-Montenegro) was signedunder the Stability Pact for South-eastern Europe. Although the deal mayfacilitate inter-regional trade, its actual effect on BiH’s export growth is likely tobe limited. BiH already benefits from the EU’s one-sided removal of restrictionson trade; local firms have so far responded only modesty to this. Althoughlower than in the immediate post-war period, the level of imports will remainrelatively high in the absence of a strong domestic recovery. BiH has beenrunning surpluses in other components of the current account, but these willnarrow; the net transfers surplus, in particular, will come down owing to a fallin official transfers. A donor conference is expected to take place in the secondhalf of 2001, and the external financing gap to be closed by capital inflows.

BiH: forecast summary(% change, year on year unless otherwise indicated)

1999a 2000a 2001b 2002b

Real GDP 10.0 5.0c 7.0 6.5

Industrial output 8.0c 8.0c 9.0 7.5

Retail prices (av) Federation –0.7 1.2 2.5 3.5 Republika Srpska 15.1 13.6 7.5 8.0

Exports of goods fob (US$ m) 635 1,070 1,100 1,200

Imports of goods fob (US$ m) 2,707 2,798 2,900 3,000

Current account (US$ m) –788 –970c –1,100 –1,200 % of GDP –17.3 –22.5c –24.5 –22.2

Exchange rates (KM:US$) Average 1.83 2.12 2.23 2.03 Year-end 1.95 2.08 2.16 1.94

a Actual. b EIU forecasts. c EIU estimate.

External sector



The political scene

Alliance for Change, the coalition of moderate parties formed after theNovember 2000 election in Bosnia and Hercegovina (BiH), came across its firstserious test in July, just three months after it took over the BiH stategovernment (February 2001, pages 12-13; May 2001, pages 11-13). At the endof May the Alliance began the process of introducing legislation to strengthenthe state government. The main innovation is to make the office of primeminister a permanent, non-rotating post for four years. The reform is part ofthe agreement reached between the parties when they formed the Alliance.

Alliance members believe that the present structure of the Council of Ministers,with two ministers from each of the three ethnic groups and the primeministership rotating between them every eight months, is inefficient, and thatalthough it is reasonable that the principle of alternating top posts betweenethnic groups apply to bodies like the state presidency, it is inappropriate forthe administration. A leading Alliance member, the Social Democratic Party(SDP), is opposed to ethnic politics, and the Party for BiH (SzBiH) would restorethe centralised state that existed before BiH split along ethnic lines in 1992.The bill was to have been ready before Bozidar Matic of the SDP completed hiseight-month stint as prime minister. Mr Matic had argued that the changeswere essential if the programme of reforms aimed at accelerating economicgrowth was to be continued, and he only accepted nomination to the primeministership on the condition that the government would be reformed.

The proposed amendments, which were drafted by the members of the SDPand the SzBiH, received a mixed reaction. From inside the Alliance, KresimirZubak, the leader of the New Croatian Initiative (NHI), objected that the billmight cause problems within the coalition. The Party of Democratic Action(SDA), which is the main Muslim party, said that it would support the proposalbecause it strengthened the central state, which the SDA had tried to achievewhile it was in power. The nationalist Croatian Democratic Union of BiH (HDZBiH) was opposed, arguing that abolishing the rotation principle would harmBosnian Croats’ national interests.

However, the real blow came from the Party of Democratic Progress (PDP) andthe Party of Independent Social Democrats (SNSD), Bosnian Serb parties thatsupport the Alliance in the BiH parliament. Mladen Ivanic, the PDP leader andprime minister of Republika Srpska (RS), said that the principles of consensus,parity and rotation should continue to apply to the Council of Ministers.Bosnian Serbs are on the watch for any attempt to resurrect a strong centralBiH government, and would prefer to preserve the Dayton settlement of 1995that set up BiH’s two entities, even though the division of the country intoseparate ethnic enclaves is administratively and economically inefficient. OnJuly 9th the BiH presidency decided to withdraw the proposal and continueconsultation among the parties.

The Alliance is also in difficulty over the draft BiH election law, which needs tobe passed soon if everything is to be in place for the BiH presidency election in

Alliance proposes reform ofBiH government

Election law is rejected

Bosnian Serbs object to thechanges



October 2002. On June 21st, after a two-day debate, the BiH lower house, theHouse of Representatives, rejected the bill proposed by the Council of Ministers.The SDP, the SzBiH and the SDA voted against, whereas the HDZ BiH and thenationalist Serb Democratic Party (SDS) voted for the law. Critics of the billobjected that it allowed displaced persons to vote in their current place ofresidence, arguing that this condoned ethnic cleansing. The SzBiH insteadwanted people to vote according to the election district in which they lived inbefore the 1992-95 war.

The adoption of an election law is one of the conditions for BiH’s admittanceto the Council of Europe and it was to have been passed by June 22nd. Since1996 general and local elections in BiH have taken place under provisionalelectoral rules and under the auspices of the Organisation for Security andCo-operation in Europe (OSCE), which has overseen the elections and theimplementation of their results. The OSCE’s mandate to conduct electionsexpired in 2000. The head of its mission in BiH, Robert Beecroft, and theinternational high representative, Wolfgang Petritsch, warned that an electionlaw must be passed as soon as possible to allow time to prepare for thepresidential and general ballots in late 2002. Preparations include establishingan election commission; hiring staff; enacting election laws for the Federationand RS, the two entities that comprise BiH; and drawing up the many detailedrules and regulations necessary for holding an election.

The main problem with the draft election law is that it maintains the principleof ethnic voting, which has preserved the lines of division between BiH’s threemain ethnic groups. The SDP and the SzBiH have asked for substantial changesto bring the law into line with the pending revision of the constitutions of theFederation and RS, which will give all three ethnic groups equal status acrossthe whole of BiH. This proposal has been opposed by Bosnian Serb and Croatnationalists, who are determined to preserve the system whereby ethnic groupsvote only for their own ethnic representatives.

Although the Alliance, and the SDP in particular, have been accused of tryingto change the election law to modify the Dayton agreement, their objectionsto the most recent draft do have legal grounds. Negotiations over the law havebeen going on for a long time, and the resulting proposal is a compromisestruck under pressure from the international community. However, it does nottake into account the implications of the Constitutional Court’s ruling of July2000 (August 2000, page 7), which would require a change in the electoralrules to reflect the principle that the three main ethnic groups have equalrights throughout BiH. Pressing on with the adoption of the election law is ashort-term policy that could impair the chances of reducing ethnic polarisationwithin BiH society and at the ballot box—and this is the SDP’s is primeconcern about. The decision of the Political Affairs Committee of the Councilof Europe on June 23rd to allow another two months for the election law to bepassed suggests that it too is aware of the contradiction between enacting thelaw in its current form and the changes required in the light of theConstitutional Court’s ruling.

Council of Europe sets anew deadline



The failure to pass the election law and the lack of support from the coalitionparties for the proposed amendments to the law on reforming the governmentled Mr Matic to resign as prime minister on June 22nd. The presidencyaccepted his resignation and asked the Alliance to propose a new candidate.The possibility was briefly considered of nominating Azra Hadziahmetovic, theBiH minister of foreign trade and economic relations and an SzBiH member.Eventually Zlatko Lagumdzija, the SDP leader, BiH minister of foreign affairsand a Muslim, was approved by parliament on July 18th. Ante Domazet, aCroat, was appointed Treasury minister in Mr Matic’s place. Mr Lagumdzija saidthat co-operating with the International Criminal Tribunal for formerYugoslavia (ICTY) in The Hague, the return of refugees to their property, andcombating organised crime and corruption were essential if BiH was to attractthe foreign direct investment (FDI) that it will increasingly need as inflows ofofficial aid start to decline. Nationalists oppose the return of refugees to theirplace of origin, as it reverses the ethnic homogenisation that was the result ofthe 1992-95 war and the Dayton agreement that ended it. (In the 1991 censusthe area now covered by RS was 54% Serb; it is now said to be 90%.)

For the time being at least the Alliance appears to have abandoned trying tochange the BiH government structure. Mr Lagumdzija admitted that it had notsecured a parliamentary majority in favour of abolishing the rotation systemfor the post of prime minister. Bosnian Serb deputies made it a condition oftheir support that he relinquish the chairmanship after eight months, as in thecurrent law. Accordingly, he received 22 votes in his favour from the Allianceand its Bosnian Serb supporters, compared with 12 votes against from the HDZBiH and the SDS, and six SDA members abstained. The episode demonstratesthe paralysis in state institutions caused by the ethnic divide in BiH society, bythe divisions within the Alliance, and by the dependence of the Alliance onthose Bosnian Serb deputies who support it in the state parliament (February2001, pages 15-16), but who oppose changes in the basic political structure ofBiH. Another example of political paralysis came when the chairmen of theethnic Croat and Muslim deputy groups in the BiH upper chamber, the Houseof Peoples, complained on July 24th that the Serb group had vetoed all thedraft laws being debated, giving their consent only to a number of reports andthe ratification of state treaties. The Bosnian Serb chairman denied obstructingthe work of the chamber, saying that there need be no problems if otherpeople’s views were respected. Laws in the House of Peoples may be blocked byany of the ethnic groups into which it is divided.

As part of their strategy of setting up temporary Bosnian Croat self-rule (May2001, pages 11-17), representatives of the HDZ BiH withdrew from BiH andFederation parliamentary bodies in March. This was a tactic designed to putpressure on the Alliance and on international representatives to give in to theirdemands. However, a senior HDZ BiH official attended a session of the BiHparliament on May 17th on the election law, and all the party’s deputies werepresent at the session on June 6th. The following day, as if to counter theimpression of a weakening of resolve, the Croat People’s Assembly (HNS), abody set up by the HDZ BiH as a parallel representative structure, threatenedcivil disobedience if Croat demands were not met. The objections of Bosnian

SDP leader takes over asBiH prime minister

HDZ BiH ends boycott



Croat nationalists to the current political structure in BiH, which does notinclude a separate Croat entity asserting their rights as an ethnic group, haveincreased since they lost control of government at state and Federation levelsto the Alliance in early 2001. They fear being overwhelmed by the largerMuslim and Serb communities.

On May 3rd the HDZ BiH formed a team for negotiating with the internationalcommunity and all BiH political parties on the constitutional position. TheHDZ BiH leader, Ante Jelavic, said that this did not mean that it was returningto BiH government institutions, but rather rejoining political life. However,Mr Jelavic’s tactics have not been successful. He is being challenged by a rivalgroup, the increasingly prominent Croatian Co-ordination, which is anassociation of political parties, non-governmental organisations (NGOs) andindividuals set up in March to promote the national interests of BosnianCroats. It was founded by a number of prominent Bosnian Croats headed byJadranko Prlic, a former BiH foreign minister and defector from the HDZ BiH,as an alternative voice for the Bosnian Croats. When Croatian Co-ordinationstarted a round of meetings with international representatives and BiH partiesin order to keep the dialogue going, the HDZ BiH perceived it as direct threat toits position. The HDZ BiH has made it clear that it has no intention of enteringinto dialogue with Bosnian Croat members of the Alliance, and particularly notthose in the Croatian Co-ordination.

Other more substantial reasons for the HDZ BiH’s change in tactics are tied upwith the dwindling of resources at the disposal of the Bosnian Croat self-ruleproject since Hercegovacka banka was put under the control of aninternational administrator (May 2001, page 16). The bank was vital forfinancing Bosnian Croat parallel structures and was controlled by the HDZ BiH.This explains why members of the Croat Defence Council (HVO), the BosnianCroat component of the Federation army, and Bosnian Croat police graduallystarted reporting back to their units, as they stopped receiving salaries from theBosnian Croat self-government. In March the HVO had been disbanded by theHDZ BiH leadership as part of its strategy of establishing parallel Bosnian Croatstructures. By June 17th, according to a spokesman for the Federation’sMinistry of Defence, some 95% of the HVO had renewed their contracts withthe army. In July the Federation defence minister, Mijo Anic, said that the HVOwas back to full strength at 7,200. However, he added that this was below theofficial payroll strength of 10,500, which had been inflated by “intruders” andby soldiers working illegally to avoid paying pension and health contributions.The Federation defence ministry has thus been able to use the HVO crisis toassert its control over the Bosnian Croat component of the army andeconomise on the military budget.

In addition, the Federation government has recently appointed new manage-ment boards to public enterprises, in particular the profitable aluminium plant,Aluminij Mostar, which has until now been another important channel forfinancing parallel Bosnian Croat political structures.

Bosnian Croat self-ruleloses steam

HVO members return toduty



The HDZ BiH has maintained that its main concern is to establish BosnianCroat equality with BiH’s other two main ethnic groups. Its demands are for theimplementation of the Constitutional Court’s ruling on the equality of all threepeoples across BiH (which the HDZ BiH interprets as favouring equal ethnicrights); the setting up a House of Peoples in RS (which lacks a second chamberto assert the rights of minority ethnic groups); the maintenance of the systemof rotation, parity and consensus in decision-making; and the preservation ofan electoral law confirming that Bosnian Croats should vote as a group for theirrepresentatives to the House of Peoples and for their own presidentialcandidate. The HDZ BiH denies having any separatist agenda, but on July 3rdthe party’s board announced that it was considering holding a referendum onsetting up a third entity within BiH, which would lead to the break up of theFederation. However, some level of disarray within the HDZ BiH is suggested byMr Jelavic’s attack on unnamed “ditherers and schemers” within the party, whowere responsible for a descent into “lethargy”. In June a senior party officialwarned that high numbers of Bosnian Croats were leaving BiH.

The idea of holding a referendum was portrayed as a reaction to amendmentsto the BiH constitution proposed by the Federation ConstitutionalCommission in order to comply with the Constitutional Court’s ruling. Theamendments envisage either abolishing the House of Peoples in the Federationparliament, or introducing an equivalent chamber in the RS parliament inwhich Bosnian Croats, Bosnian Serbs, Muslims and “others” would have tenrepresentatives each. The HDZ BiH objected that the amendments werecontrary to the Washington and Dayton agreements and would lead toBosnian Croats being outvoted in federal institutions.

The hardline position adopted by the HDZ BiH has encountered an equallyfirm response from the international community and the authorities in BiH.Now that its financial base has been weakened, the HDZ BiH is under somepressure and the Alliance gone on the offensive, at the end of July institutingproceedings against seven leading HDZ BiH members, including Mr Jelavic, forthreatening to break up the BiH state.

Having been defeated politically by the moderate Alliance, the main Muslimparty, the SDA, has been trying to adapt to its opposition role. However, it hasnot abandoned its ambition to recapture some of the vote lost at theNovember 2000 election. The SDA, much like the Bosnian Croat and Serbnationalists, believes that it is only matter of time before the Alliance, which itperceives to be a creation of the international community, breaks up because ofinternal differences. This is why it is important for them to keep the ethnicissue at the heart of national politics, hoping that a disillusioned electorate willeventually return to the fold. On May 26th the SDA leadership held a meetingin the small village of Blagaj on the outskirts of Mostar, where they openlycalled upon Muslims to “rise against” the Alliance, as its policies would lead toa resumption of war. The choice of the venue for the meeting was notaccidental. Mostar is the stronghold of Bosnian Croat hardliners and the mostvolatile city in BiH, which makes it a perfect setting for the promotion of apolitical agenda centred on ethnic homogenisation. Recent violence in RS andBosnian Croat threats of establishing a third entity provide the SDA with an

HDZ BiH considers holdinga referendum

SDA tries to recapture lostground



argument that ethnic security is still the key issue in BiH, and that the SDA canprovide it for Bosnian Muslims.

Serious violence broke out in Trebinje and in the RS capital, Banja Luka, whenMuslims attended the laying of foundation stones for the Osman Pasha andFerhadija mosques that were destroyed during the 1992-95 war. The ceremonyin Trebinje on May 5th had to be abandoned under a hail of stones fromBosnian Serb demonstrators. On May 7th rioters in Banja Luka injured 30people (one of whom later died) and forced 300 visitors, including BiH andforeign dignitaries, to run for cover inside a nearby building. The police didlittle to prevent the riot and it was only after troops from the internationalStabilisation Force (SFOR) threatened to use armoured vehicles to rescue thosetrapped inside that SDS officials moved to disperse the mob. These events werecondemned by the BiH state authorities and the international community, butthe response from the RS government was more muted. The RS prime minister,Mr Ivanic, condemned the violence, but said that religious ceremonies hadbeen unnecessarily politicised.

These incidents show that ethnic animosity still runs high in RS and thatpolitical forces exploiting it remain powerful. It is widely believed that it was the

Riots prevent mosquerefounding in RS



SDS and the banned Serbian Radical Party of RS that orchestrated the events.The fact that the RS government did not take adequate precautions and that itlet the police stand by and watch as the violence went on suggests that there isno genuine commitment to the return of refugees and to rebuilding a multi-ethnic community in RS. Recent government appointments to the managementboards of public firms have excluded Bosnian Croats and Muslims.

However, this time the RS government seems to have realised that it cannotafford to allow such incidents when it is so heavily dependent on Western aid.Chris Patten, the EU external affairs commissioner, commented pointedly afterthe Banja Luka riot that RS was receiving huge sums from the EU taxpayer. Lateon May 7th the RS leadership held an emergency session, after whichMr Ivanic said that the violence would seriously damage RS internationally. OnMay 8th 20 Serbs were arrested for their part in the riot. The interior minister,Perica Bundalo, offered his resignation and on May 24th he was replaced byDragomir Jovicic. A second attempt to hold a ceremony for the Ferhadijamosque, this time attended by the RS president, Mirko Sarovic, went aheadsuccessfully on June 18th under heavy protection from the police, who foughtrunning battles with demonstrators and arrested about 100 of them. A similarceremony to reopen the Obradovacka mosque in Gradiska on July 14th passedoff peacefully in the presence of 800 police and no demonstrators.

Only one RS official—Fuad Turalic, the minister for foreign economic relations,who is a Muslim—attended the dedication on July 11th of a memorial to the7,000-8,000 believed killed when the Bosnian Serb army overran Srebrenica in1995. Again with heavy policing and also under an SFOR guard, the ceremonypassed off without incident. The following day Bosnian Serbs held their ownceremony in memory of 1,000 people they say were killed in the Srebrenicaregion between May 1992 and February 1993 by BiH government forces. In anaddress at the ceremony strongly suggesting that the RS government wants tochange its image abroad, Mr Sarovic said that the peaceful and dignifiedcommemoration of the sixth anniversary of the killing of Muslims inSrebrenica was “the most useful thing for RS”. He went on: “We must learn tothink with our heads instead of thinking with our hearts. We must convincethe world that we, too, are victims and that we respect human rights and thenorms of civilisation.”

An important test of this new mood of respect for international law andrejection of ultranationalism came on July 26th, when the RS parliamentapproved the first reading of a bill on co-operation with the ICTY, albeit underheavy Western pressure. Before the vote, Mr Sarovic said that RS should bringto justice those whose crimes had brought dishonour on the Bosnian Serbs. Sofar, however, the Bosnian Serb authorities have not handed over to the ICTY asingle indictee, 15 of whom are believed to be on RS territory. Interest will nowfocus on whether two prominent Bosnian Serbs—Radovan Karadzic, thewartime leader of the Bosnian Serbs and the founder of Mr Sarovic’s own SDS(although the party says it no longer has anything to do with him), andGeneral Ratko Mladic, the Bosnian Serb army chief who is held responsible forthe Srebrenica massacre—follow Slobodan Milosevic, the former Yugoslav

RS government acts afterthe violence

Parliament votes for Hagueco-operation bill



president, to The Hague. Both Mr Karadzic and General Mladic are believed tobe in hiding in RS. All 31 SDS deputies voted for the ICTY bill, which requiresconfirmation in a further vote on September 15th.

Confirming his administration’s determination to see the bill through,Mr Ivanic said on July 16th that the government would face a crisis unless itwas passed. Mr Ivanic discussed the issue of co-operation with ICTY during avisit to the US in mid-July, and said that the talks took place in a completelynew climate of partnership with the US, and that he hoped agreement wouldsoon be reached on a new package of loans on favourable terms for 2002,perhaps confirming the view that RS is beginning co-operation with the ICTYfor fear of a cut in Western assistance.

The RS government’s position on co-operation with the ICTY was eased inAugust, when three prominent Muslim officers were handed over to TheHague. The Bosnian Serbs have always complained the The Hague is biasedagainst Serbs, but on August 2nd two former Bosnian government generals,Mehmed Alagic and Enver Hadzhihasanovic, and a serving officer, AmirKubura, were extradited. They are charged with committing war crimes againstBosnian Serbs and Croats in central Bosnia in 1993.

Also on August 2nd the tribunal found General Radislav Krstic guilty ofgenocide for his part in the Srebrenica killings in 1995, and jailed him for46 years. Evidence accepted in the case could also be used against Mr Karadzicand General Mladic were they to face trial.

Economic policy

In May the IMF completed its review of the economic programme for Bosniaand Hercegovina (BiH) under the stand-by facility and approved thedisbursement of the two final tranches, amounting to SDR14m (US$18m). Thestand-by facility of SDR94.4m, which was approved in 1998, initially for a year,was extended to May 2001 because of difficulties in implementing theprogramme of reforms underpinning the agreement. During the IMF’s Mayvisit to BiH, a new stand-by facility was negotiated. It is expected to start inSeptember or October and last for 18 months. The IMF, however, expects to beable to cancel this agreement before it expires—possibly as early as six or eightmonths after the start date—and replace it with a more ambitious three-yearpoverty reduction and growth facility (PRGF). The PRGF would allow for amore systematic approach that simultaneously addresses the country’s twingoals of ameliorating poverty and delivering sustainable growth. Its centrepiecewill be a programme of structural reforms aimed at establishing a stable andtransparent business environment, which would be more conducive toattracting foreign direct investment (FDI).

Among the reforms on which the IMF insists, overhauling the public financesremains a top priority. Since the internationally sponsored post-war recon-struction programme started in 1996, balancing budgets at state and entity

BiH negotiates a new IMFstand-by facility

Public financeconsolidation is a priority

Muslim officers areextradited

Bosnian Serb general issentenced



levels has been difficult, requiring ongoing external support. The absence ofwidespread economic recovery combined with vast demands on public fundshas resulted in a wide gap between public-sector revenue and expenditure that,unless closed, poses a threat to medium-tem macroeconomic stability. Thesituation has been further aggravated by a lack of co-ordination in tax reformbetween the two entities. As part of the IMF’s conditionality attached to thestand-by credit, the two entities—the Federation and Republika Srpska (RS)—have been required to harmonise their tax legislation, reducing theopportunities for tax evasion. The entity governments have recently appealedto international organisations in BiH to follow the example of the Office of theHigh Representative (OHR) and waive their exemption from payingcontributions to health, pension and employment funds for their localemployees—a measure that by itself could bring in an additional DM2.5m(US$1.1m) per month in revenue.

BiH: central state budget(KM m)

2000 Revised Actual 2001a

Revenue 269.9 263.0 295.3 BiH revenue 27.6 20.6 27.6 Transfers from entities 242.3 242.4 267.7 of which: for debt service 197.7 197.8 212.1

Expenditure 280.9 266.9 304.3 Administration 66.2 63.1 72.2 Salaries 25.0 23.6 32.4 Materials & other 41.2 39.5 39.8 Border service 17.0 6.0 20.0 Debt service 197.7 197.8 212.1

Balance (before grants) –11.0 –3.9 –9.0

a Approved.Source: IMF, Country Report, July 2001.

The problem of balancing income and spending has been particularly seriousin the Federation, which experienced substantial revenue shortfalls in 2000—atrend that continued into the first quarter of 2001, leading to delays in thepayment of public-sector salaries. In July the Federation finance minister,Nikola Grabovac, complained that all cantons except Sarajevo were makingtiny contributions to the central budget, and that local tax inspectors shouldcrack down on tax evasion. The new Federation government claims to havesucceeded in abolishing the dual accounts of budget users and the parallelMuslim and Bosnian Croat administrative structures, which will improvetransparency in public finance and cut some expenditure. At the same timethe authorities are working on amendments to the existing legislation onimport taxes and customs, as well as on high-tariff goods, to alleviate the taxburden. As part of the long-term restructuring programme the government isaiming to get under way from July, the health, pension and primary educationsystems, as well as the invalidity benefits system, are to be reorganised.However, the government has failed to reach an agreement with the IMF on



how to settle its debts to pensioners, invalids and holders of pre-war foreign-exchange savings accounts.

Federation: entity budget(KM m)

2000 2001 Revised Actual Approved 1 Qtr actual

Revenue 837.3 826.8 872.7 180.3 Taxes 785.0 768.0 813.4 166.5 Excises 371.0 313.6 335.0 78.7 Trade taxes 386.5 431.9 453.5 80.0 Profit tax 27.5 22.5 24.9 7.8 Non-tax 52.3 58.8 59.3 13.8

Expenditure 954.5 976.4 997.7 193.5 Salaries 94.5 103.0 108.2 18.1 Goods & services 24.3 29.8 32.3 8.1 Defence 305.5 309.6 290.2 57.7 Reconstruction 30.9 47.2 46.6 11.6 Subsidies 15.8 14.0 11.2 2.9 Other transfers to households 269.0 255.0 278.6 59.7 of which: war invalids 258.0 240.7 263.9 57.0 Transfers to state government 153.3 153.5 167.8 22.3 Transfers to local government 15.0 25.1 10.0 5.7 Net lending 0.0 –7.0 0.0 0.0 Other/unallocated 46.2 46.2 52.8 7.5

Balance (before grants) –117.2 –149.6 –125.0 –13.1

Source: IMF, Country Report, July 2001.

In RS revenue was 29% below budget in the first quarter. In June a specialauditing team appointed by the Organisation for Security and Co-operation inEurope (OSCE) undertook an audit of the RS budget, and a special auditorappointed by the high representative audited the Federation’s budget. Thefindings revealed large-scale violations in budgetary practice, including misuseof public funds, and this resulted in criminal charges being brought againstseveral high ranking RS officials from the former government of Milorad Dodik.

Republika Srpska: entity budget(KM m)


Revenue 678.7 718.9 727.7 138.9 Taxes 581.2 614.5 631.7 121.3 Goods & services, excises 286.9 317.1 304.6 60.5 Trade taxes 164.3 167.1 187.3 25.4 Income taxes 67.6 70.8 75.5 16.3 Other taxes 62.4 59.4 64.3 19.1 Non-tax 97.5 104.5 96.0 17.6

continued




Expenditure 778.0 793.0 824.6 154.0 Salaries 228.4 206.1 248.2 54.2 Goods & services 112.2 153.3 100.5 11.4 Defence 69.9 70.3 66.9 11.4 Banking fees 1.0 1.1 0.3 0.1 Transfers to social funds 26.3 36.7 16.0 7.4 Reconstruction 51.0 73.3 56.9 8.6 Subsidies 26.0 36.6 24.5 2.9 Other transfers to households 121.0 94.3 140.1 31.9 of which: war invalids 99.0 80.0 105.2 30.5 Transfers to other government 91.0 91.6 103.5 19.7 Net lending 0.0 7.0 0.0 0.0 Clearance of arrears 0.0 0.0 35.0 0.0 Other/unallocated 51.3 29.7 32.7 6.3

Balance (cash, before grants) –99.3 –74.1 –96.9 –15.1

Source: IMF, Country Report, July 2001.

Although privatisation of the banks in the Federation has recently been steppedup (May 2001, page 23), a number of them have passed the original June 30thsale deadline without attracting any private investors. The completion of bankprivatisation has already been put back twice and although Mr Grabovac hasbeen resisting any further postponement, a new deadline of December 31st2001 was set at the end of July, because the World Bank, which agreed aUS$15m loan in support of bank privatisation, had asked for a six-monthextension. According to the Law on Bank Privatisation, banks not sold off byJune 30th were to be liquidated. This prospect is most serious for seven banksbelonging to the Privredna banka Sarajevo group, since their liabilities, mainlyto Czech creditors, amount to DM43m. The sale of majority state-owned bankshas been difficult and in most cases the state shares have been sold well belowtheir nominal value—in some cases, for 40% of their nominal worth.

In June the World Bank approved a US$19.8m loan to help to speed up large-scale privatisation in BiH, which has been held up by political as well astechnical obstacles (May 2001, page 22). The loan is aimed at financingpreparation of the legislative and regulatory framework for the sale of theutilities, as well as assisting in the sales of other large companies. The credit isalso intended to support the setting up of transparent capital markets as thefinal stage of mass privatisation, expected by the end of 2001. Two stockexchanges—one in Sarajevo and one in Banja Luka—have opened officially, butare not likely to start working soon. The second round of public offering ofshares in the Federation began in April, and international advisers overseeingthe process insist that it should be completed without any alterations by the endof the year.

In parallel with bank privatisation, a number of measures are being taken aimedat reforming and strengthening BiH’s financial sector. Germany has extendedan US$8.7m credit to BiH’s central state government, of which half is to financethe establishment of a fund for credit guarantees, and half is to boost the funds

Some Federation banksremain unsold

World Bank supportslarge -scale privatisation

Reform of the financialsector is to be stepped up



of the Federation Agency for Deposit Insurance. The credit guarantee fundshould enable the repayment of international loans, which are channelledthrough the local banks to finance small and medium-sized enterprises (SMEs).According to Jochen Peters, the German ambassador to BiH, strengthening therole of the Agency should help to increase confidence in the local banks andcontribute to the stabilisation of the financial sector, which is perceived to beone of the greatest obstacles to the economic development of BiH.

The domestic economy

Output and demand

The strong industrial performance recorded in the Federation in the firstquarter of 2001, when output grew by 14.4% year on year, continued in thesecond quarter, when it grew by 14.5%. A detailed breakdown of output trendsis only available for January-April, when industrial output grew by 15.1% yearon year on the back of strong growth in all major industrial subsectors—asignificant improvement compared with January-February, when it rose by12.8%. Mining grew by 16.7% compared with January-April 2000,manufacturing by 15.4%, and power and utilities by 14%. Growth wasstrongest in the important food and beverages industry, which rose by 21.1%year on year, followed by base metals, also a major component of industry,which grew by 13.7%. Given that exports fell by 8.4% in the first three monthsof the year (see Foreign trade and payments), and that imports also went downby 3%, it appears that a rise in domestic demand was met by an increase inlocal output.

BiH: industrial production(% change, year on year)

2000 20012 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr

Federation 10.9 4.5 2.2 14.4 14.5

Republika Srpska 17.8 –1.2 0.2a –7.5 n/a

a EIU calculation.Sources: Federal Office of Statistics (FOS), Statistical Data on Economic and Other Trends; Office of the High Representative (OHR),Economic newsletter; Central Bank of Bosnia and Hercegovina (CBBiH), Bulletin 4—January-December 2000; Bulletin 1—January-March2001; US Agency for International Development (USAID), BiH Economic update, 2000—third quarter.

Industrial output is still about 40% of average monthly Federation output in1991. Figures for the composition of industrial output in 2000 are dominatedby energy production, which formed 35.9% of the total. Raw materials andsemi-processed products made up 39.4%. At the more capital-intensive end ofproduction, consumer non-durable goods accounted for 20% of industrialproduction, but consumer durables and capital goods made up just 2.5% and2%, respectively.

The first-quarter decline in industrial output in Republika Srpska (RS) this yearhas also continued into the second quarter. Output in January-May fell by

Industrial output remainsstrong in the Federation

Decline continues in RS



7.7% year on year, mainly owing to a 15.9% year-on-year contraction inmanufacturing. Output was down in 17 out of 23 manufacturing subsectors. Ofthe more significant subsectors, output of wood products fell sharply, by31.7%, and of processed food, by 12%; in 2000 they accounted for 6.8% and10.1% of total manufacturing output, respectively. The overall decline inindustrial output was partly cushioned by a 6% year-on-year increase inelectricity output, which represents the second largest component of totalindustrial output after manufacturing. Output of consumer durables (a mere3% of the total in 2000) increased by 25.6% in January-May compared with ayear earlier, whereas the output of raw materials and intermediate goods,capital goods, and consumer non-durables, all of which are much moresignificant in terms of their contribution to industrial production as a whole,fell by 26.3%, 15.3% and 6.3%, respectively, over the same period.

First-quarter construction output in the Federation (measured by a non-seasonally adjusted index of total volume of construction), was up by 36.2%year on year. Total workers in construction numbered 9,741 in this period, aslight increase compared with a year earlier, when 9,474 workers wereregistered. The mild winter allowed for the continuation of building activity inJanuary-March in what is normally a quiet season for construction in Bosniaand Hercegovina (BiH).

Trade between the Federation and RS has been growing rapidly in the first fourmonths of 2001. The Federation more than doubled its sales to RS; goodsworth KM57.1m (US$25m) were sold in January-April 2001, compared withKM27.2m in the year-earlier period. This is largely owing to increased sales ofelectrical goods (KM18.7m), other industrial goods (KM11.6m), metal products(KM6.8m) and food (KM7.7m). Purchases from RS amounted to KM16.7m overthe same period (an increase of 40%), indicating a continuing imbalance ininter-entity trade flows. The bulk of Federation purchases from RS consisted offood products (KM5.8m), other industrial goods (KM3.9m) and chemicals(KM2.4m). The rise in inter-entity trade is partly the result of improvedcommunication between the two entities, tax harmonisation and bettertracking of sales transactions; it is still dwarfed by foreign trade, however.

Employment, wages and prices

The trend of an incremental increase in the number of people activelyemployed in the Federation continued into the second quarter. In April thenumber actively employed stood at 374,362, up from 372,067 in January, andby 4.1% from 359,472 in April 2000. In March there was a drop in the numberof those officially employed—which includes the so-called waiting-list workerswho remain on the payrolls of companies and continue to receive benefitcontributions from them, although there is no work for them, often becausethe firms want to avoid making severance payments—to 407,764 from 411,334in January, and from 411,595 in March 2000. This is because there was a sharpfall in the number of waiting-list workers to 33,447 in March, compared with39,267 in January and 52,597 a year earlier. Foreign experts have pressed for

Federation constructionoutput is up

Inter-entity trade isbuoyant

Federation manufacturingemployment increases



reform in this practice, arguing that the waiting lists are a burden onenterprises; politicians so far have resisted reform because of the danger ofdiscontent among the poorer sections of society.

There has been a shake-out of the waiting lists in manufacturing in particular.In this sector, which is the single largest employer, official employment fellfrom 101,696 in January to 98,104 in March. Over the same period those onthe lists in manufacturing fell from 25,763 to 21,221. The result is an increasein “active” employment (total employment minus those on the waiting lists)in manufacturing, from 75,933 in January to 76,883 in March, which isconsistent with increasing industrial output during the first quarter. In March2000 there had been 34,676 on the waiting list in manufacturing, out of anofficial total of 104,291 employed, so that active employment in the sector hasincreased year on year by 10.4%, from 69,615.

As in early 2000 there was a rise in registered unemployment in the Federationin the first quarter of 2001. In March unemployment rose to 265,959, from259,001 in the same month of the previous year. The official unemploymentrate stood at 39.5% at the end of May, a slight rise from 39.1% a year earlier.The figures may be boosted by those coming off of the waiting lists.

Until recently local employees of the international agencies in Bosnia andHercegovina (BiH) were not included in the employment statistics becausetheir employers did not make the benefit contributions that form the basis foremployment records. This, combined with employment in the informal sector,has distorted the statistics. The Office of the High Representative (OHR)recently agreed to start paying salary contributions which, if followed by otherinternational agencies, will boost the figures for total employment.

The Republika Srpska (RS) Institute for Statistics does not issue regular data onemployment, and the latest figure of 220,782 for the number of peopleemployed is for August 2000. As in the Federation, the number of thoseofficially registered as unemployed has been creeping upwards, reaching154,170 at the end of March 2001, 0.6% higher than in December 2000. Theunemployment rate in RS continues to surpass that in the Federation, and inMarch it reached 40.4%.

Following a sharp monthly increase in February, the average net nominal wagein the Federation remained steady in April, reinforcing the trend of rapidlydecelerating wage growth. Whereas net wages rose by 12.8% year on year inthe fourth quarter of 2000, in the first quarter of 2001 the rate slowed to 9.9%.The average nominal wage in the Federation stood at KM437 (US$195) in May,a 7.6% nominal increase year on year. The IMF calculates that in 2000 averagegross monthly US dollar wages were just below those in Hungary, and 30%higher than in RS, where gross monthly US dollar wages were in turn higherthan in Romania, Bulgaria and Albania. As gross wages in RS approach those inthe Federation, both entities will face the problem that neighbouring countriesare more competitive in terms of wage costs.

RS unemployment edgesupwards

Unemployment in theFederation rises slightly

Growth in wages subsides



BiH: labour statistics(no. unless otherwise indicated)

2000 2001Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

FederationEmploymenta 411,201 411,234 411,253 411,261 411,307 411,297 411,305 411,334 409,908 407,764 n/a n/a “Waiting list” 52,059 51,004 51,123 47,121 45,106 42,087 40,262 39,267 35,772 33,447 n/a n/a “Active”b 359,142 360,230 360,130 364,140 366,201 369,210 371,043 372,067 374,136 374,317 374,362 374,362Unemployment 258,615 261,253 262,139 259,861 258,098 259,930 261,773 264,140 265,271 265,959 n/a n/a Ratec (%) 38.6 38.8 38.9 38.7 38.6 38.7 38.9 39.1 39.3 39.5 39.5 39.3Net wage (KM) 408 410 418 428 427 437 425 427 433 434 434 437

Republika SrpskaEmployment 228,834 n/a 220,782 n/a n/a n/a n/a n/a n/a n/a n/a n/aUnemployment 153,384 154,027 154,358 154,656 154,488 153,212 153,264 n/a n/a 154,170 n/a n/aNet wage (KM) 259 285 286 289 286 300 299 300 305 304 307 309

a Registered employment; includes waiting-list workers on stand-by, but not actually working. b Employed minus waiting list. c Unemployeddivided by unemployed plus employed; includes waiting-list workers.Sources: FOS, Statistical Data on Economic and Other Trends; OHR, Economic newsletter; CBBiH, Bulletin 4—January-December 2000; Bulletin 1—January-March 2001; USAID, BiH Economic update,2000—third quarter; BiH Foreign Investment Promotion Agency, Recent economic trends (website); Republika Srpska Institute of Statistics, 5/2001; Reuters.

A similar trend of subsiding wage growth was also recorded in RS. The averagenominal wage in Republika Srpska reached KM309 in May. This represents anincrease of 12.8% compared with the 2000 average—which in turn was 27.4%higher than the average in 1999—and a rise in real terms of 6.4%. In May thehighest average wage (KM484) was paid in public administration; the lowest(KM204) was paid in catering, although it was not much below the average inindustry (KM221).

Wages have been growing strongly since the start of the post-warreconstruction programme in 1996, in spite of high unemployment and a lackof widespread economic recovery. Large inflows of international aid haveenabled the public sector as the main employer to keep wages high, and thesehave also been pulled up by the comparatively high wages of local staffemployed in the international agencies operating in BiH. The inflexibility ofthe labour market is another factor explaining the strong growth in wages inconditions of high unemployment.



Retail price inflation in the Federation rose by 2.6% year on year in June, aslowdown from January, when it was 4.3%. Full data available for January-April2001 show a 3.6% rise in the overall index compared with the year-earlierperiod. All but one of the components of the index rose, with prices ofbeverages and tobacco growing most strongly (by 6.2%), followed by processedfoods (5%). The index was dampened, however, by a large drop in the prices ofagricultural products, which were down by 4.8% compared with January-April2000. Low producer price inflation of 0.7% in the first four months comparedwith January-April 2000 suggests that the slowdown will continue.

Similarly, the rate of growth of retail prices in RS slowed to 9.1% year on yearin June, from 14.6% in January. Over the first six months the retail price index(RPI) rose by 9.1% compared with the year-earlier period. This was largelyexplained by a 26.6% rise in the prices of services and a surge in agriculturalprices of 19.6% year on year. Industrial prices, which account for nearly 80% ofthe index, rose more slowly, by 4.9%, during this time.

BiH: retail prices(% change)

2000 2001Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

FederationMonth on month 0.6 0.0 1.5 0.4 0.3 0.0 0.5 0.0 –0.1 –1.0 0.4 0.0Year on year 2.2 2.3 3.5 4.5 4.4 4.0 4.3 3.6 3.6 2.7 2.6 2.6

Republika SrpskaMonth on month 1.1 0.7 4.2 1.7 1.2 0.3 –0.3 –1.0 –0.1 0.5a 0.5 1.6Year on year 10.0 12.5 16.5 15.6 15.9 16.1 14.6 10.6 10.3 10.2a 8.3 9.1

a EIU calculation.Sources: FOS, Statistical Data on Economic and Other Trends; OHR, Economic newsletter; CBBiH, Bulletin 4—January-December 2000; Bulletin 1—January-March 2001; Republika Srpska Institute ofStatistics, 5/2001; 6/2001; Reuters.

Retail price inflation slowsacross BiH



Foreign trade and payments

According to data from the Federal Office of Statistics (FOS), the Federation’sexports totalled US$138m in January-March and its imports US$502m; thetrade deficit (fob-cif) amounted to US$364m. Exports fell by 8.4% comparedwith the first three months of 2000, whereas imports contracted by 3%. Thefall in exports was caused mainly by a 14% fall in manufacturing exports,which was in turn explained by a 60.5% year-on-year decline in exports of basemetals (mainly aluminium) and a 13.6% contraction in foreign sales of woodand wood products, the two key export items. Manufacturing imports fell by1.7% year on year, the single largest fall being recorded in imports of motorvehicles, which were down by 37.1%.

Federation: foreign trade, Jan-Mar(US$ m; by NACE production classification)

Exports Imports 2000 2001 2000 2001

Agriculture & fishery 0.5 2.3 26.2 27.5

Mining 1.5 1.6 1.5 2.2

Manufacturing 138.8 119.4 459.0 451.3

Electricity 9.4 14.1 6.7 10.4

Total (incl unclassified) 150.5 137.8 517.4 502.0

Source: Federal Office of Statistics (FOS), Statistical Data on Economic and Other Trends.

Republika Srpska (RS) imported goods worth US$378m in January-May, withexports amounting to US$130m, resulting in a trade deficit of US$249m,according to the RS Institute of Statistics.

In 2000 Switzerland became the Federation’s second largest export market.Exports of a single item—aluminium—accounted for most of the 81.6%annual growth in this market. Exports to Switzerland plummeted in the firstquarter of 2001, falling by 71.1% compared with the year-earlier period. InMay 2001 a six-year contract was signed between Glencore, a Swiss metalsgroup, and the Mostar-based Aluminij alumina plant and smelter, wherebythe Swiss partner pledged substantial investment in expansion and modern-isation. The export of aluminium should therefore remain prominent in theFederation’s sales to Switzerland.

In January-March Federation exports to its principal EU markets, Italy andGermany, grew strongly. Since 1998 Italy has been the Federation’s largestexport market, accounting for 17.2% of all exports in 2000. Sales remainedstrong in the first quarter and were up by 11.1% year on year. Exports toGermany rose by 19.7% over the same period, thus suggesting that theFederation is possibly beginning to benefit from the trade incentives offered bythe EU (August 2000, page 22). Sales to Italy and Germany combinedaccounted for 41% of the Federation’s first-quarter exports.

The trade deficit is large

Exports to Switzerlandplummet

Federation sales to the EUgrow



Federation: trading partners, Jan-Mar(US$ m unless otherwise indicated)

2000 2001 % change

ExportsItaly 26.4 29.3 11.1Germany 22.7 27.2 19.7Slovenia 13.7 18.1 32.8Croatia 13.7 17.1 24.4Yugoslavia 14.9 11.4 –25.6Switzerland 33.9 9.8 –71.1

ImportsCroatia 88.2 78.7 –10.8Slovenia 85.1 76.4 –10.2Germany 75.5 64.2 –15.0Italy 69.9 53.8 –13.1Austria 24.1 25.4 5.7Switzerland 14.5 22.9 57.8

Source: FOS, Statistical Data on Economic and Other Trends.

Yugoslavia (Serbia-Montenegro) remains RS’s main trading partner. InJanuary-May exports to Yugoslavia amounted to US$50.8m, accounting for40% of the total. This represents a substantial decline compared with 1998,when 76% of RS exports were destined for the Yugoslav market. Import flowsfollowed a similar trend. In January-May RS imported goods worth US$63.7mfrom Yugoslavia, 10.1% of the total, compared with 42% in 1998. AfterYugoslavia, Slovenia and Croatia were the most important sources of imports,accounting for US$36.9m and US$25.9m, respectively. Italy was the secondmost important export market, taking US$41.2m-worth of goods over thesame period. The diversification of RS’s foreign trade is primarily aconsequence of the termination in 1999 of the preferential trade agreementwith Yugoslavia, a step demanded by the international community as part ofthe reform of the trading system of Bosnia and Hercegovina (BiH). Otherreasons include the difficulties of conducting business and commercialtransactions with Yugoslavia during the 1999 NATO war over Kosovo, whichforced RS to look for new partners, and the slow growth that the Yugoslaveconomy is currently experiencing.

BiH has been running a large current-account deficit since the start of post-warreconstruction in 1996. It amounted to 22.5% of GDP in 2000, driven by thelarge trade deficit. According to data from the Central Bank of BiH (CBBiH),which it says do not include all transactions between BiH residents and non-residents, as regards services, income and current transfers, the current-accountdeficit totalled US$465m in January-March. A surplus on services, income andtransfers of US$38m was recorded by the CBBiH over the same period, whichwas insufficient to offset substantially the large trade deficit. First-quarter datafrom Federation and RS statistical offices, and from the CBBiH, suggest thatanother large 2001 full-year current-account deficit is likely; the IMF projects adeficit of nearly US$1bn, even when the Fund’s own forecast of a surplus onservices, income and transfers of more than US$600m is included.

BiH is running a largecurrent-account deficit

RS diversifies its trade



BiH has the lowest rate of foreign direct investment (FDI) in the region.(According to the UN Economic Commission for Europe’s Economic Survey ofEurope, 2001 No. 1, cumulative FDI inflows for 1988-99 into BiH came toUS$200m, compared with US$84.4bn for eastern Europe as a whole; for FDIper head of population, BiH comes last, with US$57.) Political instability andcorruption are frequently cited as the main deterrents to potential investors.

However, there are other factors affecting BiH’s attractiveness as a foreigninvestment destination. By itself, BiH is a small market, which heightens theimportance of access to the major communication routes in the region andfurther afield. The roads are being upgraded with international help, but thedestruction of the railway network, which before the 1992-95 war carried mostof the traffic, has affected commercial activities. In June the European Bank forReconstruction and Development (EBRD) approved a €21m (US$18m) loan tomodernise those sections of the rail network that form a part of Pan EuropeanTransport Corridor V, traversing Europe from east to west. Section C of thecorridor contains the most important route, some 1,000 km of working railtrack in BiH, and provides a major international link for the country.Upgrading it would make the railways a reliable transport service for industryand commerce. The project is co-financed by the European Investment Bank,which will provide €40m towards replacing old track. In May a loan toCroatia for the same amount was approved so that it could improve its sectionof the same corridor; both projects are approved within the framework of theStability Pact for South-eastern Europe set up in 2000 to promote regionalintegration. A passenger service between Sarajevo and Zagreb resumed in Juneafter a break of nine years, an illustration of how long and severe thedisruption of normal links has been.

Slovenia is one of BiH’s most important foreign investors and is expected toinvest some DM230m (US$103m) in the BiH privatisation process in 2000-01.An estimated 1,500 jobs were created from investments by Sloveniancompanies in BiH in 2000, and according to the Slovenian economy minister,Tea Petrin, investment in 2001 could amount to DM100m, creating another4,000 new jobs. Ms Petrin and her BiH counterpart signed an agreement onbilateral promotion and investment protection in May.

The Yugoslav government has rejected a proposal from the BiH government toenter a trade agreement of the kind BiH has with Croatia. Instead of anasymmetric model, Yugoslavia insists on reciprocal relations, on the groundsthat Yugoslavia itself suffers to a large extent from the same kind of economicproblems as BiH. Under the agreement between Croatia and BiH, which cameinto force on January 1st 2001, Croatia will abolish duties on imports fromBiH, and duties on Croatian exports to BiH will be phased out over a three-yearperiod. RS and the Federation used to have preferential trade agreements withYugoslavia and Croatia, respectively, but these were abolished at the request ofthe international community. Instead, a new agreement had to be negotiatedbetween the central BiH state and the two countries in question. As part of theagreement with Croatia, BiH has said it will not give more favourable terms toany other country.

BiH is still negotiatingYugoslav trade deal

More effort is needed toattract foreign investors

Slovenia expects to investmore



On June 27th seven south-east European states signed an agreement to create afree-trade zone between Albania, BiH, Bulgaria, Croatia, Macedonia, Romaniaand Yugoslavia. The agreement will come into effect at the end of 2002 andenvisages major tariff reductions within a six-year period, with the result thatat least 90% of mutual trade will be free of duty by 2008. On June 12thagreement was reached between Yugoslavia and BiH on setting up a series ofjoint committees to examine trade and customs, investment protection,avoidance of double taxation, and payments transfers. In a region of smallstates, where trade has been severely disrupted by

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