Bosnia & Herzegovina Business Forecast Report Q4 2007

Reform Deadlock Weighs On Economic Stability

Tensions in Bosnia's tripartite presidency are likely to persist as constitutional reforms will remain at the forefront of the political agenda of the new Bosnian Croat presidency chair. Beyond his tenure, constitutional reform will remain a major risk to EU integration. With growing demands for an independent Croat entity the new high representative will encounter great difficulty in securing consensus. The political standoff will remain the key obstacle in meeting EU criteria for the initiation of the Stabilisation and Association Agreement (SAA). That said, with a more proactive envoy, the signing of the SAA by the end of 2007 can still become a reality. Key will be to agree on the merger of the Republika Srpska (RS) and Muslim-Croat Federation police forces. However, interventions by the high representative will likely be mitigated due to concerns that they undermine democratic progress in Bosnia in the long term, and could alienate electoral support for EU integration, potentially fuelling nationalist sentiments.

Despite a lack of legislation, which underpins ownership rights on state property, the entity Premiers Nedzad Brankovic of the Muslim-Croat Federation and Milorad Dodik of the RS signed a memorandum of understanding to create a fund for public administration reform and a platform for the implementation of a reform strategy. If successful, this development should aid the process of revamping Bosnia's defence sector, which would improve the country's prospects for full NATO membership, and set an important precedent for other inter-entity reforms going forward.

We are concerned that government spending growth levels are too high and could threaten the current fiscal surplus in the near future. Government expenditures increased by 19% year-on-year (y-o-y) to BAM7.45bn in 2006, with consolidated expenditures among the Federation and RS increasing by 15% and 21% y-o-y, respectively. Going forward, we expect expenditure growth to exceed revenue growth, with spending set to rise by 3.8% y-o-y to BAM7.73bn this year. Indeed, despite the impressive surplus in 2006, we expect the fiscal surplus to decline by more than half this year to 1.2% of GDP, on the back of a contraction in revenue growth of 5.6% y-o-y (partly due to base effects).

The European Bank for Reconstruction and Development (EBRD) extended an EUR82mn loan to the Bosnian government in late July, and pledged to allocate further funding for the private sector. The loan will be used for major infrastructure projects across the country's two entities, with EUR75mn to be allocated to the development of Bosnia's road network. Indeed, the move is expected to help rehabilitate 2,300km of roads across the country, and will help to upgrade existing links and maintenance operations. BMI welcomes the development, as it will assist Bosnia's infrastructure to move closer to European standards and improve the country's regional trade links with its neighbours.