Bosnia and Herzegovina: Risk Assessment

Country Rating¹

Rating: D

Business Climate Rating¹

Rating: C

Risk Assessment²

A modest recovery
After undergoing a moderate recession in 2009, associated with the decline in foreign demand for processed metals, economic growth recovered weakly in 2010: The recovery in domestic demand was limited by the stagnation of wages, the growth of unemployment (from 24% to 27% according to the World Health Organization methodology), the drying up of credit, the effects of the fiscal consolidation implemented under the agreement with the IMF. Conversely, exports and private transfers increased again, with economic activity gradually recovering in the European Union and the Balkans. 
GDP growth is expected to accelerate in 2011 as a result of the expected increase in investment, underpinned moreover by the recovery of credit in the framework of the Vienna Initiative intended to ensure that parent companies maintain the credit lines granted to their subsidiaries. And the economic recovery, albeit soft, in Western Europe in conjunction with the firmness of world prices will support exports. Moreover, the dynamism of expatriate worker remittances (12% of GDP) is expected to enable private consumption to grow, thereby providing support for the retail trade.

A weak financial position
Fiscal consolidation was the focus of both the stabilization and Association Agreement concluded with European Union in June 2008 and the Confirmation Agreement with the IMF in May 2009. The narrowing of the deficit attests to the progress made in 2010. And that trend will likely continue in 2011 with both the privatization process and economic growth expected to resume. The public debt will thus remain at sustainable levels. With two thirds of the total denominated in foreign currency, however, it nonetheless remains vulnerable to exchange rate risk.
With the gradual revival of economic activity in the European Union and the Balkans spurring a rapid recovery in exports and expatriate worker transfers, the current account deficit declined in 2010. But it is nonetheless still substantial and only covered to a very limited extent by foreign direct investment inflows. Foreign debt remains, however, at sustainable levels. 
After the financial crisis broke out, the banking sector had to contend with massive withdrawals of deposits and a contraction of foreign exchange reserves. But the tense situation in the financial sector eased thanks especially to the liquidity that foreign banks injected into their subsidiaries. Foreign exchange reserves stabilized moreover with the conclusion of an agreement with the IMF. And they will likely stay at satisfactory levels in 2011 endowing Bosnia-Herzegovina with reasonably good capacity to withstand capital flight. Although the country's extremely rigid exchange-rate regime held up well in the crisis, it remains nonetheless vulnerable. The possibility of a contagion effect would moreover not be out of the question if Latvia and Lithuania were to experience further tensions over the peg of their currencies to the euro.

A difficult political and institutional context 
Bosnia-Herzegovina continues to be hobbled by institutional and ethnic fragmentation and by its limited administrative capacity. The central government only has a limited mandate with the two entities that form the country, the Srpska Republic and the Bosnian-Croatian Federation, itself divided in several ethnic-dominated cantons, exercising essential economic power. Uncertainty continues to cloud the country's future in view of the major divergences between Bosnian Serbs -who advocate broad-based independence for their entity - and Bosnian Muslims, who prefer strengthening federal institutions. And the tensions have been running high over the same issues between the high representative of the United Nations and the Serbian entity. Parliamentary and presidential elections in October last year failed to contribute to a strengthening of political stability in the country. Without a clear majority, the formation of a coalition government has proven to be a complicated process, further delaying progress on structural reforms and accession to the status of candidate for European Union membership.

Strengths

• Banking reform
• Beneficiary of debt cancellation (67%) by the Paris Club and of assistance from the IMF
• Conclusion of a stabilization and association agreement with the European Union in June 2008
• Substantial inflows of private transfers thanks to the increasing mobility of workers in the region

Weaknesses

• Current account imbalance with exports lacking diversification and dependent on world price trends
• Borrowers highly exposed to exchange rate risk
• Deficiencies in infrastructure and the business environment
• Very high unemployment, as much as 43% at high-end of the bracket
• Institutional and ethnic fragmentation