Bosnia and Herzegovina: Risk Assessment
Country Rating1
Rating: D
Business Climate Rating1
Rating: C
Risk Assessment2
A modest recovery
Since the sharp contraction of activity in 2009 the economy is struggling to return to its pre-crisis growth rate. In 2011, the slight rebound in growth resulted from the dynamism of manufacturing production (intermediate goods) and mining (iron, metals, coal, lignite) as well as energy (electricity, natural gas). The recovery will run out of steam in 2012 due to the slowdown observed in the European Union, which accounts for 54% of exports, and the slow pace of structural reforms. Private consumption will remain restricted by unemployment of over 20%, private sector debt reduction and fiscal consolidation measures (reduction of civil service wages social security spending cuts). However, foreign direct investment (Italy, United Kingdom) is expected to remain steady as attested by the gas pipeline construction project enabling natural gas to be sent from Croatia to Austria via Bosnia-Herzegovina and Hungary.
A weak financial position
As to public finances, the budget deficit will improve as a result of the combined effect of the broadening of the tax base and the continuation of the privatization process (aluminum industry, insurance company, pharmaceutical industry, telecommunications operator). However, the public accounts will remain vulnerable because of rising informal employment (13% of GDP) in the construction, restaurant and retail sectors. Moreover, State financing will be jeopardized by the freezing of disbursements previously agreed by the IMF as part of a €1.2 billion loan concluded in July 2009. Although public debt is at a relatively modest level, it will nevertheless remain vulnerable to exchange rate risk, with two thirds of the debt denominated in foreign currency.
Exports will continue to be buoyed by the rise in the aluminum price. The current account balance will remain in deficit at the not inconsiderable level of 5% of GDP. It is, however expected to continue its downward trend in line with the sluggishness of domestic demand and the contraction of imports. After falling sharply during the financial crisis, foreign exchange reserves are expected to be reconstituted thanks to the combined effect of the export recovery, foreign currency inflows from the tourist trade and transfers from the diaspora (12% of GDP). The possible resumption of the financial aid agreed by the IMF will likely also enable foreign exchange reserves to be increased. The current account deficit, however, remains substantial and is only very partially covered by foreign direct investment inflows. In this context, the exchange rate risk will remain significant.
A difficult political and institutional context
The central government has a limited mandate with the two entities that constitute the country, the Srpska Republic and the Bosnian-Croatian Federation, itself divided into several mainly ethnic cantons, exercising essential control over the economy through taxation. Political stability deteriorated following the October 2010 parliamentary and presidential elections. The absence of a clear majority is delaying the implementation of the reforms indispensable to candidate status for membership of the European Union, notably the reform of the judicial system, harmonization of the constitution with European norms, reform of public administration, and combating corruption. Moreover, the risk of social conflict will be exacerbated by the intensification of austerity measures and persistent ethnic tensions between the Bosnian Muslim, the Croatian Catholic and the Serbian orthodox communities.
Strengths
- Substantial inflows of private transfers thanks to the increasing mobility of workers in the region
- Banking reform (building equity)
- 67% cancelation of debt with the Paris Club (2000) and IMF financial assistance
- Conclusion of a Stabilization and Association Agreement with the European Union in June 2008
Weaknesses
- Weak diversification of exports and vulnerability to world prices shocks
- High exposure of borrowers to foreign currency risk
- Deficiencies in infrastructure and business environment
- High unemployment rate
- Institutional and ethnical fragmentation