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COUNTRY REPORT

Bosnia and Hercegovina

February 2002

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

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Bosnia and Hercegovina 1

EIU Country Report February 2002 © The Economist Intelligence Unit Limited 2002

Contents

3 Summary

4 Political structure

6 Economic structure6 Annual indicators7 Quarterly indicators

8 Outlook for 2002-038 Political outlook9 Economic policy outlook

10 Economic forecast

13 The political scene

19 Economic policy

23 The domestic economy23 Economic trends26 Industry27 Financial and other services

28 Foreign trade and payments

List of tables

10 International assumptions summary12 BiH: forecast summary23 BiH: industrial production24 BiH: labour statistics25 BiH: retail prices, 200126 Federation: industrial production27 Republika Srpska: industrial production, Jan-Nov28 Federation: foreign trade, Jan-Nov29 Federation: trading partners, Jan-Oct30 Republika Srpska: foreign trade, Jan-Sep30 Republika Srpska: trading partners, Jan-Sep

List of figures

13 BiH: gross domestic product13 BiH: current-account balance25 BiH: retail prices and wages, 2001



Summary

February 2002

The elections in 2002 are more likely to return the present authorities in Bosniaand Hercegovina (BiH) than the nationalists. Alliance for Change, the rulingcoalition in BiH and the Federation, will probably re-form, with the SocialDemocratic Party (SDP) and the Party for BiH (SzBiH) emerging as the strongestnon-nationalist parties. However, if Bosnian Croat parties regroup around thenationalist Croatian Democratic Union of BiH (HDZ BiH), renewing a coalitionwith the SDP and SzBiH will be difficult. In Republika Srpska (RS), unless thenationalist Serb Democratic Party (SDS) is banned, the Economist IntelligenceUnit expects a continuation of the broad coalition of moderates andnationalists. As international assistance declines, considerable fiscal adjustmentwill be needed. Real economic growth is likely to moderate to around 5-6% peryear in 2002-03. Inflation in the RS is forecast to moderate to 3% annually in2003; in the Federation inflation will rise a little from the 1.7% rate of 2001. Thecurrent-account deficit will remain wide at about 13-14% of GDP in 2002-03.

Tensions have risen over minority rights in the entities, and Bosnian Serbs fearthat the RS’s existence is threatened. The Alliance for Change has avoided aninternal crisis, but frictions remain within the coalition. HDZ BiH deputieshave returned to the Federation parliament. A crisis looms in the RS because ofSDS obstruction of the government. There have been hitches in relations withCroatia, and the hand-over of suspected Islamic terrorists to the US hasprovoked protest.

Budgets for 2001 have been revised, and draft budgets for 2002 have not beenapproved. The RS government has increased military spending. More assetshave been sold to foreign investors.

Industrial production has grown in the Federation but fallen in the RS.Agricultural and construction performance have been stagnant. The level ofemployment has changed little. Inflation has been low in both entities.Confidence in the banks has improved.

The Federation’s trade deficit shrank over the first 11 months of 2001. A goodperformance by clothing manufacturers has driven exports, which havecontinued to be strong to the EU. Exports to Croatia have recovered. The RS’strade deficit is little changed, with both exports and imports falling in January-September year on year. Trade has fallen with Italy, but grown with the RS’sneighbours. Foreign investment in BiH has improved.

Editors: Michael Taylor (editor); Stuart Hensel (consulting editor)Editorial closing date: January 24th 2002

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

Outlook for 2002-03

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 the RS. A valid majority requires the support of at least one-third of the membersrepresenting each entity. The Federation and the 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 & economy 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 Ramo Maslesa (SzBiH)Justice Zvonko Mijan (SDP)Social affairs & refugees Rifet SkrijeljTrade Andrija Jurkovic (SDP)Transport & communications Besim Mehmedic (SzBiH)Veterans’ affairs Suada Hadzovic (SDP)

President Mirko Sarovic (SDS)Vice-president Dragan Cavic (SDS)Prime minister Mladen Ivanic (PDP)

Agriculture Rodoljub TrkuljaDefence 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

a Officially, the party affiliations of ministers have not been revealed.

Federation

Key ministers

Key ministersa

Republika Srpska



Economic structure

Annual indicators

1997 1998 1999 2000a 2001a

GDP at market prices (KM bn) 6,562 7,439 8,319 9,261 10,111

GDP (US$ bn) 3,661 4,245 4,546 4,370 4,630

Real GDP growth (%) 36.6 9.9 9.9 5.9 6.0

Retail price inflation (%; av) Federation 10.8 5.1 –0.9 1.2b 1.7b

Republika Srpskac –6.8 2.0 15.1 13.6b 6.5b

Population (m; mid-year; resident) 3.74 3.65 3.73 3.80 3.87

Exports of goods fob (US$ m) 303 593 749 1,070 1,140

Imports of goods fob (US$ m) –1,643 –2,723 –3,077 –3,109 –3,075

Current-account balance (US$ m) –642 –844 –758 –774 –700

Reserves excl gold (US$ m) 80 175 452 497b 920b

Total external debt (US$ bn) 4.1 3.0 3.1 2.6 2.8

Exchange rated (KM:US$; av) – 1.76 1.83 2.12b 2.18

January 24th 2002 KM2.21: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 Convertible marka (KM) introduced in June 1998 and fixed at KM1:DM1—since January 2002,KM1.95583:€1.



Quarterly indicators

1999 2000 20014 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Financial indicatorsExchange rate KM:US$ (av) 1.885 1.984 2.097 2.164 2.252 2.121 2.243 2.199 KM:US$ (end-period) 1.885 1.984 2.097 2.164 2.252 2.121 2.306 2.142Interest rates (av; %) Deposit 9.07 16.40 14.70 15.12 14.67 16.50 n/a n/a Lending 24.29 30.50 30.50 30.50 30.50 30.99 n/a n/aM1 (end-period; KM m) 1,149 1,193 1,253 1,362 1,463 1,504 1,672 1,890 % change, year on year 199.2 202.8 192.1 129.3 27.3 26.1 33.4 38.8M2 (end-period; KM m) 2,326 2,279 2,368 2,437 2,564 2,668 2,853 3,151 % change, year on year 27.5 30.6 30.5 26.3 10.2 17.1 20.5 29.3

Foreign tradea (US$ m)Exports fob 177 147 164 185 188 193 185 n/aImports cif –732 –581 –682 –685 –697 –616 –701 n/aTrade balance –555 –434 –518 –500 –509 –423 –516 n/a

Foreign reserves (US$ m)Reserves excl gold (end-period) 452 419 432 422 497 478 497 588

a DOTS estimates.Source: IMF, International Financial Statistics; IMF, Direction of Trade Statistics.



Outlook for 2002-03

Political outlook

Despite the authorities’ promises to improve the situation, conditions inBosnia and Hercegovina (BiH) will remain difficult. Public discontent is likelyfrom such unpopular measures as social-security benefit cuts, lay-offs in thepublic services and evictions from property occupied illegally since the war’send in 1995. Yet the return of the moderates in some form after the electionsin late 2002 is likely, if only because the alternative, the election of thenationalists, would take BiH back into impasse and would lose support for thecountry from abroad.

BiH faces an extremely turbulent period. Important steps have to be taken,including constitutional changes, speeding up economic reform and holding—without outside help—the 2002 elections that now gives the authorities a four-year mandate. The moderate BiH prime minister, Zlatko Lagumdzija, is expectedto argue that his Alliance for Change coalition needs a longer period in office tocarry out reform. Some important achievements have been made since theAlliance formed governments in BiH and the Federation in early 2001. At thecentral state level the stalled legislative process has been unblocked. The StateBorder Service is being tightened up. A start has been made on social sectorreform, and initial progress made towards the creation of a single marketthroughout BiH. Constitutional reform has been initiated. In the Federation theAlliance has focused on the economy and is trying to cut unemployment. Inthe Bosnian Serb entity of Republika Srpska (RS) the political situation is muchmore complicated, but order in the public finances has improved.

The Alliance is expected to return to power after the elections, if not in itspresent form. Most parties seem in favour of standing in the elections alone, asin 2000, forming a coalition afterwards. In the Federation Mr Lagumdzija’sSocial Democratic Party and the Party for BiH (SzBiH) are likely to emerge againas the strongest non-nationalist parties, and the SzBiH may do better than in2000, if its rival for the Muslim vote, the Party of Democratic Action, continuesto lose support. A regrouping of Bosnian Croat parties is likely, and maydetermine the shape of a post-election coalition government at the Federationand state levels. There is a risk that the nationalists will succeed in uniting themajor Bosnian Croat parties around them in a single bloc, making re-formingan Alliance coalition after the elections very difficult. The EconomistIntelligence Unit expects, however, that a single bloc will not be formed.

Unless the nationalist Serb Democratic Party (SDS) is banned, in the RS we expecta similar outcome as in 2000—a broad coalition of parties uniting moderates andnationalists. The SDS, like other nationalist parties throughout BiH, continues toenjoy considerable electoral support and any attempt to push them to thesidelines would provoke a popular backlash. The RS prime minister, MladenIvanic, is under pressure to reshuffle the government, because of SDS obstruc-tionism. If the SDS’s convention in March brings forward a more moderateleadership, he may be able to re-form the RS government with the SDS’s support.

Domestic politics

Election watch



BiH’s shaky equilibrium is supported by international involvement, which islikely to be scaled down in the forecast period, putting its security into somedoubt. The NATO presence may be reduced when the North Atlantic Councilcompletes its review of the security requirement in mid-2002. The US militarycontribution (important in terms of the implicit guarantee it offers) will almostcertainly change in kind if not in total, as frontline troops are drawn away tomeet threats elsewhere. The mandate of the UN’s International Police TaskForce is due to expire by the end of 2002. The international civilian presencemay also be wound down, and is certainly to be reshaped, following a meetingof the Peace Implementation Council (PIC—the international body supervisingimplementation of the Dayton peace agreement) in December 2001. The gap isto be filled by the EU, whose machinery for forming policy and taking actionabroad is still underdeveloped. However, since the EU needs stability so close toits borders, it is likely to rise to the challenge.

The Alliance authorities have made some progress along the path laid out by theEU “Road Map”, which sets out 18 conditions for starting the stabilisation andassociation process towards closer EU ties. Half of the conditions, which establishhow close BiH is to meeting EU norms in such matters as administration and therule of law, have been dealt with. BiH has some way to go to catch up with otherEuropean states with longer and more settled traditions, but if it can satisfy theremaining conditions, a feasibility study for the stabilisation and associationagreement (SAA) may come in the first half of 2002. The process has alreadystrengthened co-operation between the candidate countries, and BiH’s relationswith its immediate neighbours, Croatia and Yugoslavia (Serbia-Montenegro),which are crucial for the country’s stability, should continue to improve.

Economic policy outlook

As international assistance declines, considerable fiscal adjustment will beneeded to ensure the sustainability of the public finances. Governments willfocus on reducing public spending, which remains a threat to macroeconomicstability over the forecast period. This would require further reform of thebenefits system, particularly for war invalids, restructuring of the public sectorand cuts in military expenditure. At the same time, governments are poised toundertake further tax reforms aimed at increasing public revenue. The BiHauthorities have an incentive towards fiscal prudence in that it is a conditionfor the new IMF stand-by arrangement that may be agreed in early 2002.

Privatisation will remain a priority in the forecast period. The remaining largecompanies, including public utilities, will be offered for sale with expert helpfrom abroad. This is expected to relieve the state of the burden of subsidies,reduce pressure on the budget and boost development of the private sector,which will play a crucial role in BiH’s development in the long term. Attractingforeign direct investment (FDI) is an important element in economic policy.BiH is favoured by low inflation, a stable exchange rate and a reformedbanking sector, but it is held back by political instability, excessive regulation, acomplex and dilatory legal system, and a burdensome and complex system oftaxes and social benefits that encourages enterprises into the grey economy.

International relations

Policy trends



The central state government is hampered by insufficient revenue. In 2002KM56m (US$25m) will be needed for the funding of the State Border Service,which has prompted the BiH Treasury minister, Ante Domazet, to look foradditional revenue. He is looking into introducing a tax on movable property.The government is trying to cut expenditure for individual ministries, and todownsize the administration. BiH as a whole is over-administered, but to alterthis requires radical constitutional change, which is unlikely. At the entity andcanton levels an inflated public wage bill puts a heavy burden on the budget.The Federation is likely to try to tighten budget discipline among the cantongovernments. Military expenditure remains the highest in the region. Cutshere, and in benefits for war invalids, are likely to meet strong resistance, butunder pressure of necessity we expect them to be carried out.

Entity governments have based their budget projections on optimistic growthforecasts that may not be met. Staying within the budget is further underminedby the fact that 2002 is an election year—in which public spending constraintstend to be relaxed. This will leave limited space for increasing capitalexpenditure, which is likely to remain dependent on foreign aid.

No change in monetary policy is expected over the forecast period, and thecurrency board will continue, strictly enforced by the Central Bank of BiH(CBBiH). Maintaining the credibility of the regime will be assisted by furtherinflows of foreign exchange in 2002-03, which were boosted at end-2001 bythe exchange of cash D-marks held outside the banking system for new eurobanknotes. Under the currency board rules the CBBiH cannot issue bonds, butthe government is considering issuing short-term securities to help to establishthe local money market.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2000 2001 2002 2003

Real GDP growthWorld 4.7 2.2 2.4 4.2OECD 3.8 0.9 0.9 3.0EU 3.3 1.5 1.3 2.5

Exchange rates (av)US$:€ 0.924 0.896 0.960 1.015

Financial indicators€ 3-month interbank rate 4.48 4.28 3.13 4.60US$ 3-month commercial paper rate 6.32 3.59 1.71 4.88

Commodity pricesOil (Brent; US$/b) 28.5 24.3 18.3 20.2Food, feedstuffs & beverages (% change in US$ terms) –6.1 –1.0 11.9 13.4Industrial raw materials (% change in US$ terms) 13.4 –9.7 1.3 14.8

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

Fiscal policy

Monetary policy



In 2002 we expect world output initially to fall, but growth to resume by thesecond half of the year. For the year as a whole, we expect world growth toaverage just 2.4% (at purchasing power parity exchange rates). In the US thereare signs that the recession is bottoming out and that the economy will expand(albeit weakly) in the second quarter, and modest growth is expected in thesecond half of the year, when policy stimulus starts to feed through morestrongly. Western Europe, particularly Germany, will remain depressed, startingto revive in the second half of the year as global demand recovers. Althoughthe EU did not weaken as much as the US during 2001, it did not receive thepolicy stimulus that the US did and there are few reasons to expect the pace ofrecovery earmarked for North America. In 2003 the OECD economies areexpected to perform strongly, aided by 3.8% growth in the US. This will help toboost performance in eastern Europe, whose small, open economies are muchinfluenced by the EU’s performance.

The main risk to our forecast is a deeper and more protracted recession in theUS than we are currently forecasting. Our forecast prices of dated Brent Blendcrude have come down to average about US$18/barrel in 2002, in anticipationof minimal global oil demand growth, although prices are expected to returnto around US$20/b in 2003. However, the benefit of this easing in oil importcosts, which are priced in US dollars, will be reduced by the appreciation of theBiH currency against the US dollar in 2002-03.

BiH’s deceleration from the high growth rates of immediate post-warreconstruction is likely to continue over the forecast period, and we expect realGDP growth of around 5-6% per year in 2002-03. This is based on theassumption that, although international assistance will fall, much is still in thepipeline to fund new projects, contributing significantly to growth. Localproduction will continue to be erratic, and a more defined upward trend maybe expected towards the end of forecast period, when we expect a more steadycontribution from privatised companies. Businesses in BiH stand to benefitfrom better transport links. Further consolidation of the financial sector shouldalso facilitate business activity, particularly start-ups. The main risk to ourforecast remains political instability, which might hamper economic reformand further reduce the international assistance on which BiH depends.

Domestic demand is expected to slacken in 2002. We expect wage growth tocontinue to decelerate, particularly as wages in public administration will bemostly frozen in 2002. Consumption will also be affected by job cuts in thepublic administration and the military. Later in the forecast period there willbe a further squeeze on private consumption as social security benefits arereduced and more jobs are cut by the restructuring of privatised companies.Increased private savings in Federation banks at the end of 2001 would suggestbetter prospects for domestic investment, which the entity governments areeager to encourage. In the Federation the bulk of the windfall from successionto the assets of the former Yugoslavia is earmarked for supporting privateentrepreneurial activity. We expect a slight pick-up in the inflow of foreigninvestment as the remaining strategic companies and banks come up for sale.As far as export growth is concerned, we do not share the government’soptimism that exports will become the main engine of growth in 2002-03. EU

International assumptions

Economic growth



growth is forecast to pick up only slightly in 2002, which is likely to arrestsome of BiH’s export growth, since the EU is BiH’s main export destination.BiH’s export base remains very limited and its export dynamics rather volatile.During 2001 strong export growth in the Federation was accompanied by adecline in the RS, resulting in stagnation at the BiH level. However, theprospects of improved regional co-operation could contribute quitesignificantly to improved export performance.

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

2000a 2001a 2002b 2003b

Real GDP growth 5.9 6.0 5.0 6.0

Industrial output 8.0 9.0 8.0 8.0

Retail price inflation (av) Federation 1.2c 1.7c 3.0 2.0 Republika Srpska 13.6c 6.5c 5.0 3.0

Merchandise exports fob (US$ m) 1,070 1,140 1,250 1,400

Merchandise imports fob (US$ m) –3,109 –3,075 –2,825 –2,950

Current-account balance (US$ m) –774 –700 –770 –825 % of GDP –18 –15 –14 –13

Exchange rate (av; KM:US$) 2.12c 2.18 2.04 1.93

a EIU estimates. b EIU forecasts. c Actual.

We expect the disinflationary trend in the RS to continue over the forecast period,in line with our projections of RS growth. In the Federation a moderate increasein prices is likely. We expect the convertible marka (KM) to remain tied to theeuro under the currency regime rules, providing a major brake on price escal-ation, especially since euro-zone countries are among BiH’s leading suppliers.

From January the euro replaced the D-mark as the reference currency. The KMis now fixed against the euro at KM1.95583:€1 and will follow its fortunes. In2002, as the euro gains ground against an overvalued US dollar, we expectnominal appreciation of about 7%, to an average exchange rate ofKM2.04:US$1, resulting (given the expected inflation rate differential betweenthe US and BiH) in real appreciation against the US dollar of about 10%. In2003 real appreciation is forecast at about 6%, as the KM appreciates nominallyto KM1.93:US$1. This will have an impact on US dollar-denominated trade,but BiH conducts most of its trade with the euro zone.

The current-account deficit will continue to be a source of concern, particularlyas donors’ interest in BiH diminishes. In the past the gap has been filled byconcessional funding, which at its present scale is clearly not sustainable.Although the trade deficit narrowed in 2001, no significant reduction in thecurrent-account deficit is expected over the forecast period. Rather, the weexpect that in 2003 the current-account deficit will widen slightly in US dollarterms, and fall gradually to 13% of GDP, from 15% of GDP in 2001. Animproving trade balance will be countered by a deteriorating current transfersbalance, owing to a fall in official transfers of foreign aid. However, animprovement in FDI inflows is forecast to ease pressure from the external

Inflation

Exchange rates

External sector



financing gap. BiH may find its debt burden increasing over the forecastperiod, because repayment of principal is due to start. Already in 2001 the RSparticularly was finding servicing its share of the debt difficult.

The political scene

As the March deadline approaches for the implementation of the decision ofthe Constitutional Court of Bosnia and Hercegovina (BiH) on the constituentstatus of all three of BiH’s peoples across the country, tensions are runninghigh among the local parties over its application. In July 2000 the court ruledthat Serbs, Croats and Muslims are constituent peoples in both entities, theFederation and Republika Srpska (RS), requiring the amendment of the entities’constitutions (August 2000, page 7). Application of the ruling has beenpostponed several times. It was only after the November 2000 elections thatthe international community took a firm stance, demanding that entityconstitutions be brought into line with the ruling. Constitutional commissionscharged with protecting minority rights have been set up in both entities untilan agreement is reached on how the ruling is to be applied. The discussions onamending the constitutions that are under way in both entities seem to beleading to yet another situation in which the international community’s highrepresentative, Wolfgang Petritsch, will have to impose a decision.

Most Bosnian Serb parties are opposed to establishing in the RS parliament—on the lines of the House of Peoples in the BiH and Federation parliaments—asecond chamber to reflect all constituent peoples in the entity, a change that isimplied if the ruling is to be applied in the RS. Instead, the Serb DemocraticParty (SDS) is suggesting, as a compromise, that any discriminatory elementsbe deleted from the RS constitution. This, they argue, would give Muslims andBosnian Croats equal rights to those enjoyed by Bosnian Serbs. The Party ofDemocratic Progress (PDP) of the RS prime minister, Mladen Ivanic, seems infavour of keeping the constitutional commissions and allowing greaterparticipation of minorities in the government. Both parties fear that full

Tensions rise over minorityrights in entities

Bosnian Serbs fear RS’sexistence is threatened



harmonisation of the entity constitutions would be the first step towards thedisappearance of the RS as a political entity. The advocates of this approachreceived backing from Snjezana Savic, a Bosnian Serb judge in the BiHConstitutional Court, who said that the court’s ruling was not binding as it waspassed without the consent of its Bosnian Serb and Bosnian Croat members.One Bosnian Serb party, however, the Serb People’s Alliance (SNS), supports theintroduction of a House of Peoples in the RS, provided that the ethnicproportion of its deputies is in line with recent election results and not the1991 census, according to which Muslims should have 55% representation.

Muslim and Bosnian Croat deputies in the RS National Assembly are resistingcompromise and demanding the establishment of a House of Peoples in the RS.Sulejman Tihic, who is not only deputy speaker of the RS National Assemblybut also chairman of the main party representing Muslim interests in BiH, theParty of Democratic Action (SDA), said that parallel solutions should be foundin both entities and that Bosnian Serb proposals gave Muslims just tokenrepresentation. A six-hour session of the constitutional commission onDecember 21st 2001 broke off without agreement on the text of amendmentsto be put before parliament. Heated discussion ensued over participation inlegislative and executive bodies by representatives of the three peoples; theissues of language and alphabet were also contentious, as was the Muslimdemand for representation on the RS Constitutional Court. The SDA represen-tatives also demanded that the president and vice-president of the RS comefrom different constituent nations and that decisions be reached by consensus.

Comments from a number of international officials on the course of the debateon amending the RS constitution prompted a warning by the SocialDemocratic Party (SDP), which leads coalition governments at the BiH statelevel and in the Federation, that no compromise was acceptable since theremust be identical constitutional solutions for both entities. The party decidedon January 8th to table a motion in the Federation parliament to bring theFederation constitution into line with the Constitutional Court’s decision. TheSDP position is that the ruling should be fully and immediately applied, and ithas prepared a draft version of the new constitution. Responding to critics,Mr Petritsch told a Sarajevo newspaper, Dnevni Avaz, that he was not againstthe introduction of a House of Peoples in the RS, but that his main interest wasthat a symmetrical decision be reached so that the constituent rights of allpeoples would be protected. He reproached the entity authorities for not takinga more energetic stance on the issue, and vowed that the process of aligningthe entity constitutions would soon be completed.

In early January the collapse of the ruling coalition in the BiH and Federationgovernments, the Alliance for Change, was averted when a junior partner, theBosnian Patriotic Party (BPS), was persuaded not to defect. The party had refusedto take over the rotating chairmanship of the Alliance’s co-ordinating body,complaining that the Alliance had been unfair in assigning leading positions instate-owned enterprises in Sarajevo canton. It threatened to leave the Allianceunless its leader, Sefer Halilovic, on temporary release from the InternationalCriminal Tribunal for former Yugoslavia (ICTY) in The Hague (November 2001,

SDP warns internationalofficials not to compromise

Alliance coalition avoids aninternal crisis

RS Muslims and Croatspress for second chamber



page 20), was allowed to resume his post as minister for social affairs andrefugees. The Office of the High Representative (OHR) said that retainingMr Halilovic as minister was unwise and could set a dangerous precedent.

Without the BPS the Alliance coalition would lose its majority in theFederation parliament. It is said to have approached the Bosnian Party (BOSS),sounding it out on joining the Alliance if the BPS left. The BOSS president,Mirnes Ajanovic, said that his party had been offered a seat on the board of theSarajevo-based Energoinvest company in exchange for supporting the Alliancein the Federation parliament. Eventually tensions were defused when at ameeting on January 12th all members of the Alliance agreed that the BPSshould nominate a replacement for Mr Halilovic, who would become agovernment adviser. After a promise that its demands for greater participationon the boards of Sarajevo canton companies would be met, the BPS announcedthat it would remain a member of the Alliance.

Co-ordinating the work of government officials affiliated to different politicalparties within the Alliance remains a serious problem, giving the public a poorimpression of government unity and effectiveness. In November new headswere appointed to the Muslim and Bosnian Croat intelligence services in theFederation. The appointments came only two months ahead of the deadlineset by the international community for the two intelligence services to merge.The decision suggested that there were problems in the way the Allianceoperated. Ivo Komsic, the SDP vice-president, said that there had been noconsultation about the appointments within the Alliance. Moreover, he said,they made no sense as the government had no control over these services andnew legislation on the intelligence service was in the offing. Prolonging theexistence of the present arrangements in the intelligence service, according toMr Komsic, amounted to perpetuating parallel institutions inherited from theformer nationalist-led government.

In December it was reported in the press that the BiH prime minister andforeign minister, Zlatko Lagumdzija, who is president of the SDP, favouredreplacing the Federation defence minister, Mijo Anic, a Bosnian Croat. Whenasked about it, Mr Anic said that there had been no official contact with himon the matter, although he was aware that some Muslim representatives mightbe unhappy about the defence bill, which was about to be presented toparliament. The main point of disagreement, according to Mr Anic, is an articlethat allows the retention of separate Muslim and Bosnian Croat componentswithin the Federation army. Muslims are in favour of merging all armycommand and operational structures, whereas Bosnian Croats prefer tomaintain a degree of separation. Mr Anic was criticised by Mr Lagumdzija for atrip to Israel, which he had paid without consulting his deputy, FeridBuljubusic, and without the knowledge of the BiH foreign ministry.

Deputies of the Croatian Democratic Union of BiH (HDZ BiH) took part in thesession of the Federation’s House of Representatives on November 29th, endingthe boycott they had observed since January (February 2001, pages 17-18).Their representatives had walked out of the chamber’s inaugural session inprotest over the new procedure for electing its deputies, and in anger that the

Frictions in the Alliancenonetheless remain

HDZ BiH deputies return tothe Federation parliament



secretary of the House had been chosen in the absence of HDZ BiH deputies.Their return to Federation institutions follows the HDZ BiH’s failure toestablish Bosnian Croat self-rule as a means of securing acceptance of itsproposals for the political re-organisation of BiH. The only way the HDZ BiHcould have any influence over political processes in the country, includingimportant decisions on constitutional change, was to return to its institutions.

Little significance should be attached to this move, however. The HDZ BiH’spolitical agenda, which revolves around demands for the highest possibledegree of autonomy for Bosnian Croats, is likely to remain unchanged. Forexample, it persists in campaigning for a separate Bosnian Croat channel onFederation television, and recently called on all Bosnian Croats to stop payingthe TV licence for as long as they lacked a channel broadcasting in Croatian.

An initiative to create a bloc of Bosnian Croat parties for the October 2002elections was launched by the Croat People’s Union (HNZ), an umbrella forBosnian Croat parties and organisations. Its president, Miljenko Brkic, said thatBosnian Croat parties needed to reach a consensus on constitutional reform.The proposed bloc would include the HDZ BiH, currently in opposition, as wellas the New Croatian Initiative (NHI) and the Croatian Peasant Party of BiH(HSS BiH), the two Bosnian Croat parties that are members of the Alliance.

The HDZ BiH responded immediately by supporting the initiative. The partyitself has floated a similar idea within the framework of the Croat People’sAssembly (HNS), established as part of the self-rule initiative (May 2001,page 14). The HDZ BiH seems to be interested in creating an all-Bosnian Croatcoalition ahead of the elections in order to increase its prospects ofparticipating in the next government. It is being closely watched by the highrepresentative, Mr Petritsch. The HDZ BiH leader, Ante Jelavic, recently saidthat it feared being banned. The HDZ BiH also fears that it may lose popularityfollowing allegations of abuse of public office by its officials, in connectionwith the Hercegovacka banka affair (May 2001, page 16).

Since a coalition government was formed in the RS following the November2000 elections, the SDS has set itself on a path of obstructing the work of boththe RS and the BiH central state governments (February 2001, pages 18-20).The SDS is the largest party in the RS National Assembly, but under pressurefrom the international community it was not officially included in the cabinet,and ministers’ party affiliations have been kept confidential. SDS members,however, are present in all government bodies and on the management boardsof public companies, whence they have consistently sabotaged the moderateprime minister, Mr Ivanic. The agriculture minister resigned because of SDSpressure (November 2001, page 17), and it is said that the finance minister,Milenko Vracar, may follow suit over the refusal by SDS-controlled companiesto pay taxes.

The RS government has found it increasingly difficult to function because ofSDS obstruction. The SDS has blocked the passage of important legislation,which in turn has curtailed the international support that the RS relies on forcontinuing with economic reform. As a result, the economic situation in this

Bosnian Croat politicalbloc may be formed

Crisis looms in the RS



part of BiH has deteriorated sharply over the past year, and large-scale socialunrest leading to the downfall of the government is feared.

Mr Ivanic, who took up the prime ministership thinking that he would be ableto control the SDS, has found himself in a difficult position. If he cuts himselfoff from the SDS his government will have to rely on the support of 11parliamentary parties to pass legislation. Publicly, Mr Ivanic has called on theSDS to change its ways or there will be no place for it in the RS government. Inpractice, however, Mr Ivanic, as often before, is pursuing a middle way. InNovember he said that he would propose the reshuffle of the government,including reducing the number of ministries. This would allow him to disposeof the more extreme SDS members, without recourse to the more radicalsolution of forming a “government of experts”.

A final decision on the SDS may come from international officials, who havestepped up the pressure on the party. In November Mr Petritsch met the SDS’sMirko Sarovic and Dragan Cavic, the RS president and vice-president,respectively, to convey the warning that unless the SDS proved more co-operative and lifted its obstruction of the government, the RS was headingtowards economic collapse. Soon afterwards, Mr Petritsch sent an open letter toDragan Kalinic, the president of the SDS and speaker of the RS NationalAssembly, demanding that SDS delegates in the BiH state parliament stopblocking its work. Banning the SDS has yet again become an option that thehigh representative may decide he needs to consider.

The SDS had also held up co-operation between the RS and the ICTY in TheHague, which is an obligation under the Dayton peace agreement. However, alaw on co-operation with the war crimes tribunal was passed in October(November 2001, page 17). The government now has an office for co-operationwith The Hague and in January it passed on the cases it had compiled against 12Bosnian Serbs suspected of committing war crimes in 1992, having previouslyfiled charges with the ICTY only against Muslims and Croats. The expectation is,however, that the ICTY will refer the cases back for prosecution in a local court.

The SDS has been aware of the Ivanic government’s vulnerable position. Itsmain motive has always been to preserve the privileged position that many ofits members secured while the SDS was in power. It did not expect Mr Ivanic tohave the courage to co-operate with the international community to the extentthat he has, or that its own survival would therefore come into question.Rather, it expected that such co-operation on Mr Ivanovic’s part would lead thepublic to align with the SDS. This is hardly a possibility now, because of thegrave economic situation: the SDS’s usual tactic of calling for mass protest in itssupport would probably now fail.

Determined to retain its position, the SDS appears to be adopting a differentstrategy. It recently indicated that internal party reform would be under way.At the party congress in December the SDS passed a motion banning frommembership all those indicted by the ICTY. This includes its founder and long-time former leader, Radovan Karadzic, who although in hiding is widelybelieved still to exercise great influence in the party. Mr Kalinic told the

Mr Ivanic looks to end thegovernment crisis

The SDS is determined tohang on to its privileges

Co-operation with ICTY isdespite SDS resistance



congress that the RS had to shake off its “burden as an apartheid state” andoffer its minorities “as much freedom as we demand for ourselves”. The SDShas in the past spoken of reconciliation without much real change in policy.Now it seems that this is no longer an option, as the SDS political project of anexclusively Serb RS is in retreat. Like the HDZ BiH, the SDS will have to look fordifferent means of pursuing its political goals.

Haris Silajdzic, the former leader of the SzBiH (the second largest party in theAlliance coalition), who withdrew from politics in September (November 2001,pages 18-19), appears to be considering a come-back. In December he visitedthe US, apparently to discuss his proposals for the constitutional reform of BiH.Mr Silajdzic has been a vehement proponent of revising the Dayton agreementand abolishing the two entities. When he did not take up a post in the Alliancegovernment, various explanations appeared for his motives. Some believedthat he had been asked by the international community to maintain a lowprofile for fear of an indictment by the ICTY for his part in the 1992-95 war, orbecause of embarrassment over his role in bringing foreign Islamic volunteers,the so-called mujahidin, to fight alongside the Army of BiH. Such talkintensified when he stepped down as SzBiH chairman.

That he may now be contemplating a return to politics seems to rule out suchspeculation. It seems more plausible that he was awaiting the chance of a moreprominent political post. Now that the SDA’s long-time leader, AlijaIzetbegovic, has departed the scene (November 2001, page 18), it may losevoters to the SzBiH. One of the SDA’s strongest supporters, the IslamicCommunity of BiH, recently withdrew its support from the party for failing toreturn Islamic property nationalised after the second world war. Mr Silajdzicmay be hoping that in the next elections his party may significantly increaseits vote, giving it more influence over the government.

Some fear that Mr Silajdzic’s return to politics would further complicate thefunctioning of the Alliance, because of a personality clash with Mr Lagumdzija.It could certainly escalate tensions within the Alliance in the run-up to theOctober elections. However, Bosnian Serbs are the most opposed toMr Silajdzic’s come-back. He has made many enemies in the RS by calling for itsabolition and they see him as an advocate of a unitary, Muslim-dominated BiH.

In December the constituent session of the interstate council for co-operationbetween BiH and Yugoslavia (Serbia-Montenegro) was held in Sarajevo. Themove follows a period of intense argument between the RS and BiH govern-ments over the nature of the separate agreement on special parallel relationsbetween the RS and Yugoslavia, reached without central state involvement.The council is designed to provide a legitimate framework for addressing allissues of mutual concern for the two countries. Already it has led to a free-tradeagreement, paving the way for improved economic and political relations.

BiH has had a similar interstate council with Croatia for more than four years,but implementation of agreements reached between the two sides has beenextremely slow. One case in point is the agreement on the port of Ploce. Signedin December 1998 (1st quarter 1999, page 18), it has not yet been ratified by

Mr Silajdzic may stage apolitical come-back

Relations with Yugoslaviaimprove

There are hitches inrelations with Croatia



the Croatian parliament. The agreement stipulates that the port should bemanaged by a seven-member board—three representatives from BiH, threefrom Croatia and one foreigner. In the former Yugoslavia, of which BiH andCroatia were republics, much of the investment in the port’s facilities camefrom BiH companies. Following the break-up, Croatia has denied BiH access toPloce. The city authorities have become the main obstacle to implementing theagreement. Use of the port would greatly benefit the BiH economy, as itprovides a short route to the Adriatic. The Ploce authorities recently demandedthe exclusion of foreign participation in the port’s management. The BiHgovernment insists that the agreement be ratified first.

Relations were further damaged on January 16th, when the Croatian govern-ment banned transport of oil and oil derivatives by road across its territory,saying that hazardous cargoes were better transported by pipeline, rail or water,and that it was trying to prevent smuggling. The restrictions had been partly ineffect in December, and seemed to favour the main Croatian distributor (whichwas exempt) over a Slovenian rival. BiH and Slovenia protested that Croatiawas violating its agreements, and on January 24th the BiH government decidedto continue with its own ban on oil imports from Croatia, dissatisfied with aCroatian move to allow oil transport to resume but only along defined routes.

The six Algerians arrested in October as alleged members of an internationalterrorist cell (November 2001, page 19) were handed over to the US authoritiesin January, just before they were to be released for lack of evidence. The US hadfailed to supply the BiH legal authorities with details to back up its tip-off thatthey were connected with the Saudi-born militant, Osama bin Laden, who isbelieved to be behind the September 11th attacks on the US. The handoverprovoked strong protests from human rights groups and Islamic activists in BiH,and about a hundred supporters had picketed the Sarajevo prison where theAlgerians were being detained. The demonstrators had to be dispersed by riotpolice before US troops could take the six away. The protest was co-ordinated byActive Islamic Youth, which was founded in 1995 to promote the strict SaudiWahhabi form of Islam, and has organised similar protests in the past.

Although the government had already rescinded the BiH citizenship of five ofthe men, its action was doubtful legally, since the Federation’s Supreme Courthad ruled that they should be set free. Mr Lagumdzija has been accused ofsubordinating BiH sovereignty to the wishes of the US government, and theissue may come back to haunt him as the elections approach. However, for thetime being militant Islam seems to have only a minority appeal in BiH.

Economic policy

In December the House of Peoples of Bosnia and Hercegovina (BiH) adopted arevised budget for 2001 for the central state. Planned expenditure was increasedto KM351.5m (US$158m) from the original KM304.3m (May 2001, pages 18-19).The increase was owing to higher than expected spending on the State BorderService (DGS) and BiH’s foreign service. In 2001 the DGS budget of KM32m

The state budget for 2001 isrevised

Islamic suspects’ handoverto the US provokes protest



included donor support from the UK and Netherlands governments of KM10.7m.In September the BiH Treasury minister, Ante Domazet, had warned that budgetexpenditure was escalating and rebalancing might be necessary. A condition forBiH’s next IMF US$100m stand-by arrangement (November 2001, pages 20-21) isfiscal prudence. Additional revenue for the 2001 budget is to come from entitycontributions, donations by the Netherlands and UK governments, the UN HighCommissioner for Refugees (UNHCR) and BiH’s share of the assets of the formerYugoslavia under the agreement on succession, reached by the successor states in2001 (August 2001, page 32), whereby BiH was allocated KM153m.

The government has pledged to use the bulk of the succession windfall toextend loans to companies and to provide export and credit risk guarantees.The entities are also to receive some KM51m to clear salary, pension anddisability benefits arrears. However, Republika Srpska (RS) deputies in theHouse of Peoples objected to the criterion used for the division of the assets,according to which two-thirds go to the Federation and one-third to the RS.Instead, they argued, the main criterion should be the actual number ofbeneficiaries in each entity. They also demanded that funds should be paiddirectly to the entities rather than disbursed by the central state government.They voted against the law on the use of the succession assets, requestingparliamentary oversight of their use—a condition that was incorporated intothe law. Some KM23m in expenditure went towards financing the DGS.

In early January 2002 the BiH cabinet failed to agree on the draft 2002 statebudget, which is largely funded by transfers from the two entities, theFederation and the RS. Ministers questioned increased demands for funding forjoint BiH institutions, refugee return and elections. Although the 2002 draftbudget stipulates a freeze on public employment and wages, the governmentwas criticised for allowing the number of employees and salaries to rise in2001, contributing to the overspend. However, a draft was approved by thestate presidency on January 18th for expenditure of KM461.3m, about 25%more nominally than in the revised 2001 budget.

An extra KM10m will be needed in 2002 to fund the elections. Ministersinsisted that there were simply no local funds available and that fundingwould have to be covered by donors, as in the past when the Organisation forSecurity and Co-operation in Europe (OSCE) organised the elections. The headof the OSCE mission to BiH, Robert Beecroft, said that the OSCE and otherinternational organisations in BiH would help to find the money, which wouldinclude donor funding. However, he also urged the authorities to look for localsources and only to borrow from donors if necessary, as foreign debt servicingis already budgeted at KM292m for 2002. A substantial item in the 2002 budgetis increased funding for the DGS, which is to rise (but not by as much asoriginally projected) to KM56m. Improvements in the DGS are essential if BiHis to tackle revenue loss from porous borders, and reassure the West thatterrorists cannot enter and leave BiH with ease. In 2001 the EU’s Customs andFiscal Assistance Office (CAFAO) estimated the loss to the BiH authorities fromcigarette smuggling alone at US$250m a year.

Arguments continue overdraft budget for 2002



The Federation’s House of Peoples approved in mid-December a revised 2001budget for KM1.19bn (US$537m)—an increase of about 20% on the originalbudget. Agreement came after the Federation House of Representatives hadrejected an earlier version brought by the government to parliament in lateNovember. Following an all-day debate, representatives of the opposition Partyof Democratic Action (SDA), the Croatian Democratic Union of BiH (HDZ BiH)and the Croatian Christian Democratic Union (HKDU) voted against therevision, objecting in particular to rises in the salaries of government employees.

When the revised budget was put to the House of Representatives again onDecember 12th, 73 deputies voted for, and 41 (from the SDA and HDZ BiH)abstained. The finance minister, Nikola Grabovac, dismissing accusations fromthe HDZ BiH and the SDA, insisted that most of the funds collected throughstricter tax and customs control would be used to clear pension and disabilitybenefit arrears.

The Federation government is proposing a draft 2002 budget amounting toKM1.34bn, a nominal increase of about 11% on the revised 2001 budget.Mr Grabovac said that revenue would be increased by implementing aprogramme of customs and tax administration reforms. The budget allocatesfunds for the stimulation of production and employment in industry,agriculture, forestry and water management, particularly by supporting smallenterprises. The government is working on a plan to pay what it owes inbenefits, including pension arrears, which are partly to be covered byprivatisation receipts, succession assets and improved tax collection.Mr Grabovac also pledged improved transparency in the management ofpublic funds, a point raised by SDA deputies. The government’s 2002 budgetprojection is based on optimistic assumptions of 8% real growth in GDP, asubstantial increase in investment and a 10% increase in exports, of which thelast is the most likely to be fulfilled. Under international pressure, efforts arebeing made to improve budget discipline, which has been poor in the past.

In late November the RS’s National Assembly approved a draft 2002 budget ofKM886m, a nominal 7% increase on the previous year. However, Muslim andBosnian Croat deputies vetoed it, under the constitutional provision allowingthem to protect their “vital national interests”. Their main objection pertainedto the amount allocated to the return of refugees. They demanded that theKM12m allocated for refugee return in previous budgets in 2000 and 2001 beprovided first. Dzevad Osmancevic of the Party for BiH (SzBiH) said that onlyKM1.3m had been spent on refugees in 2000-01. They complained that theKM10.5m earmarked in the draft 2002 budget for the return of Bosnian Croatand Muslim refugees as well as internally displaced Bosnian Serbs wasinsufficient, and that the proposal discriminated against the most destitute partof the population. The prime minister, Mladen Ivanic, warning the Muslim andBosnian Croat deputies that the government would not succumb to blackmail,said that the allocation was adequate and their demands were politicallymotivated. The Office of the High Representative (OHR), the representative ofthe international community in BiH, is to adjudicate on the issue.

The Federation budget for2001 is rebalanced

A draft Federation 2002budget is proposed

Draft RS 2002 budgetawaits adjudication



The increase in the RS’s 2002 budget is to be met primarily from internalsources, revenue from which is expected to rise from KM727.7m in 2001 toKM755.9m in 2002. The largest increase is expected in the sales tax, which is toyield some KM321m from improved collection. In an effort to increaserevenue, the government has introduced taxes on such movable property ascars, weapons, boats, cellular telephones and aircraft. Excise and customsduties are to provide most of the remainder. “Special revenue”, which includesgrants and aid, is projected to fall slightly in 2002. In 2001 this category fellbelow the budgeted amount of KM77.6m, as international donors withheldsupport, citing obstruction by RS deputies in the BiH parliament and dilatoryreform in the RS (see The political scene).

The largest portion of the RS’s 2002 budget, KM89.6m, is earmarked for themilitary. According to a former RS prime minister, Milorad Dodik, most of themoney is settlement of arrears of pay and does not address the problem ofcurrent underfunding. The financial standing of the RS army is if anythinglikely to worsen in the near future, owing to a curtailment in funding byYugoslavia (Serbia-Montenegro). One of the conditions for the IMF’s financialsupport for the government in Belgrade is to stop funding the RS military.Defence spending in BiH as a whole is excessive for its population size, partlybecause of the duplication of armed forces (November 2001, page 21).

Overall, projected budget expenditure is nominally 5% higher than in 2001 andexceeds the limits recommended by the IMF, but the government is hopefulthat it can secure additional funds. Mr Dodik commented that the budget,which is smaller than that of the Federation’s largest canton, Tuzla, could notguarantee the continued functioning of such vital institutions as the army andpolice. Mr Ivanic contends, however, that the RS’s debt repayment schedule andthe present state of its economy necessitate restrictions on public spending.

One of the main problems underlying BiH’s weak fiscal position is theunreformed social sector. BiH inherited from former Yugoslavia a generoussystem of social benefits, which under present circumstances is no longersustainable. Proposals for social sector reform put forward by the World Bankhave met strong opposition locally, but a new law on pensions, imposed by thehigh representative, came into effect on January 1st 2001. Reform of the rest ofthe welfare system, however, has been held up. The Bank’s next target is theoverhaul of benefits for the disabled and families of the war dead. The problemis particularly acute in the Federation, where different systems are in place inthe Muslim and Bosnian Croat-majority areas. The Federation government isexpected to complete a draft regulation by the end of January, which is toreduce the amount of benefits and ensure that they go to the more deserving.Only those with more than a 50% disability are to be eligible for financialassistance in future. The proposal has already received strong condemnationfrom veterans’ associations, particularly the Bosnian Croats, but the Bankinsists that reform must go ahead.

Privatisation of the RS’s large companies has been progressing at an acceleratedrate, spurred on by the need for finance. Following the sale of the Birac alumin-ium plant (November 2001, page 25), in October the paper company, Celex,

RS government increasesmilitary spending

World Bank pushes forsocial sector reform

More assets are sold toforeign investors



was sold to a Slovak investor, and Fabrika Cementa Lukavac, the RS’s largestmanufacturer of cement, to an Austrian firm. In January Kreis of Switzerlandbought a 66.35% stake in the Banja Luka food-processing company, Vitaminka.However, the sale of Banja Luka Brewery to Interbrew of Belgium fell through,and negotiations were expected to begin in January with Lasko (Slovenia). An84% stake in one of the ten state-owned banks, Banjalucka banka, was sold to aYugoslav company, Verano Motors, which has promised to restore the bank’sliquidity by the end of March. The sale of the other banks is proving moredifficult and the deadline has been postponed until the end of 2002.

Some 50 large companies are to be privatised in the RS and the government istrying to encourage foreign buyers. It recently amended legislation to allowdecisions in the general assemblies and management boards of privatisedcompanies by simple majority, replacing the requirement for a 75% majority,which was perceived as a deterrent for potential buyers. In November, in arelated development, the government prepared a programme of action aimedat removing obstacles to foreign direct investment (FDI).

In the Federation, where about 80 large companies are currently beingprepared for privatisation, Lemano Trading (Switzerland) bought the MostarTKM textile company at the end of October. Privatisation proceeds have beenmodest so far, as privatisation has mostly involved small and medium-sizedenterprises, and much is expected from the privatisation of utilities. By end-December all eight state-owned banks had been privatised or their sell-off wasbeing finalised. The BiH government is expected to draft a strategy for theprivatisation of the state telecommunications company by the end of January.

The domestic economy

Economic trends

In 2001 industrial output in the Federation of Bosnia and Hercegovina (BiH)grew by 12.2% compared with 2000. Growth gradually decelerated throughoutthe year, but the full-year figure still surpassed significantly the 8.8% growthattained in 2000. A sizeable contribution was made by the clothing sub-sector,which may have benefited from the misfortunes of competitors in troubledMacedonia during mid-2001. Industrial output in Republika Srpska (RS)contracted sharply in January-November, falling by 11.6% year on year. Thecontraction was especially sharp in the third quarter (see Industry).

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

2000 20014 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Federation 2.2 14.8 14.5 13.7 6.6

Republika Srpska 0.2a –7.5 –7.7b –18.0 –8.7a

a October-November; EIU calculation. b 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 (various issues); Reuters.

Industry grows inFederation but not in RS



Agriculture in the Federation seems to have contracted since 2000, partlybecause of drought, judging by figures for trade in agricultural products, whichwere 10% down year on year in the first 11 months of 2001. A 1.4% fall in thesown area as of late 2001 suggests that there will be little improvement in the2002 harvest. Construction output fell sharply in the second half of the year, asreconstruction slowed. This is in contrast to the same period of the previousyear, when output growth was sustained throughout. January-Novemberconstruction output (measured by a non-seasonally adjusted index of totalvolume of construction) showed no change year on year. In the RS, following a30.3% fall in the first six months, construction increased sharply in July. This,however, did not significantly improve the overall nine-month figure, sinceJanuary-September output was still 27% lower than in the previous year.

The number of people officially in work in the Federation continued to declinein 2001 and stood at 406,275 in November—a fall of 1.2% since January. Thereason for the contraction of official employment is the termination of jobs forlarge numbers of “waiting list” workers (those kept on company payrolls butwith no work to do): their numbers fell by 7,500 between January andNovember, whereas the number of “active” workers rose by nearly 2,500 in thesame period. The number of registered unemployed climbed from 264,140 inJanuary to 270,202 in November. Full employment statistics are not availablefor the RS, but unemployment has hardly altered, reaching 153,231 inSeptember. Both entity governments are increasingly concerned withstagnating employment and the fact that the unemployment rate of around40% is the highest in the region. Both the Federation and the RS recentlypledged to take a more proactive approach in combating unemployment, butwithout more widespread growth the prospects are not very promising.

BiH: labour statistics(no. unless otherwise indicated)

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

FederationEmploymenta 411,305 411,334 409,908 407,764 407,677 406,783 406,185 406,116 406,147 406,244 406,269 406,275 “Waiting list” 40,262 39,267 35,772 33,447 33,315 32,421 32,060 31,991 31,959 31,807 31,755 31,752 “Active”b 371,043 372,067 374,136 374,317 374,362 374,362 374,125 374,125 374,188 374,437 374,514 374,523Unemployment 261,773 264,140 265,271 265,959 266,095 263,228 262,918 266,372 267,976 269,639 270,344 270,202 Ratec (%) 38.9 39.1 39.3 39.5 39.5 39.3 39.3 39.6 39.8 39.9 40.0 39.9Net wage (KM) 425 427 433 434 434 437 441 439 445 446 459 461

Republika SrpskaEmployment 227,748 n/a n/a 221,326 n/a 227,740 n/a n/a n/a 221,628 n/a n/aUnemployment 153,264 153,858 154,121 154,170 153,697 153,556 153,378 153,810 153,242 153,231 n/ n/aNet wage (KM) 299 300 305 304 307 309 298 303 312 309 313 312

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 (various issues); BiH Foreign Investment Promotion Agency, Recent economic trends (website);Republika Srpska Institute of Statistics; Reuters.

Wages growth in both entities accelerated in the last quarter of 2001 comparedwith the first six months, when some slowing down in growth was recorded.In the Federation the nominal wage in November amounted to KM461

Agriculture andconstruction stagnate

Employment statisticsshow little change

Wages growth accelerates



(US$208)—an increase of 8.5% since December 2000. In the RS the nominalwage reached KM312 in November, 4.7% higher than at end-2000. Wage risesoutpaced inflation in the Federation but fell behind in the RS during the first11 months of 2001. Continuing large wage differentials between the twoentities are increasingly dissatisfying employees in various sectors in the RS.Although it is much smaller, there is also a gap in average pensions betweenthe two entities. In May pensions averaged KM170 in the Federation andKM105 in the RS.

In the Federation, the annual rate of retail price inflation continued to fallthroughout the year, resulting in an average for 2001 of 1.7%. Falling prices ofagricultural products (down by 1.6% compared with 2000) were the mainfactor keeping price increases in check. Manufactured goods prices rose by amere 1.8% and those of services by 2.6%. Producer prices rose by 2.3% in 2001,mainly driven by an 8% increase in power prices.

BiH: retail prices, 2001(% change)

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

FederationMonth on month 0.5 0.0 –0.1 –1.0 0.4 0.0 –0.7 –0.4 0.3 0.4 0.3 0.6Year on year 4.3 3.6 3.6 2.7 2.6 2.6 1.3 0.8 –0.4 –0.5 –0.2 0.3

Republika SrpskaMonth on month –0.3 –1.0 –0.1 0.3 0.5 1.6 –0.1 0.3 0.0 –2.5a –2.5a 0.1Year on year 14.6 10.5 10.3 10.0 8.3 9.1 9.2 8.8 4.4 0.0a –3.6a 2.2

a EIU calculation.Sources: FOS, Statistical Data on Economic and Other Trends; OHR, Economic newsletter; CBBiH, Bulletin (various issues); Republika Srpska Institute of Statistics; Reuters.

Retail price inflation in the RS also decelerated in the last quarter, because ofthe depressed state of the economy, which deteriorated further in the thirdquarter. The January-December average rate of inflation slowed to 6.5% from8% recorded in January-September. Major factors driving retail price inflationin 2001 were the prices of services, which rose by 18.2% year on year, and a12.7% increase in agricultural products prices.

Inflation falls



Industry

Industrial growth in the Federation in 2001 was propelled by a strongperformance by manufacturing. Output was up by 14.3% compared with 2000.Electricity, gas and water supply grew by 10.4%, boosted by increased demandfrom manufacturing.

Federation: industrial production(indices of physical volume; % change year on year unless otherwise indicated)

2000 2001% change % of total % change

Mining 10.4 11.6 2.7Manufacturing 7.9 62.2 14.3 of which: base metals 47.9 18.1 7.6 food products & beverages 2.7 13.7 23.7 wood & wood products –4.4 4.8 1.2 clothing & furs –12.5 3.9 10.6 other non-metallic mineral products –7.2 3.7 4.7 metal manufactures (not machinery) 29.3 3.3 28.4Electricity, gas & water supply 10.4 26.2 10.4Total industry 8.8 100 12.2

Energy 11.3 35.9 8.5Intermediates excl energy 20.0 39.4 8.2Capital goods 20.1 2.0 24.7Durable consumer goods 5.0 2.6 23.3Non-durable consumer goods –11.6 20.2 23.5

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

Growth was rapid in the two largest manufacturing subsectors, food andbeverages, and basic metals. A number of smaller export industries grewstrongly in 2001, partly owing to greater use of Federation firms for outwardprocessing for abroad. Output in clothing, in 2000 the fourth largestsubsector, rose by 10.6%, and leather processing was up by 33.1%.International aid and some inward investment has allowed some growth, butfrom a low base—industrial production is still about 60% lower than its levelin 1991.

In the RS the year-on-year fall in January-November manufacturing output,by 19.5%, was largely attributable to a 34.7% contraction in the manufactureof wood products, an 11% fall in food and beverages output, and a 35.6%drop in the manufacture of fuels. Clothing production, which is one of theRS’s more important subsectors, contracted by 24%. The Modrica oil refinerywas not working for a while, causing a fall in the output of refinedpetroleum products. The RS is much affected by the economic problems inYugoslavia (Serbia-Montenegro), a major market for its exports. There couldalso be pre-privatisation lethargy in many enterprises. Larger inflows ofcapital to the Federation are another explanation for poorer performance inthe RS, which had very little international assistance apart from budgetarysupport in 2001.

Federation manufacturingoutput grows strongly

In the RS manufacturing isnearly 20% down



Republika Srpska: industrial production, Jan-Nov(indices of physical volume)

% of total, 2000 % change 2001/00

Mining 9.4 –4.2Manufacturing 66.0 –19.5 of which: food products & beverages 10.1 –11.0 wood & wood products 6.8 –34.7 fuels 6.2 –35.6 metal manufactures (not machinery) 6.2 –1.9 clothing & furs 5.7 –24.0 chemicals & chemical products 5.1 –39.9Electricity, gas & water supply 24.6 7.2Total industry 100 –11.7

Energy 36.0 –1.3Intermediates excl energy 33.6 –27.3Capital goods 8.6 –11.4Durable consumer goods 3.0 39.0Non-durable consumer goods 18.8 –11.6

Source: Republika Srpska Institute of Statistics, Indices of Retail Prices & Living Costs in the RS, December 2001.

Financial and other services

The European Bank for Reconstruction and Development (EBRD) hasannounced that it will fund a €20m (US$17.7m) project to upgrade fourthermal power stations in BiH—Ugljevik and Gacko in the RS, and Tuzla andKakanj in the Federation. This is a part of a larger World Bank project toreconstruct the country’s power sector, which was heavily damaged duringthree and a half years of war. The EBRD has already invested some €90m in thepower sector, of which some €50m was spent in 2000 to reconnect BiH to theregional and international electricity grid. As part of the World Bank’sEnergija-3 project, the RS signed an agreement at the end of October for a€99.5m loan to bring the energy system back to its pre-war level. The WorldBank is also about to finance the reform and privatisation of the energy sectorwith €289.9m, but is demanding changes in legislation in line with theDayton peace agreement. This would require the establishment of a singlestate-run electricity distribution company in BiH and a single regulatoryagency for the sector.

Reform in the banking sector has been rapid and successful, confidence isreturning and depositors are bringing money back into the system.Competition is being encouraged by the entry into the BiH market of severalforeign banks, in which Bosnians have more trust. This is shown by the rapidrise in foreign-currency accounts, with DM2bn (US$884m) deposited in the lastquarter of 2001, as Bosnians brought D-marks and other euro-zone currenciesheld “under the mattress” into the banks in order to exchange them for neweuro currency. To wean people off holding cash, the banks are changingD-marks held in bank accounts into euros free of charge.

EBRD to fund BiH’s powersector reconstruction

Confidence in banksimproves



Foreign trade and payments

According to preliminary data from the Federal Office of Statistics (FOS), theFederation’s trade deficit contracted in January-November to US$1,376m, fromUS$1,474m in the first ten months of 2000. Exports were worth US$745m, arise of 20% year on year, whereas imports increased by just 1.3%, toUS$2,121m. Compared with the second quarter, when exports rose by 42%year on year (November 2001, page 29), export growth seems to have slackenedin the third quarter. Although the rate of growth of exports is impressive, andcertainly higher than the Federation government projected, it is still from a lowbase. The main reason for the fall in the trade deficit is stagnation in importgrowth owing to the scaling down of import-intensive reconstruction.

Manufacturing exports rose by 21.7% in US dollar terms in the first 11 monthsof 2001, driven by strong growth in clothing exports (see The domesticeconomy). Exports of clothing nearly tripled, making them the Federation’ssecond most important export, after basic metals. Leather-processing exportsalso rose, by 55.3%. However, other important sectors showed a decline. Basicmetals exports (mainly aluminium) fell by 2.9% year on year in January-November. Exports of wood contracted by 10% over the same period.

Sharp falls in the value of motor vehicle imports (by 28% year on year),machinery (13.4%), fuels (by 5.4%) and chemicals (0.4%) helped to dampenexpenditure on imports in the first 11 months, despite 4.8% growth in importsof food and beverages and nearly fourfold growth in clothing imports,reflecting the re-export of finished goods under outward processing contracts.

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

2000 2001 % change

Exports (incl unclassified) 620.1 744.7 20.1 Agriculture & fishery 11.1 10.7 –3.9 Mining 6.2 8.6 38.0 Manufacturing 568.1 691.1 21.7 of which: clothing 46.5 127.2 173.5 wood 93.1 83.8 –10.0 basic metals 185.8 180.3 –2.9 Electricity 32.2 30.0 –6.7

Imports (incl unclassified) 2,094.0 2,120.7 1.3 Agriculture & fishery 93.8 81.6 –12.7 Mining 7.4 7.0 –5.5 Manufacturing 1,907.1 1961.1 2.8 of which: clothing 36.2 139.0 284.2 wood 20.0 22.2 10.9 basic metals 75.7 86.4 14.3 Electricity 25.4 15.2 –40.1

Balance –1,473.9 –1,376.0 –6.6

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

Federation’s trade deficitshrinks

Clothing performancedrives exports



Federation exports to the EU increased to US$354m in January-November, fromUS$260m in the same period of 2000. The EU’s share in total Federation exportsrose from 41.9% to 47.6%. Among leading EU markets, sales to Italy grew by52.5%, boosting by clothing re-exports, and those to Germany rose by 32%.

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

2000 2001 % change

Exports fobItaly 108.9 166.1 52.5Germany 97.9 129.2 32.0Switzerland 106.5 95.1 –10.7Croatia 67.6 83.8 23.9Slovenia 54.6 62.6 14.6Yugoslavia 63.1 58.6 –7.0

Imports cifCroatia 365.7 369.0 0.9Italy 242.4 352.5 45.4Slovenia 329.6 278.9 –15.4Germany 297.2 261.2 –12.1Austria 108.7 109.6 0.8Hungary 81.4 68.7 –15.5

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

The effects of the free-trade agreement between Croatia and Bosnia andHercegovina (BiH) that has been in place since January 1st 2000 are reflected ina strong revival in Federation exports to Croatia. Sales for January-Novemberrose by 24% year on year. However, this is still some 20% below the value ofexports in the same period of 1999. Trade between the two countries hadplummeted after an earlier trade regime, which was essentially unfavourable toBiH, was terminated at the insistence of the international community. Thevalue of imports from Croatia, however, grew by just 0.9%, partly because theasymmetrical trade agreement favours BiH’s exports more than its importsfrom Croatia, and because the ending of an earlier preferential trading regimein 1999 caused BiH to seek other suppliers than Croatia.

The trade balance with Slovenia continues to improve. Exports to Slovenia roseby 14.6% in January-November, and imports fell by 15.4%. Imports of mineralwater and fruit juice form the largest share of BiH imports from Slovenia,because of traditional high demand for such products in BiH, where they areperceived as of superior quality. The free-trade agreement signed between thetwo countries in November 2001 (November 2001, page 31) is likely toimprove BiH’s balance of trade with Slovenia.

There was a large rise imports from Yugoslavia (Serbia-Montenegro) in the first11 months of 2001—by 77.6%, although the total value is still low, at US$26m.Commercial relations have improved between the two countries, following theestablishment of diplomatic relations. Exports contracted by 7% for January-November, probably because of the low level of economic activity inYugoslavia. BiH and Yugoslavia initialled an asymmetrical free-trade agreementin December 2001. BiH exports are now duty-free and duties on its imports

Strong exports to the EUcontinue

Exports to Croatia recover

Imports rise fromYugoslavia



from Yugoslavia will fall gradually, until trade becomes completely duty-freefrom 2004.

In Republika Srpska (RS) the trade deficit for the first nine months amountedto KM7775m (US$350m), almost unchanged from January-September 2000.Exports contracted by 14.7% and imports by 5.8%, in line with slackeningeconomic activity. The sharper contraction in exports than imports, whilekeeping the deficit steady, reflects the weak state of the RS economy, whichremains heavily reliant on imports as local production falters.

Republika Srpska: foreign trade, Jan-Sep(KM m; fob-cif)

2000 2001

Exports 529.1 451.3

Imports –1,304.4 –1,228.4

Balance –775.3 –777.1

Source: Republika Srpska Institute of Statistics, Monthly Statistical Review, 3/2001.

In 2000 the EU had accounted for 37.5% of RS exports (in convertible markaterms); its share dropped to 25.8% in the first three quarters of 2001. The mainreason was a 42.1% contraction in exports to Italy, whose share in RS exportsin value terms fell from 26.4% in January-September 2000 to 17.9% in thesame period of 2001. After Yugoslavia, Italy is the RS’s largest export market.Exports to Germany rose by 7.3%, increasing its share of total exports from4.6% in January-September 2000 to 5.8% in the same period of 2001.

Republika Srpska: trading partners, Jan-Sep(KM m unless otherwise indicated)

2000 2001 % change

Exports fobYugoslavia 209.3 229.2 9.5Italy 139.6 80.8 –42.1Germany 24.3 26.1 7.3Croatia 12.3 24.7 100.2Slovenia 17.3 19.6 13.6Austria 6.4 9.3 44.6

Imports cifYugoslavia 306.7 294.5 –4.0Slovenia 164.6 162.4 –1.3Croatia 89.6 114.4 27.7Hungary 89.9 104.9 16.6Austria 84.5 84.6 0.1Italy 85.9 72.9 –15.2

Source: Republika Srpska Institute of Statistics, Monthly Statistical Review, 3/2001.

The loss of trade with the EU was partly compensated for by more intensecommerce with former Yugoslav republics, abetted by BiH’s free-tradeagreements. Yugoslavia continued to be the RS’s most important tradingpartner, in terms of both exports and imports, accounting for 50.8% of exportsand 24% of imports in January-September 2001. Goods sold to Yugoslavia rose

The RS trade deficit is littlechanged

Exports to the EU decline

Trade with neighboursgrows



to KM229m, although imports fell to KM295m. Exports to Croatia doubled toKM25m, although its share in total exports was only 5.5% in January-September. Imports from Croatia increased to KM114m. Exports to Sloveniaalso grew strongly in January-September, to KM20m, although imports fellmarginally, to KM162m.

The inflow of foreign direct investment (FDI) into BiH has been modest so far.Political volatility, the derelict state of much of BiH’s industry, slow progress ineconomic reforms and complex legislation have worked as strong deterrents topotential investors. Those who decided to invest did so mainly by buyingassets offered for sale in the process of privatisation; greenfield investmentswere few and far between. BiH has one of the lowest rates of FDI in the region.According to East European investment prospects, published by the EconomistIntelligence Unit in November 2001, in 2000 the FDI stock per head wasUS$93, which compares unfavourably with Croatia’s US$1,130, a neighbouringcountry that was also war-ravaged in the early 1990s, although not on thesame scale or for as long as BiH.

Foreign investment seemed to pick up in the course of 2001, particularly in theRS, where assets in some of its largest companies were bought by foreigncompanies (see Economic policy). So-called strategic companies, includingutilities, are yet to be offered for sale, and they could attract more foreignbuyers. Prospects seem to have improved along with a lessening in politicaltensions in the region. The BiH authorities, at both the entity and the statelevel, with the help of international agencies assisting the implementation ofeconomic reform in BiH, are amending foreign investment legislation in aneffort to attract more FDI.

Foreign direct investment in Bosnia and Hercegovina

Stocks and flows: Foreign direct investment (FDI) inflows into Bosnia andHercegovina (BiH) in 2000 were US$131.5m, below the 1999 total ofUS$148.8m. Thanks to considerable disincentives for investors—includinghigh and differing tax rates, an intrusive bureaucracy, long and costly companyregistration procedures, a weak judicial system and restrictive labour laws—FDIin anything more than negligible quantities did not begin entering the countryuntil 1998, three years after the end of the war. The estimated stock of inwardFDI at the end of 2000 was just US$355m. BiH thus has a low level of FDI stockper head compared with other countries in south-eastern Europe, at just US$93at end-2000. FDI inflows increased to an annual average of just above 3% ofGDP in 1998-2000.

Origin and distribution: According to the European Bank forReconstruction and Development (EBRD) more than 1,700 companiesinvolving foreign investment were registered between 1996 and April 1999.Nearly 1,000 of these registered with the minimum equity of DM10,000(US$4,500 at current exchange rates), and 764 were joint ventures. Investmentin banking accelerated in 2000, when Raiffeisen Zentralbank of Austriaacquired Market banka (now called Raiffeisen banka dd Bosnia Herzegovina)and Zagrebacka banka of Croatia acquired a majority stake in Universal banka.Crossborder investments are on the rise, and both Croatian and Slovenian

Foreign investment recordsimproves



companies have taken advantage of lower wages to make investments in food-and tobacco-processing, car parts, pharmaceuticals and retail. The maininvestors by country as of September 1999 (the latest data available) wereKuwait (64%), Croatia (9.5%), Germany (7.1%) and Turkey (5.2%). The top fiveinvesting companies or organisations were the Kuwait Investment Agency,Coca-Cola Beverages (Netherlands), Germany’s Volkswagen, Germany’sHeidelberg Cement and Austria’s Volksbank.

Determinants: The formal legislation on FDI is relatively liberal. However,the potential effect of this is more than offset by problems in just about everyother area of the business environment. All sectors are open to foreigninvestment, but a restriction of 49% ownership applies to media and armsproduction. There is no discrimination in law between foreign and domesticinvestment, and investments are legally protected. However, the large blackmarket and the inefficient judicial system make these laws less robust inpractice. Profits can be freely repatriated or reinvested and hard currency canbe converted.

Impact: Inflows of FDI have been too low to have a significant impact on theeconomy. Nor has the absence of FDI, despite a large trade deficit, had a seriouseffect on the balance of payments, owing to large inflows of foreign aid. FDIhas started to have some positive impact in the Federation’s banking sector asforeign participation has influenced a fall in the spread between lending anddeposit rates.

Potential: As foreign aid falls over the coming years and external imbalancesremain high, the authorities have a greater incentive to improve the regulatoryenvironment for foreign investors. Further integration with the EU, andenhanced market access, will have a positive effect. These include the EU’sabolition of import duties on almost all industrial products, and thestabilisation and association agreement (SAA) that is being negotiated. Theopening up of the economies in neighbouring Croatia and Yugoslavia (Serbia-Montenegro) will provide new opportunities as well as challenges. BiH hasreached free-trade agreements with Croatia, Slovenia and Yugoslavia.Nevertheless, other Balkan countries with larger populations, in particularYugoslavia, will compete with BiH for investment because they also havereasonably well-educated labour forces with a knowledge of foreign languages,particularly as average wages in the Federation have been pushed up by localemployment in international agencies. After the utilities are privatised (theFederation’s electricity and telecommunications companies are expected tocome up for sale in 2002), sectors that are likely to attract investment in thelong term are light industry, such as food- and tobacco-processing, as well aswood, pulp and paper and possibly textiles. The expected sale of the powerutility, most likely in 2003, should lead to an upward surge in FDI inflows inthat year.

COUNTRY REPORT · Finance Milenko Vracar Foreign economic relations Fuad Turalic Health & social...

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