IMF on BiH: Candidate status has not yet led to a reform momentum!

(Patria) - The International Monetary Fund (IMF) Executive Board concluded the Article IV consultations with Bosnia and Herzegovina.

Russia's war in Ukraine continues to create significant difficulties for the European economy, which has
consequences for BiH. Moreover, global tightening of financial conditions is expected to
burden economic activity in the country. Although all new governments were formed after the 2022 elections, political tensions continue to hinder economic policy and reforms. The country's candidate status for European Union membership, which BiH obtained in December 2022, has not yet led to a reform momentum.

Economic growth fell from 7.4 percent in 2021 to 3.9 percent in 2022 and is expected to further decline to 2 percent this year due to weaker domestic and external demand. Inflation peaked at 17.4 percent in October 2022 and has been declining continuously since then, but it remains elevated. In line with the decrease in food and energy prices internationally, average inflation is expected to fall to 6 percent in 2023. High negative risks are present, including a possible sharp economic slowdown in Europe, intensified political tensions domestically, and the realization of financial risks.

The fiscal position improved in 2022 and the overall fiscal surplus increased to 0.9 percent of GDP from 0.6 percent in 2021. A sharp increase in current spending due to measures to mitigate the cost-of-living crisis was accompanied by a smaller increase in capital spending.

Total government debt fell below 30 percent of GDP in 2022, also due to slower
disbursement and project implementation. With expenditures growing faster than revenues, the fiscal balance is expected to shift to a deficit of 1.5 percent of GDP in 2023.

Financing needs increased in 2023 due to large debt repayments.

Executive Board Assessment 2

Executive Directors noted that after the recovery in 2021, growth in Bosnia and Herzegovina has slowed while inflation, although declining, remains elevated. Given the continued high risks and uncertainty surrounding the economic outlook, Directors emphasize the need for decisive policies and reform efforts to strengthen macroeconomic stability and foster medium-term growth. In this context, they highlight the importance of greater political consensus and call for the EU candidate status to be used to promote necessary reforms.

Strengthening the implementation of IMF recommendations with capacity development support will also be important.

Directors underscored the need to limit fiscal expansion to curb inflationary pressures, given the limited monetary policy instruments, and to reduce pressure from financing needs. To strengthen fiscal sustainability, Directors urged the authorities to further limit current spending, including by capping public sector wage spending, better targeting social spending, promoting public investment, and improving revenue collection.

They also noted that investments in infrastructure, green energy, and digitalization, supported by public financial management reforms, will help foster sustainable development.

Directors welcomed the timely steps taken by the authorities to strengthen the currency board arrangement, which has served the country well so far. They advised the authorities to allow for increases in interest rates in response to market conditions, while taking measures to preserve financial stability. Directors also urged against calls for the Central Bank to finance entity budgets or lend to the private sector. The Central Bank should further increase its deposit facility rates to narrow the interest rate differential with the Eurozone and reduce the risk of capital outflows.

Directors emphasized that banking agencies should remove measures that distort interest rates, and strengthen supervision and crisis preparedness, including through strict and timely implementation of all prudential and corrective measures.

They stressed the need to improve information exchange and establish a country-wide financial stability fund to facilitate bank restructuring and ensure liquidity in exceptional cases.

Directors underscored the importance of structural reforms to accelerate growth, promote green and digital transitions, and raise living standards. They called for accelerated governance reforms and urged the authorities to request an IMF diagnostic assessment of governance to help identify key weaknesses and prioritize reforms. Directors also urge the authorities to urgently adopt a new anti-money laundering law and to prioritize the implementation of the legal framework for preventing corruption. Continued efforts to strengthen transparency and oversight of public enterprises remain important. Regarding climate change, they recommended strengthening decarbonization efforts, connecting the electricity market with the EU market, and transitioning to renewable energy sources.