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COUNTRY REPORT

Bosnia and HercegovinaThe full publishing schedule for Country Reports is nowavailable on our web site at http://www.eiu.com/schedule.

4th quarter 1999

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

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Bosnia and Hercegovina 1

EIU Country Report 4th quarter 1999 © The Economist Intelligence Unit Limited 1999

Contents

3 Summary

4 Political structure

6 Economic structure

7 Outlook for 2000-01

11 The political scene

17 Economic policy

20 The domestic economy20 Output and demand22 Employment, wages and prices

24 Foreign trade and payments

27 Trade data

List of tables

7 Forecast summary18 Customs revenue20 Federation: industrial production, 199921 Republika Srpska: industrial production, 199922 Federation: construction23 Federation: waiting-list workers, 199927 Federation: structure of trade27 Federation: direction of trade

List of figures

10 BiH: gross domestic product10 BiH: current-account balance21 Federation: construction



Summary

4th quarter 1999

The international community will try to scale back its involvement in Bosniaand Hercegovina by shifting greater responsibility onto local politicians.However, a recent corruption scandal has exposed the limitations of such anapproach. The pace of political change will hinge on the results of the nextgeneral election, scheduled for September 2000. Milorad Dodik looks set tohold on to power in the Republika Srpska. Real GDP growth is expected to slowto 7% in 1999, picking up only slightly to 8% in 2000. Progress on structuralreform will be crucial for sustained growth.

Sloga, the coalition of moderates in the RS, has launched a campaign to fill thepost of president. Muslim deputies in the RS have been lobbying for greaterpower, although they are unlikely to carry out their threat to bring down theSloga-led caretaker government. In-fighting between senior Muslim politicianshas intensified as they jockey for power after Alija Izetbegovic, the Muslimrepresentative on the state presidency, leaves the political scene. The OSCE hashelped draft a permanent election law designed to remove biases in favour ofethnically based parties.

The Federation is likely to cut budget expenditure in 1999, although risingcustoms revenue has alleviated budgetary strains in both entities. The CentralBank of BiH has banned the use of the kuna and the D-mark for non-cashtransactions in the Federation. Privatisation has started in the RS and shouldstart soon in the Federation.

• Industrial output rose by only 9.2% year on year in the first nine months of1999, in spite of a pick-up in the manufacturing sector. There is little evidenceof an industrial recovery in the RS, despite the end of the war. Output in theFederation construction sector has fallen.

• Unemployment has remained high as a result of faltering job creation, andcould worsen as privatisation gathers momentum.

Revised data show that the Federation recorded a $1.2bn trade deficit in thefirst seven months of 1999. Trade between BiH and Croatia has fallen heavily.Foreign direct investment looks set to pick up.

Editor: Gavin GrayAll queries: Tel: (44.20) 7830 1007 Fax: (44.20) 7830 1023

Next report: Our next Country Report will be published in February

October 24th 1999

Outlook for 2000-01

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 the 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 two-chamber parliament comprising the House of Representatives and theHouse of Peoples, two-thirds of whose members are elected from the Federation andone-third from the RS. A valid majority requires the support of at least one-third of themembers representing each entity. The Federation and the RS have their ownparliaments

September 12th-13th 1998; next parliamentary election due by September 2000. Nextpresidential election due by September 2002

BiH has a collective presidency of three, elected on September 12th-13th 1998: AnteJelavic (president of the presidency), Alija Izetbegovic and Zivko Radisic

There is a small Council of Ministers under two co-chairmen (prime ministers) and avice-chairman, nominated by the presidency. On February 3rd 1999 the BiH stateparliament approved them and three departmental ministers, each with two deputies.The entities have their own governments

Croatian Democratic Union of BiH (HDZ BiH); New Croatian Initiative (NHI); Party ofDemocratic Action (SDA); Party for BiH (SZBiH); Social Democratic Party (SDP); SerbianDemocratic Party (SDS); Serbian People’s Alliance (SNS); Serbian Radical Party of theRepublika Srpska (SRSRS); Socialist Party of the Republika Srpska (SPRS)

The Dayton peace agreement called for the appointment of a high representative, asenior foreign diplomat charged with monitoring the implementation of the agreementand co-ordinating the activities of international organisations operating in BiH. Thehigh representative is advised by the Peace Implementation Council (PIC), whichincludes all the signatories to the Dayton agreement. Since December 1997 the highrepresentative has been able to impose decisions in cases of disagreement and to dismissofficials who obstruct the Dayton agreement

Co-chairmen Haris Silajdzic;Svetozar Mihajlovic

Vice-chairman Neven TomicCivil affairs & communications Marko AsaninEconomic relations & foreign trade Mirsad KurtovicForeign affairs Jadranko Prlic

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 Ivo Andric LuzanskiVice-president Ejup GanicPrime minister Edhem BicakcicDeputy prime minister & minister of finance Dragan Covic

Defence Miroslav PrceEducation, science, culture & sports Fahrudin RizvanbegovicEnergy, mining & industry Mirsad SalkicEnvironment Ramiz MehmedovicHealth Bozo LjubicInterior Mehmed ZilicJustice Ignjat DodikSocial affairs, refugees & displaced persons Sulejman GaribTrade Branko IvkovicTransport & communications Besim Mehmedic

President vacantVice-president Mirko SarovicPrime ministera Milorad Dodik

Defence Manojlo MilovanovicEducation Nenad SuzicEnergy & mining Vladimir DokicFinance Novak KondicHealth Zeljko RodicIndustry & technology Djuradj BanjacInterior Milovan StankovicForeign economic relations Savo LoncarJustice Petko CancarTrade & tourism Nikola KraguljTransport & communications Marko Pavic

a Outgoing government before elections on September 12th-13th 1998.

Federation

Key ministers

Republika Srpska

Key ministersa



Economic structure

Latest available figures

Economic indicators 1994a 1995a 1996a 1997b 1998b

GDP at current prices ($ bn) n/a 2.0 2.8 3.3 3.9

Real GDP growth (%) n/a 33.0 28.0b 15.0 20.0

Retail price inflation (av; %) Federation 780.3 4.0 –20.1 10.8c 5.1c

Republika Srpska 1,061.0 118.0 60.0 1.4c 37.2c

Exports fob ($ m) 91 152 336 570d 650

Imports fob ($ m) 894 1,082 1,882 2,199d 2,500

Current-account balance ($ m) –177 –193 –748 –1,046d –1,090

External debtd ($ bn) n/a 3.4 3.6 4.1e 3.4

October 15th 1999 KM1.86:$1; KM2.03:€1

Federation: origins of GDP 1998f % of total Republika Srpska: origins of GDP 1997d % of total

Agriculture & fishing 10.4 Agriculture, fisheries & forestry 32.7

Trade 17.1 Industry 22.4

Industry & mining 22.4 Trade 9.8

Transport & communications 8.8 Transport 6.3

Others 41.3 Others 28.8

Total 100.0 Total 100.0

Main destinations of exports 1996d % of total Main origins of imports 1996d % of total

Croatia 33.9 Croatia 32.1

Italy 26.3 Slovenia 15.4

Germany 16.4 Germany 13.2

Slovenia 8.2 Italy 12.5

a World Bank and European Bank for Reconstruction and Development estimates. b EIU estimates. c Actual. d IMF estimates. e Excludes debtrelief. f Estimates of the Federation’s Federal Institute of Statistics.



Outlook for 2000-01

Forecast summary

($ m unless otherwise indicated)

1998a 1999a 2000b 2001b

Real GDP (% change, year on year) 20.0 7.0 8.0 5.0

Industrial output (% change, year on year) 24.0 6.0 7.0 8.0

Exports fob 650 750 800 1,000

Imports fob 2,500 2,500 2,200 2,200

Trade balance fob-fob –1,850 –1,750 –1,400 –1,200

Current-account balance –1,090 –1,025 –850 –800 % of GDP –28.3 –24.5 –17.6 –14.4

a EIU estimates. b EIU forecasts.

The introduction and implementation of the Dayton Peace Agreement, whichbrought the 1992-95 war in Bosnia and Hercegovina (BiH) to an end, hasrequired massive involvement on the part of foreign governments, inter-national bodies and non-governmental organisations (NGOs). Although thenumber of foreign troops stationed in BiH has fallen to 30,000, roughly half itspeak, a large number of international staff are still engaged in non-militaryaspects of the agreement, co-ordinated by the Office of the High Representative(OHR) and led by the high representative, a position assumed by WolfgangPetritsch, an Austrian diplomat, in August.

Nearly two years ago the international community decided to broaden andstrengthen the role of the high representative in response to the lack of co-operation between local politicians. As a result, virtually no issue on whichlocal parties disagree can be resolved without his involvement, so much so thatthe international community has in effect assumed the task of running thecountry, and BiH has become a de facto international protectorate. This hasbrought some benefits. It has paved the way for the enactment of laws onissues that in most countries would be viewed as banal—such as the design ofcar number plates—but which have been blown up into major threats by thenationalist parties that dominate the political scene. However, critics maintainthat this approach carries a long-term cost, as the increasing involvement ofthe high representative has served to absolve local leaders of responsibility fortheir actions and has removed the incentive for them to compromise withtheir counterparts from other ethnic groups.

The international community has recognised the drawbacks of its stance, andis reluctant to extend its involvement much further, given the heavy cost sofar, as well as its additional military and administrative commitment toKosovo. Although the international commitment will remain substantial overthe outlook period—there is little serious talk yet of an exit strategy—the focusis shifting to measures that will give greater responsibility to local politicians.Mr Petritsch articulated this objective on taking up his post, when he calledfor a new approach based on the concept of “ownership”. He indicated thatlocal leaders should assume responsibility for implementing the Dayton

—by shifting greaterresponsibility onto local

politicians—

The internationalcommunity will try to scale

back its involvement—



agreement and for the future of their country, as this was their legitimate taskas democratically elected leaders. The role of the international communityshould be scaled back to one of facilitating and guiding the actions of localpoliticians, which would eventually create the conditions for an internationalwithdrawal from BiH.

Mr Petritsch’s initiative came amid a corruption scandal triggered by an articlein The New York Times on July 17th. The article alleged that over $1bn of publicfunds and donor money had been lost through fraud, attributing its finding toan anti-fraud unit at the OHR. It cited various cases of misuse of donor fundsthat were intended to finance the repair of housing, schools and hospitals.Although the story was rejected by both the US government and the OHR—which denied that it had ever produced such a report—it put the issue ofcorruption, which most observers agree is rife, in the spotlight. Thisdemonstrates that it could be a long time before local politicians are capable ofassuming the role that Mr Petritsch has identified for them.

The post-war reconstruction programme has focused on repairing the physicaldamage caused by the war, and the process of institution-building has laggedbehind. In the absence of a functioning legal framework and institutions of law,it is unsurprising that fraud proliferates. It has taken enormous pressure fromthe international community to set up common institutions and agree basiclegislation. However, the structure so painstakingly erected by the internationalcommunity has failed to supersede the local institutions that have been createdand sustained by those opposed to rebuilding BiH as a unified state. This is bestillustrated by the slow progress in the return of refugees, which is pivotal to thesuccess of the Dayton peace agreement and to long-term stability.

One of the main reasons why, three-and-a-half years after the end of the war,BiH is still far from being a viable economy and society is that the process ofpeacebuilding has relied on consensus between the main nationally basedpolitical parties. Their agenda of creating ethnically homogeneous enclaves, inwhich they would have unchallenged authority, has remained unaltered sincethe end of the war. Progress in bringing BiH closer to a normal society, inwhich institutions function and democratic norms are respected, threatenstheir current power structures. The nationalist parties won the post-warelections in 1996 and 1998, albeit with a reduced share of the vote, because ofthe fear of other ethnic groups that they instil in their own people. Theinternationally sponsored reconstruction programme, which has given thenationalist leaders a prominent role, has created a situation in which theyhave benefited from international assistance while simultaneously carrying outtheir own political agendas. In this context, the prospect of “ownership”advocated by the international community may well fall short of its ambitionsbefore the local power structures operating on the principle of exclusivenationalism are dismantled.

Genuine change in BiH will only be possible with the arrival of new leaders,and the elections scheduled for 2000 are therefore crucial. Local elections are tobe held in April, while a parliamentary election will take place in September.

—as it requires politicalchange—

—which is not guaranteed

—but a corruption scandalshows how long such an

approach could take—



From now on parliaments will be elected for four-year, rather than two-year,terms. Another nationalist victory would perpetuate the existing divisions insociety. Much depends on a planned permanent election law (see The politicalscene), which is being drafted partly with the aim of reducing the presentelectoral system’s bias towards ethnically based parties.

Although the power struggle in the Republika Srpska (RS) has continuedunabated since the September 1998 presidential and parliamentary elections, itseems increasingly likely that the caretaker prime minister, Milorad Dodik, willhang on to power at least until the September 2000 election (see The politicalscene). The vice-president, Mirko Sarovic, will probably assume the presidency,replacing Nikola Poplasen, who won the presidential election in September1998 but was dismissed in March 1999 by the then high representative, CarlosWestendorp. Mr Dodik, who is a moderate, is strongly backed by theinternational community, which is likely to press for him to remain in office.Although the hardline Serbian Democratic Party (SDS), which is the largestparty in the RS, backed Mr Poplasen in his efforts to unseat Mr Dodik, it is nowlikely to back-pedal on this campaign. This reflects its realisation that, withlocal elections scheduled for April 2000 and the next parliamentary electionless than a year away, it has little to lose by remaining in opposition. Moreover,in-fighting between the conciliatory and hardline wings of the SDS has madethe party less decisive than in the past.

The slowdown in industrial production in the Federation at the beginning of1999 has worsened, despite the end of the war in Kosovo, and there is littleevidence of a post-war recovery in the RS, which suffered a far greater knock-on effect from the economic collapse in Yugoslavia. The EIU therefore expectsreal GDP to rise by only 7% in 1999—a significant slowdown from the double-digit growth rates recorded in the immediate aftermath of the 1992-95 war.

Although the war in Kosovo has exacerbated the slowdown, growth wouldhave decelerated in any case, as the post-war reconstruction programme haspassed its peak. We therefore expect real GDP growth to rise to only 8% in2000, falling back to 5% in 2001. Growth was sustained in the immediate post-war period because the reconstruction programme stimulated domestic produc-tion, particularly in construction and services. Although manufacturing outputand exports are growing, this has come from a very low base, and it is doubtfulwhether this pace of growth is sustainable. Moreover, there is evidence thatdomestic demand subsided in the third quarter, having grown strongly sincethe start of the reconstruction programme. BiH’s growth will be constrainedover the forecast period by sluggish real GDP growth in its two most importantexport markets—Croatia and Yugoslavia (Serbia-Montenegro)—with Croatiarecovering from a painful recession and Yugoslavia from the impact of NATO’sair campaign. Our growth forecasts are based on the assumption that there isno resumption of hostilities.

As the initial reconstruction phase draws to a close, the key to sustaining therecovery that has been generated and translating it into long-term growth willbe to persevere with economic reforms, while maintaining macroeconomic

—and progress onstructural reform is crucial

for sustained growth

The economic slowdowncontinues—

Milorad Dodik looks set tohold on to power



stability. A basic framework for reforms to transform BiH into a marketeconomy has been put in place, and price stability has been achieved. In ourforecast, we have assumed that substantial international financial assistancewill continue to flow into the country for at least another two to three years,underpinning economic growth. Domestic savings will take time to recover,and foreign productive investment on a larger scale is unlikely. Although it isdifficult to predict what impact the corruption scandal will have on theattitude of donors, given the importance of stability in BiH for the wider regionthere should be no substantial reduction in foreign assistance.

Privatisation has been perceived as one of the key reforms in helping to reduceBiH’s dependency on foreign assistance by attracting foreign direct investment(FDI). Political obstacles have delayed the passage of the necessary legislationand the establishment of the key institutions to implement it. Many of BiH’smost attractive pre-war assets have been tarnished not only by war-timedamage, but also by a lack of investment over the past ten years and theerosion of skills. Political barriers aside, the combination of the problemsinherited from the communist system, such as the issue of land-ownershiprights, and those specific to the voucher-based method of mass privatisationsuggests that the process will be slow. This in turn will delay the process ofrestructuring, which is necessary in order to rebuild the productive base of theeconomy to allow for sustainable growth.

BiH has run large trade deficits since the end of the war, largely because of thequantity of goods imported for the reconstruction programme. Although muchof this has been paid for by foreign governments and NGOs—and is thereforereflected in current transfers—the country is estimated to have run a current-account deficit of $1.03bn (24.5% of GDP) in 1999. This has been covered byloans from abroad—largely from multilateral financial institutions onconcessional terms—and to a much lesser extent by FDI. We expect thecurrent-account deficit to narrow to $850m (17.6% of GDP) in 2000 and$800m (14.4% of GDP) in 2001, but the country will remain heavily reliant onmultilateral loans.

0

4

8

12

16

20

1997(b) 98(b) 99(b) 2000(c) 01(c)

BiH

Eastern Europe (a)

BiH: gross domestic product% change, year on year

(a) Excluding former Soviet Union. (b) EIU estimates. (c) EIU forecasts.Source: EIU.

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

1997(b) 98(b) 99(b) 2000(c) 01(c)

BiH: current-account balance$ bn

Difficulties withprivatisation will deter

foreign direct investment

External imbalances willrequire continued

borrowing



The political scene

A power struggle has been under way in the Republika Srpska (RS), one of thetwo entities that make up Bosnia and Hercegovina (BiH), since the country-wide general election in September 1998. For most of this period the focus ofconfrontation has been the National Assembly, where two hardline parties—the Serbian Democratic Party (SDS) and the Serbian Radical Party of theRepublika Srpska (SRSRS)—have tried, and failed, to unseat the caretaker govern-ment led by Milorad Dodik. However, Mr Dodik has been unable to secure re-nomination for his government, which is backed by Sloga, a coalition of threemoderate parties, and has failed to reach a compromise with the SDS thatwould have paved the way for a reshuffle (3rd quarter 1999, pages 12-13).

Over the past quarter Sloga has tried to divert attention away from theNational Assembly and towards the presidency, which has been vacant sinceMarch when the then high representative, Carlos Westendorp, dismissedNikola Poplasen, who won the post at the September 1998 election.Mr Poplasen steadfastly refused to renominate Mr Dodik, while parliamentrejected Mr Poplasen’s prime-ministerial candidates, and there has been aconstitutional vacuum since March. In August Sloga called for an early

Sloga tries to focusattention on the presidency

of the Republika Srpska—



presidential election, arguing that Mr Poplasen’s deputy, Mirko Sarovic, hadhad enough time to decide whether to assume the presidency, which the highrepresentative had offered him at the time. Mr Sarovic failed to respond by thedeadline set by Mr Westendorp, as the launch of NATO air strikes againstYugoslavia eclipsed other events, and the matter was left unresolved.

Sloga reopened the issue in response to a call from Mr Poplasen—who hasnever accepted his dismissal and remains politically active—for the dissolutionof the National Assembly and the staging of a fresh parliamentary election. Hisproposal for the dissolution of the National Assembly came shortly after hehad met the president of Serbia, Milan Milutinovic, and the Serbian primeminister, Mirko Marjanovic, two loyalists of the Yugoslav president, SlobodanMilosevic. This prompted renewed accusations from Sloga that Yugoslavia istrying to destabilise the RS. Mr Poplasen convened a meeting of the Senate, thepresidential advisory board, which was attended by one-third of its members. Itbacked his call for an early parliamentary election and demanded that relationswith Serbia be strengthened.

The struggle for power in the Republika Srpska

September-October 1998: A hardliner, Nikola Poplasen of the Serbian Radical Partyof the Republika Srpska (SRSRS), is elected president of the RS, setting him on a collisioncourse with the ruling Sloga coalition, which has strengthened its position in theNational Assembly.

December 1998: Mr Poplasen nominates Dragan Kalinic, the head of the SerbianDemocratic Party (SDS), as prime minister, but he is unable to form a government.

December 31st 1998: Mr Poplasen nominates Brano Miljus, a renegade member ofMilorad Dodik’s Party of Independent Social Democrats (SNSD), as prime minister. He isrejected by parliament on January 25th 1999.

February 3rd 1999: Mr Poplasen nominates the speaker of parliament, Petar Djokic,as prime minister in an attempt to divide Sloga. Mr Djokic belongs to the Socialist Partyof the Republika Srpska (SPRS), which forms part of Sloga and is committedto supporting Mr Dodik.

March 5th 1999: Amid rumours that Mr Poplasen is planning to dissolve the NationalAssembly, Carlos Westendorp, the high representative of BiH, dismisses the president.Mr Poplasen’s dismissal, the announcement the same day of the arbitration decision forthe town of Brcko and (in late March) the launch of NATO air strikes against Yugoslavia(Serbia-Montenegro) provoke angry anti-Western demonstrations throughout the RS.

Mid-March 1999: An independent economics professor, Mladen Ivanic, is nominatedas prime minister by Mirko Sarovic, the deputy president, prompting Mr Djokic to allowhis candidature to lapse. However, Mr Ivanic’s candidature lapses.

Late March-June 1999: The National Assembly meets only in emergency sessionduring the Kosovo conflict, preventing serious discussions about the formation of apermanent government.



The SDS, which is the largest party in the National Assembly, backedMr Poplasen’s initiative in the realisation that public opinion had shifted in itsfavour because of the adverse reaction to the dismissal of Mr Poplasen, thearbitration decision on the status of the town of Brcko (2nd quarter 1999,page 12-13) and the outbreak of the Kosovo crisis. Public opinion was furtherradicalised in August by the arrest of the Republika Srpska Army’s chief ofgeneral staff, Momir Talic, who was apprehended on war crimes charges on theinitiative of the International Criminal Tribunal for former Yugoslavia (ICTY)in The Hague. Mr Talic is the highest-ranking military official to be captured onthe orders of the ICTY, and the circumstances of his arrest enraged thepopulation of the RS—he had been attending a seminar on defence policy, towhich he had been invited by the Organisation for Security and Co-operationin Europe (OSCE). As was the case when Mr Poplasen was dismissed, Mr Talic’sarrest gave hardliners an excellent opportunity to score points against Sloga.They were able to maintain that the incident demonstrated that the inter-national community was opposed to the Bosnians Serbs and that Sloga, byengaging the West, had undermined the RS’s autonomy.

The power struggle in the RS over the past year has largely pitted moderateparties representing ethnic Serbs—principally the three parties that make upSloga—against the hardline SDS and SRSRS. The battle for power took a newturn in August with the involvement of the Coalition for a Single andDemocratic Bosnia and Hercegovina (KCDBiH)—most of whose supporters anddeputies are Muslims—which is dominated by the Party for Democratic Action(SDA), the largest Muslim party in the country. The KCDBiH has 15 deputies inthe 83-seat National Assembly and holds the balance of power. Without itssupport, Sloga would have been unable to form a government in early 1998 orto cling on to power since then.

In August the KCDBiH threatened to withdraw its support unless the govern-ment did more to allow Muslims and Croats expelled from the RS during the warto return to their homes. Mr Dodik did not respond by the deadline of August29th set by the KCDBiH, which reiterated its threat and, in addition, demandedformal inclusion in the government. This was far more radical than its earlierdemands, and it is unlikely that Mr Dodik would countenance such a move. Hehas already lost the support of some floating voters by relying on Muslimbacking, and to enter into a coalition with them would probably cause all buthis most pragmatic supporters to desert him at the next election. At the sametime, Muslims feel they have gained less than they hoped from backing hisgovernment. When he took office, Mr Dodik said he would strive to make the RSa multi-ethnic entity—as it was before the war—but the very slow rate at whichMuslim and Croat refugees have returned to their homes in the RS has led theKCDBiH to claim that his commitment to this policy is only half-hearted.

Mr Dodik reluctantly agreed to meet the KCDBiH, but initial talks wereinconclusive, leading the Muslims to claim that the government was stalling.They speculated that Mr Dodik wanted to try to keep the talks going so thathe could convene the National Assembly with KCDBiH support. Meanwhile,Mr Dodik reached an agreement with the Federation’s minister for refugees,

The government searchesfor a way out—

The Muslims put pressureon Sloga

—as public opinion isfurther radicalised



Sulejman Garib, on a reciprocal scheme under which 10,000 Muslims andCroats would be allowed to return to the RS, while a similar number of Serbswould be allowed to return to the Federation. He made a further gesture to theKCDBiH by entering discussions on plans to rebuild two mosques in BanjaLuka that were destroyed during the war.

However, Mr Dodik is believed to have ruled out the notion of the KCDBiHjoining the government. Around the same time he held talks with the SocialDemocratic Party (SDP), a multi-ethnic grouping that has two seats in theNational Assembly, and invited it to enter into government with him—but theSDP turned down his offer. On September 10th Mr Dodik issued a statementrejecting the idea of a government reshuffle, which he said would destabilisethe RS. He also reiterated his call for a fresh presidential election.

The SDS attempted to defuse Sloga’s campaign by saying that Mr Sarovic mighttake the presidency after all, possibly in October, although he had not done soby the middle of the month. If this were to happen, it could be a blow forMr Dodik. It would open the way for the nomination of a new prime ministerand, if the KCDBiH were to carry out its threat to withdraw its support, neitherMr Dodik nor Sloga would have much chance of holding on to power.However, we believe such an outcome is unlikely (see Outlook for 2000-01).

An economics professor in the RS, Mladen Ivanic, announced in lateSeptember that he was setting up a new political party, the Party ofDemocratic Progress of Republika Srpska. Mr Ivanic already enjoys a highprofile, both in his position at Banja Luka university and because he haspositioned himself as a technocrat who is able to stand above party politics.He has twice been put forward as prime minister of the RS, in early 1998 andearlier this year (2nd quarter 1999, page 14), although in the second case theoutbreak of war in Yugoslavia meant that his candidature was allowed to lapse.He has positioned his party as occupying the political centre ground, and itsobjective is to defend the rights that the RS gained from the Daytonagreement. The party also aims to defuse the damaging power strugglebetween hardliners and Sloga that has polarised the political scene in the RS.The new party intends to field candidates for the local elections in 2000, andis considering taking part in the general election in the Federation.

In the Federation relations between the parties that make up the KCDBiH haveworsened as the power struggle between moderates and hardliners hasintensified. This also reflects the struggle for the de facto succession to AlijaIzetbegovic, the Muslim representative on the state presidency and the Muslimleader during the war. The two main rivals for his post are Haris Silajdzic, theco-chairman of the Council of Ministers and leader of the Party for BiH(SzBiH), and the more hardline Edhem Bicakcic, who is the Federation primeminister and a member of the SDA. The animosity between the two men hasexacerbated the poor state of relations between the bodies they lead.

Recent events suggest that Mr Silajdzic is losing influence. He declared inSeptember that he was dissatisfied with the pace of implementation of theDayton agreement and threatened to resign unless the return of refugees was

—while the hardlinerscounterattack

A new party is establishedin the Republika Srpska

Pre-election realignmentgathers momentum in

the Federation



speeded up. This was interpreted as evidence that he was exploring otherpolitical options. He has also held meetings with members of the SDP and theNew Croatian Initiative (NHI), which was set up by Kresimir Zubak, the formerleader of the Croatian Democratic Union of BiH (HDZ BiH). This has raised thepossibility of post-election coalitions to challenge the HDZ BiH and the SDA,hitherto the largest nationally based parties.

A permanent election law has been drafted which, if adopted, will be used inthe general election in September 2000. The two sets of elections since the endof the war have been conducted under provisional rules, which have beenheavily criticised for forcing the populace to vote along ethnic lines—therebyfavouring the nationalist parties that have dominated the political scene sincethe fall of communism. The new law is designed to redress the balance, as wellas to strengthen the accountability of elected officials and promote moderatepolitics. The most important changes include the following.

• In order to win the BiH state presidency, candidates would have to gain atleast some support from voters in both entities.

• The first-past-the-post scheme would be partly replaced by a preferentialvoting scheme, enabling voters to rank candidates in order of preference. Thiswould apply to the election for the state presidency, as well as the presidencyand vice-presidency of the RS.

• The new law would oblige parties and coalitions to put forward opencandidate lists for all bodies at all levels. This would enable voters to expresstheir preferences not only for a particular party, but also for particularcandidates.

• Multi-member constituencies would be created for the legislative bodies atthe state level and in the two entities.

The draft law was completed by a seven-member working group co-ordinatedjointly by the OSCE and the Office of the High Representative (OHR). It hasbeen submitted to the Peace Implementation Council steering board and theCouncil of Europe for review, after which it will be passed to the BiH stateparliament for discussion and passage into law. Assuming that there are nofurther hitches, the provision of open lists is expected to be used in the localelections in April 2000.

Although the draft law would encourage people to vote for candidates fromother ethnic groups for the first time, opposition parties argue that it does notgo far enough—and that voters in the Federation will continue to vote over-whelmingly for Muslims and Croats at elections for the state presidency, whilethose in the RS will vote predominantly for Serbs. However, more radicalreform would involve amending the Dayton agreement—an anathema to theinternational community and most local politicians, as it would open thefloodgates to a series of other demands for amendments to Dayton. It isunclear whether the amendments put forward by the OSCE would result in thenationalist parties’ losing their stranglehold on power. Their reaction to thenew law has been low-key, suggesting that they are not particularly worried.

A draft of the permanentelection law is put

forward—

—but it is criticised for notgoing far enough



The legislative process in the Federation has been held back in recent monthsby the lack of co-operation between Croats and Muslims. This has impeded thepassage of important legislation, including laws on unification of the domesticpayment system, the two pension funds, employment bureaux and power-distribution companies. In each of these areas parallel institutions establishedduring the war have continued to operate in the Muslim- and Croat-controlledparts of the Federation. This has hampered progress on economic reform andreunification of the Federation.

Recently several sessions of the Federal parliament have ended with deputiesunable to agree on the agenda. Consequently, the passage of the law on labourhad to be postponed, although privatisation—which directly affects the areasregulated by this law—had already begun in the Federation. In September theFederation’s law on labour was turned down by the House of Representatives.The House of Representatives originally adopted the law in August 1998, butthis version was rejected by the upper house, the House of Peoples. In July1999 the House of Peoples approved an amended version, but this was laterrejected by the House of Representatives. On October 5th the House ofRepresentatives adopted the law, but it is not clear whether this version willmeet the approval of the upper house.

There have also been obstructions to the planned reform of the schoolcurriculum, which has been identified as one of the main preconditions forBiH to join the Council of Europe. Under intense international pressure, thethree ethnic groups have reviewed textbooks and removed material consideredoffensive by other groups. However, the process has been stalled by objectionsfrom the Bosnian Croats, and the Federation president, Ivo Andric Luzanski, aCroat, has refused to sign an agreement on a common curriculum.

Following the arrest of Mr Talic, Bosnian Serb representatives failed to turn upfor a meeting of the Standing Committee on Military Matters scheduled forSeptember 8th. This was not surprising as the Bosnian Serbs have reacted in asimilar way on other occasions when they considered themselves underthreat—such as the sacking of Mr Poplasen and the launch of NATO air strikesagainst Yugoslavia—in each case boycotting institutions that form part of thecentral state apparatus. This committee, which meets every month, falls intothat category; its role is to co-ordinate defence issues between the armies of theFederation and the RS and to work on confidence-building measures betweenthem. However, the Bosnian Serbs soon ended their boycott following theintervention of the high representative.

Likewise, the Bosnian Serbs’ reaction to the publication in August of theannexes to the Brcko arbitration decision was milder than expected. There hadbeen angry protests in the RS in early March, when the arbitrator had declaredthat Brcko would become a neutral district under BiH’s joint institutions.Brcko, whose status was left unresolved by the Dayton agreement, lies in anarrow corridor linking the eastern and western parts of Republika Srpska, andis viewed by Bosnian Serbs as crucial to the preservation of the RS’s territorialintegrity. It had been placed under international supervision, with its statusto be decided by arbitration (2nd quarter 1999, page 12; 3rd quarter 1999,

Frictions in the Federationimpede the reform process

The Bosnian Serbs endtheir boycott of the state

institutions—

—and the annex to theBrcko arbitration ruling

is accepted



page 11). The annexes reaffirmed the arbitrator’s decisions, and confirmed thatthe town would be demilitarised and ruled by a new multi-ethnic districtgovernment under international supervision. The SDS complained that noneof its demands had been incorporated into the annex, protesting that theBrcko decision signalled the end of the existence of the RS. The RS armyinitially refused to leave the town until all the relevant authorities had beenestablished, allegedly fearing a mass exodus of Bosnian Serbs. Soon afterwards,however, there were reports that preparations for the army’s withdrawal wereunder way. A joint police force, comprising Federation and Republika Srpskapolicemen, began patrolling the town in September.

Economic policy

The Federation finance minister, Dragan Covic, and IMF representatives haveagreed that the Federation’s budget expenditure for 1999 needs to be reviseddownwards again. In early 1999 budget expenditure was projected at KM980m($537m), but it was cut to KM920m when the budget was passed in Marchbecause revenue in the first quarter of the year had come to only half theprojected level (3rd quarter 1999, page 16). All areas of public expenditure werelowered, apart from debt-service contributions and funding for central stateinstitutions. The fiscal situation in the Federation has deteriorated further sincethen as a result of the economic slowdown around the time of the Kosovocrisis, and the next revision will reduce expenditure to KM888m. Despite this,the Federation prime minister, Edhem Bicakcic, declared in mid-October thatthe government was planning to lift expenditure by 7% in 2000, to KM950m.

The Republika Srpska (RS), which was hit even harder by the Kosovo crisis,faces even greater budgetary strains. Although it has received budgetarysupport from donors, it may be forced to review its spending. Moreover, bothentities are under political pressure to scale back their defence commitments asa result of an initiative of the BiH state presidency to cut defence expenditureby 15% by the end of 1999. This involves reducing expenditure on the army,as well as the territorial defence forces, which are to undergo significantchanges in size and structure.

The budgetary strains facing the two entities have been partly offset by stronggrowth in customs revenue since late May, when they ended their preferentialtrade agreements with Croatia and Yugoslavia (3rd quarter 1999, page 19).Goods entering BiH are now charged the same customs duty regardless of thecountry of origin or point of entry. The entities had previously levied differentlevels of customs tariffs, while the Federation allowed customs-free importsfrom Croatia, and the RS gave the same privilege to goods from Yugoslavia.This, compounded by the impact of widespread fraud and customs avoidance,deprived entity budgets of significant revenue: the cost of customs and taxfraud in 1998 was estimated at KM1bn. Even so, customs receipts have beenone of the main sources of the entities’ budget revenue. In the first eightmonths of 1999 the Federation received KM352m from customs and exciseduties, while the RS raised KM156m.

Further public spendingcuts are planned for 1999—

—despite rising customsrevenue



Customs revenue

(KM m; excl excise duties)

1998 1999 Jun Jul Aug Jun Jul Aug

Federation 23.1 17.8 23.5 27.7 28.6 38.4

RS 2.3 1.8 0.6 11.9 10.7 13.9

Source: Office of the High Representative (OHR).

Both entities intend to continue customs reform, with the emphasis on betterenforcement of customs legislation and improving the functioning of thecustoms services. Both of them are setting up customs enforcement divisionswithin their customs services with backing from the EU Customs and FiscalAssistance Office (CAFAO). Other plans include the enactment of additionallegislation to deal with customs offences and penalties, while the setting up ofa joint BiH border police will deter border crime. Particular attention will bepaid to measures to combat corruption in the customs service, and the newprocedures are being put in place with the assistance of CAFAO.

The Central Bank of Bosnia and Hercegovina (CBBiH) has been pressing aheadwith measures to encourage greater use of the convertible marka, the commoncurrency introduced in June 1998, and speed up reform of the domestic pay-ments system. When the marka was introduced, the Muslims were using theBosnian dinar, the Croatian kuna circulated in Croat-controlled areas and theBosnian Serbs were using the Yugoslav dinar, while the D-mark served as a unitof account and means of payment throughout the country. The CBBiHdeclared that from September 30th neither the Croatian kuna nor the D-markcould be used in non-cash payments through payments bureaux in theFederation. All such payments would henceforth have to be made in marka,although cash transactions could still be conducted in other currencies. Bankshave also been instructed to transfer deposits in kuna or D-marks to the CBBiH,while interbank deposits may henceforth only be made in marka. Inter-entitypayments can be made only in marka. Similar measures came into effect in theRS in December 1998, when payment bureaux were barred from making trans-actions in Yugoslav dinars or D-marks. The finance minister in the RS, NovakKondic, has indicated plans to restrict the use of the dinar further.

A highly contentious, but probably just as beneficial, measure is reform of thepayment bureaux that carry out domestic transfers. The bureaux are relics ofthe Yugoslav era, when in addition to processing all domestic payments theyautomatically collected taxes and carried out some auditing and accountingfunctions. BiH now in effect has three discrete payment systems, one for eachof the three ethnic groups, and the bureaux have failed to embrace new tech-nology. Their monopoly on payments has also impeded the development ofthe banking sector (3rd quarter 1999, page 20), and there have been accusa-tions that funds have been misappropriated. In mid-October the Federationfinance minister, Mr Covic, said that commercial banks would assumeresponsibility for certain types of payment transactions from January 1st 2000.

Reform of the domesticpayment system is set

to speed up



The beginning of the distribution of vouchers in May marked the officiallaunch of privatisation in the Federation. State-owned apartments, shops andsmall enterprises will be the first to be offered for sale, followed by strategicenterprises and banks. Assets with a total value KM26bn are to be sold for cashor vouchers, including strategic assets, such as the telecommunications sectorand power supply. Numerous false starts have held back privatisation, andfurther problems have emerged with the distribution of vouchers. Some600,000 vouchers were found to be faulty, while some people eligible forvouchers did not receive any at all; corrected vouchers were not distributeduntil late September.

The main barrier to privatisation is that very few people can afford to take part.Although state-owned apartments can be bought with vouchers alone, allother assets require a minimum cash payment of 35% of their value. This hasprompted the privatisation agency of the largest canton, Sarajevo, to considerchanging the rules to attract more investors. It plans to lower the threshold to10% for the acquisition of enterprises. There are other deterrents to investors.One is the lack of attractive enterprises for sale, given that, beyond repairingwar damage, few of them have started rationalisation or investing in newtechnology. A further impediment to privatisation could be the issue of com-pany land ownership. Most socially owned companies in former Yugoslaviafailed to register land they occupied and used, which was consequently notrecorded in their balance sheets. The Law on Privatisation in both entitiesstipulates that companies must complete the land-registration procedure andenter its value into their books before they can be offered for sale.

In the RS, where privatisation started in July, ten small companies werereported to have been sold by mid-September. Some 350 small companies areup for sale in the first stage of the sell-off programme, and preparations forvoucher privatisation, scheduled to begin in January 2000, are under way. Thevouchers will not have a fixed value and can be used to purchase shares insome 1,700 companies offered for sale.

Initially scheduled to start by the end of 1999, bank privatisation is nowexpected to kick off in early 2000. The main reason for the delay has been thepolitical crisis in the RS following the election in September 1998 (see Thepolitical scene). The state has a majority stake in ten banks in the RS, and theirprivatisation plans require government approval. Like the Federation,Republika Srpska aims to attract Western capital and much-needed expertise inorder to strengthen its undercapitalised banking sector. With that aim, frozenpre-war foreign-currency assets and other debts have been removed from thebanks’ balance sheets. As a result, bank assets have been reduced to 10% oftheir initial value, and the prospect of attracting foreign buyers appears slim.Rehabilitation of the banking sector through privatisation is essential for thedeepening of market reforms, which have been implemented as part of thereconstruction programme in BiH.

Privatisation gets off to aslow start

Bank privatisation inRepublika Srpska

is delayed—



The shake-up of the Federation’s banking system in preparation forprivatisation started with the passage of legislation increasing the minimumcapital requirement from KM2.5m to KM5m, effective from April 1st 1999. In1998, 36 banks failed to meet the capital requirement of KM2.5m. Severalsmaller banks have had to merge to avoid closure, and the process of elimina-tion of unsound banks is continuing. In one of its most recent actions, theFederation Banking Agency introduced interim management for the Mostar-based Gospodarska banka on September 22nd. Before this, one of the largerbanks, BiH banka, had gone bankrupt in a widely publicised scandal over themisappropriation of public funds in BiH.

The domestic economy

Output and demand

Industrial production in the Federation continued to slow in the third quarterof 1999, despite the end of the Kosovo conflict. In the first nine months of theyear there was a 9.2% year-on-year rise in production, less than half the 24%year-on-year growth rate recorded in 1998 as a whole. The slowdown began inthe second half of 1998 and was magnified by the escalation of the Kosovoconflict (3rd quarter 1999, pages 22-23), because of the resulting disruption totransport links. Although industrial production growth picked up to 9.9% inJune, it slowed to 9.5% in August and 8.1% in September.

Federation: industrial production, 1999

(% change, year on year)

Apr May Jun Jul Aug Sep

Month 11.7 1.7 9.9 8.2 9.5 8.1

Year to date 11.6 9.4 9.5 9.3 9.3 9.2

Source: Federal Institute of Statistics, Statistical Data on Economic and Other Trends, various issues.

As was the case earlier in 1999, the manufacturing sector has been growingfaster than the industrial sector as a whole. In the first three quarters of theyear manufacturing output rose by 16.2% year on year, although even thisrepresented a slowdown compared with the first half of the year, when outputrose by more than 20% year on year (3rd quarter 1999, pages 22-23). Output ofbase metals grew by 66.7% year on year in the first nine months of 1999, andstrong rises were also recorded in the tobacco sector (with output up 38.3%year on year), chemicals (up 42.4% year on year) and leather products (up39.6%). However, the largest sector of manufacturing—food and beverages—continues to expand more slowly, and output grew by only 8.9% in the firstnine months of 1999.

In the first half of 1999 the impact of the strong performance of manufacturingwas dampened by falling output in mining and electricity, the two sectors thatled the industrial recovery in 1996-98 (3rd quarter 1999, pages 22-23). In thethird quarter, however, there was evidence of a pick-up in electricity

—while banks in theFederation faceincreased strain

Industrial production inthe Federation continues

to slow—

—despite a pick-up in themanufacturing sector



production. In August it grew by 13.3% year on year, while over the first threequarters of 1999 it increased by 0.4% compared with the year-earlier period. Inthe first half of 1999, by contrast, electricity production had fallen by 3.5%year on year.

The escalating Kosovo crisis had a far greater impact on the RS than on theFederation, because the RS remains economically integrated with Yugoslavia.Having fallen while the conflict was under way, industrial output in RS hasdisplayed a faltering recovery since the end of the war. In June industrial out-put grew by 10.1% year on year, but it fell back by 4.3% year on year in July.Although the pace of recovery quickened in August, when output rose by17.9% year on year, this still represented a slower rate of expansion than in1998 as a whole, when output grew by 23% year on year. In addition to theimpact of the war, industrial production has slowed in the RS becausereconstruction-related activity is tailing off. However, industrial productionstatistics may overstate the scale of the slowdown: RS official statistics arebelieved to have poor coverage of the private sector, while the industrialstatistics are heavily influenced by the output of the oil-refining sector; thisdepended heavily on the Yugoslav refining sector, which sustained substantialdamage during the war.

Republika Srpska: industrial production, 1999

(% change)

Mar Apr May Jun Jul Aug

Month on month 14.6 –25.4 –3.9 20.5 –0.9 13.1

Year on year 15.9 –12.6 4.2 10.1 –4.3 17.9

Source: OHR.

The value of construction work completed in the Federation in the first eightmonths of the year totalled KM211m, a decline of 0.3% compared with thefirst eight months of 1998. Other indicators provide further evidence that theconstruction industry is contracting. The average level of employment in theindustry, based on the number of workers, was 5.7% lower in the first eightmonths of 1999 than in the year-earlier period, while the number of hoursworked was 2% lower.

The fall in construction activity was partly due to seasonal factors—whichresulted in a low level of output at the beginning of 1999. An even moreimportant factor was the unsustainably high level of activity recorded in mid-1998, when year-on-year growth rates of 40-60% were recorded. This is themain reason why the value of construction output in July 1999 was 17.5%lower than in the corresponding month of 1998. The main impetus for theconstruction boom in 1998 was the internationally funded reconstruction pro-gramme. It has decelerated in 1999, but owing to the slow pace of industrialrestructuring private-sector activity has not picked up the slack. However, theconstruction sector would receive a fillip if, as is possible, there is a pick-up inthe rate of return of refugees and international donors provide additionalfunds for new housebuilding.

Output in the Federationconstruction sector

declines—

There has been a falteringpost-war recovery in the RS

-10

0

10

20

30

40

50

Sep . Nov . Jan . Mar . May . Jul .

Federation: construction (a)% change, year on year

(a) Hours worked.Source: Federal Institute of Statistics.

1998199819981998199819981998199819981998199819981998199819981998199819981998199819981998 9999991998 991998 99991998 991998 991998 991998 991998 991998 991998 991998 991998 991998 991998 99



Federation: construction(% change, year on year)

1998 1999 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug

Value of work completed (KM)Year to date n/a n/a n/a n/a –2.6 5.1 2.5 6.7 2.1 4.7 –0.6 –0.3Month 49.8 28.4 –12.6 161.3 –2.6 13.3 –1.2 16.5 –8.5 13.5 –17.5 1.1

Hours workedYear to date n/a n/a n/a n/a –5.3 –4.0 –1.3 2.2 0.9 –1.2 –2.3 –2.0Month 40.2 30.2 32.3 9.8 –5.3 –2.8 3.7 11.1 –3.1 –9.0 –7.4 –0.2

No. of construction workersYear to date n/a n/a n/a n/a –13.0 –11.3 –9.9 –6.2 –6.3 –5.7 –6.3 –5.7Month 43.4 38.7 34.6 13.6 –13.0 –9.6 –7.3 3.5 –6.6 –3.3 –8.9 –2.7

Source: Federal Institute of Statistics, Statistical Data on Economic and Other trends, No. 10, 1999.

In the Federation retail sales rose by 7.5% year on year in the second quarter of1999. Retails sales growth has slowed as the sharp rise in wages in 1997-98 hastailed off (see Employment, wages and prices), while wage and pension arrearshave eroded purchasing power. However, trade between the two entities hasrisen, according to the Federal Institute of Statistics. Federation purchases fromthe Republika Srpska rose by 11.2% month on month in June and 17% monthon month in July. In August Federation exports to Republika Srpska rose by59% month on month.

Employment, wages and prices

The slow pace of job creation at a time when the population is expandinggradually and refugees are returning to the country (albeit in small numbers)has ensured that unemployment remains high. Although comprehensive, up-to-date labour market statistics are not available, the unemployment rate hasprobably risen from the 37% recorded in December 1998. There were then250,000 people employed in the RS, although owing to job losses duringNATO’s air campaign against Yugoslavia the number has probably fallen sincethen. According to the Federal Institute of Statistics, in July 407,200 peoplewere employed in the Federation. According to data published by the Agencyfor Statistics of Bosnia and Hercegovina, a total of 407,859 unemployed wereregistered in March 1999. However, these official figures have to be treatedwith caution since much economic activity remains unrecorded, while some ofthe unemployed have not registered with employment bureaux.

Nevertheless, the Federation data indicate that job creation is very slow andunemployment remains high, and these trends are backed by anecdotalevidence. In the first seven months of 1999 the number of employed in theFederation rose by only 173, compared with the 14,400 jobs created in January-July 1998. Unemployment, meanwhile, increased by 6,000, albeit a less extremeexpansion than in the first seven months of 1998, when it rose by 11,000.

Assessment of the true nature of conditions in the labour market is compli-cated by the number of “waiting-list” workers, who are registered as employed,and have been laid off because their employers are operating at a fraction of

—and retail sales grow at aslower pace

Unemployment remainshigh—

—as job creation falters



capacity. Although they are not receiving wages, in some cases their employerscover their social security contributions or give them food parcels. As far as theenterprise is concerned, the workforce is idle, although some workers are em-ployed in the informal economy. Nevertheless, it makes sense for workers tostay with the company in the hope that when business picks up they will bethe first to be taken on, rather than those who are formally unemployed.

A decline in the number of waiting-list workers in 1999 suggests that some ofthem have returned to work, which may explain the very weak rate of jobcreation. However, most companies remain overstaffed, and even if there is asignificant economic revival it is unlikely that all these workers will be able tostay on the company payroll—particularly as privatisation is still looming.Thus, it will not be easy to reduce unemployment substantially.

Federation: waiting-list workers, 1999

(‘000)

Jan Feb Mar Apr May Jun Jul Aug

68.4 68.4 67.9 66.4 66.7 66.2 65.9 64.7

Source: Federal Institute of Statistics, Statistical Data on Economic and Other Trends, No.10, 1999.

In the Federation nominal wages fell by 2% month on month in March,bringing 12 successive months of rising wages to an end. Although wages rosein April, they fell again in both May and June. In July the average wage stoodat KM377. Over the first seven months of 1999 nominal wages were 14.8%above the average for 1998. This compares with average wage growth of 23.5%in 1998 as a whole. Nominal wage growth has slowed partly because ofdiminished inflationary expectations, but also because of the deceleratingeconomic recovery. Wages have been growing much faster in the RS than inthe Federation, albeit from a lower base. The average wage edged up in thesecond quarter, rising to KM229 in July, when it was 49% higher than theaverage for 1998. Growth has been underpinned by a larger inflow ofreconstruction aid, which international donors extended in support of themoderate government of Milorad Dodik when it took over in early 1998.

The downward trend in inflation has continued throughout most of 1999. Inthe Federation retail prices in the first seven months of 1999 fell by 0.1% yearon year. The biggest fall has been in the prices of agricultural products—in linewith the Europe-wide fall in food prices—which were 6.9% lower than inJanuary-July 1998. The average price of services rose by 3.6% year on year—thesharpest rise of any category. However, service price inflation has cooledcompared with 1998, reflecting the lower rate of wage inflation.

In the RS retail prices fell by 0.7% month on month in July, the first month-on-month fall since the RS started publishing data in marka rather than Yugoslavdinars. The RS has endured higher inflation than the Federation throughoutthe post-war period, mainly because of its close connection with the Yugoslaveconomy and the continuing use of the Yugoslav dinar. More widespread use ofthe marka in 1999, partly in response to the weakening of the dinar, has servedto decouple monetary conditions in the RS from those in Yugoslavia.

Wage growth slows—

—and prices fall



Foreign trade and payments

As the EIU has noted before, the accuracy of trade data published by theFederation’s Federal Institute of Statistics is open to question as smugglingremains widespread and the official figures have failed to capture much of thetrade flows involving Croat-controlled parts of the Federation. The FederalInstitute’s estimates of import expenditure have been substantially lower thanmight have been expected given the pace of reconstruction expenditure andanecdotal evidence of consumer spending. However, the figures appear to haveimproved over the past 12 months (3rd quarter 1999, page 25), probably as aknock-on effect of a crackdown on smuggling co-ordinated by the EU Customsand Fiscal Assistance Office (CAFAO).

Recently revised data put import expenditure far closer to what we believe tobe the true level. In mid-October the Federal Institute estimated that imports(cif) totalled $1.53bn in the first seven months of 1999, a substantial revisionfrom its original estimate of $971m. However, it has revised import figures forthe corresponding period of 1998 only slightly—by $8m to $1.16bn, which webelieve still substantially underestimates the true level of imports last year.

Export data have been revised up as well. The Federal Institute estimates thatexports totalled $289m in the first seven months of the year, compared withan initial estimate of $228m. This indicates that export receipts grew by 54%year on year in the first seven months of 1999. The new data imply that theFederation recorded a trade deficit (fob-cif) of $1.2bn in January-July. Althoughthe official figures indicate that the trade deficit has widened—from $975m inthe first seven months of 1998—we believe that the deficit has in fact beennarrowing. This is based on evidence that the two main sources of importdemand—consumer spending and reconstruction activity—have grown veryslowly in 1999.

Official trade figures for the Republika Srpska (RS) are published only in-frequently. In 1998 its trade deficit widened as foreign-funded reconstructionprojects gathered momentum following the appointment of the moderategovernment led by Milorad Dodik. The deficit is believed to have increasedfurther in 1999 because of the economic downturn in Yugoslavia (Serbia-Montenegro), the RS’s largest export market, at the beginning of the year, andeven more so after the launch of NATO air strikes on Yugoslavia. In the firsthalf of 1999 imports (cif) are reported to have exceeded exports six times over.However, the trade deficit probably narrowed in June and July because re-construction activity was slowing and the end of the war will have allowedsome traders in the RS to resume exports to Yugoslavia.

The volume of trade between BiH and Croatia fell very sharply after BiHabolished trade privileges in mid-May and Croatia responded by erecting tradebarriers of its own (3rd quarter 1999, page 19). According to the Croatianauthorities, Croatia’s exports to BiH fell in dollar terms by 3.6% year on year inthe first five months of 1999 while imports (cif) from BiH declined by 4.3%.

The accuracy of Federationtrade data is still open

to doubt—

Trade between BiH andCroatia plummets—

The trade deficit in the RSwidens sharply before

narrowing again

—but revised figures showa substantially larger

deficit



Over the first eight months of the year, by contrast, exports fell by 12.4% indollar terms and Croatia’s imports from BiH collapsed by 22.6%—indicatingthat exporters from BiH have been hardest hit by the measures.

The revised Federation trade figures portray a substantially different geo-graphical pattern of trade than previously published data. The Federation’slargest export market in the first seven months of 1999 was Italy, with exportreceipts totalling $70m or 24.2% of total export receipts. Croatia—whichaccording to previous figures was twice the size of any other market—is now insecond place, with Federation export receipts from Croatia totalling $67m, or23% of the total. Germany was the third largest market in the first seven monthsof the year, with receipts totalling $38m (12.9% of the total). Part of the reasonthat Italy has displaced Croatia as the Federation’s top export market is thatCroatia suffered an economic downturn in the first half of 1999, compoundedby the impact of the new trade barriers. An even more significant factor hasprobably been improved coverage of trade with western Europe, as the FederalInstitute’s data imply implausibly high growth rates compared with 1998.

In the first seven months of 1999 the Federation imported goods worth $359mfrom Italy (23.5% of total imports), compared with imports worth $348m(22.8% of the total) from Croatia. Once again, previous figures had indicatedthat Croatia was a much more important provider of imports than any othercountry. Imports from Slovenia totalled $186m in the first seven months of theyear, representing 12.2% of total import expenditure.

The Dayton Peace Agreement made the central state of BiH responsible forservicing the country’s external debt, including debts incurred by the twoentities that make up the country. As the central state has few independentsources of revenue, the agreement also obliged the two entities to transferfunds to the state budget to cover the cost of debt service. This has necessitatedan agreement between the entities on how this cost should be divided. InAugust they agreed that the Federation would cover 66.7% of the country’sexternal debt service, with the remainder provided by the RS. An agreement onservicing debt to the European Investment Bank (EIB), which will follow thegeneral accord, is expected to pave the way for the EIB to release a €160m loanthat will finance transport projects and support the entities’ budgets.

Foreign debt incurred by the Federation totalled KM3.7bn ($2bn) in May, ofwhich KM1.3bn was run up before the war. In 1998 the Federation’s debt-service requirement totalled KM42m, of which 85% went towards servicingpre-war debt and 15% related to post-war debt. Its debt-service burden isexpected to rise to KM68m in 1999 and KM85m in 2000. However, BiH’soverall debt burden will remain modest over the forecast period. Many of thepost-war loans were given on concessional terms, and principal payments oninitial reconstruction loans do not begin to fall due until 2006. In addition, thecountry has received substantial forgiveness on its pre-war debt both to theLondon Club (covering commercial bank loans) and the Paris Club (bilateralsovereign loans).

The entities agree to dividethe cost of servicing

external debt

—and Italy becomes theFederation’s largest trading

partner



The first stages of economic recovery in BiH have been directed by inter-national institutions, such as the World Bank, the IMF and the Office of theHigh Representative, and financed mostly by transfers from foreign govern-ments or concessional loans from multilateral financial institutions.Commercial lenders and private investors have been deterred by the politicalrisk and disappointing pace of economic reform. There have also been wide-spread reports of foreign companies interested in investing in BiH pulling outbecause of corruption and bureaucratic obstacles (3rd quarter 1999, page 27).Most investment so far has come either from investors who already hadexperience of operating in BiH (such as Volkswagen) or in very low-risk servicesectors; very few investors have been willing to inject funds into existingmanufacturing plants.

However, there was evidence that these obstacles were beginning to ease inSeptember when a Belgian brewer, Interbrew, declared that it had reached anagreement to buy a 51% stake in the Uniline brewery. Brewing has been one ofthe first manufacturing sectors to be privatised in many other countries ineastern Europe, as it is a relatively low-risk industry offering strong growthprospects as consumer spending rises. The Uniline deal is expected to pave theway for several other investments by Western companies later in 1999 or inearly 2000. One of these is likely to be the sale of majority control of theKakanj cement plant, located in Zenica-Doboj canton in the Federation.Although a 13.5% stake in the plant has already been sold to the employees,the other shares remain in “social ownership”—Yugoslavia’s hybrid form ofindustrial structure in which management and employees enjoyed de factoautonomy in day-to-day operations. The cement plant’s management, whichplans to sell 51% of the socially owned stake to a foreign investor, says thatpotential bidders include firms from France, Germany, the UK and Sweden.Having put the deal on hold during the Kosovo conflict, management nowhopes to reach an agreement in principle by the end of this year. Assumingthat it achieves this, the deal could be an important milestone in theprivatisation process and may encourage additional foreign investors tocommit funds in BiH. Other factories up for sale to foreign investors include athermoelectric generating facility, also in the town of Kakanj, and the Lukavaccement plant (3rd quarter 1999, page 27).

Foreign direct investmentis set to rise



Trade data

Federation: structure of trade($ ’000)

Imports cif Exports fob Jan-Jul Jan-Jul Jan-Jul Jan-Jul

1998 1999 1998 1999

Food 229,275 229,205 17,959 16,321Beverages & tobacco 39,786 50,700 1,529 2,072Raw materials 15,985 12,218 56,386 68,097Mineral fuels 69,616 89,346 5,854 21,467Chemicals 111,122 138,965 4,707 8,967Manufactures 193,014 367,310 57,623 70,091Machinery & transport 265,214 346,202 13,725 28,471Miscellaneous manufactures, incl clothing 115,507 193,821 19,601 73,366Total incl others 1,162,700 1,526,529 187,913 289,380

Source: Federation of BiH Federal Institute of Statistics, Statistical Data on Economic and Other Trends.

Federation: direction of trade($ ’000)

Imports cif Exports fob Jan-Jul Jan-Jul Jan-Jul Jan-Jul

1998 1999 1998 1999

EU 355,185 688,557 62,852 134,006 of which: Austria 65,524 58,422 12,890 16,225 France 10,690 19,793 1,438 4,297 Germany 117,016 174,749 21,831 37,555 Italy 102,237 358,965 23,240 70,133

Other developed countries 149,188 100,293 19,183 38,746 of which: Turkey 13,918 16,319 1,438 4,683 US 70,813 33,120 2,959 4,256

Other 658,327 737,679 105,878 116,627 of which: Croatia 417,342 348,357 74,844 66,589 Macedonia 7,677 5,984 2,168 4,995 Slovenia 160,001 185,625 17,585 26,775 Czech Republic 14,959 23,346 1,397 425 Hungary 28,348 55,637 376 1,174Total 1,162,700 1,526,529 187,913 289,380

Source: Federation of BiH Federal Institute of Statistics, Statistical Data on Economic and Other Trends.

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