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Standard&Poor's Ratings Services (S&P) said on Friday it affirmed its B/B long- and short-term foreign and local currency sovereign credit ratings on Bosnia and Herzegovina. The outlook on the ratings is stable, the agency said in a statement.
S&P also said in the statement:
The ratings on Bosnia and Herzegovina are constrained by its fragile, overlapping government institutions, its weak fiscal management framework, and external vulnerabilities arising from persistent current account deficits and funding challenges. The ratings are supported by our expectation of continued and significant international support. We believe that the domestic political environment will likely remain divided along ethnic lines and entity boundaries.
Under the 1995 Dayton Agreement that concluded the 1992-95 Bosnian war, Bosnia is divided along ethnic lines into three political entities--the Federation of Bosnia and Herzegovina (with a predominantly Bosnian Muslim (Bosniak) and Croat population), Republika Srpska (Serbian Orthodox Christian and Bosniak) and the Brcko District (Bosniak and Croat). Under the Agreement, both the Federation and the Republika Srpska have their own parliament, which has executive legislative powers over the respective entity. Among other responsibilities, foreign policy, judicial powers and monetary policy are with the State and exercised through state-level institutions.
Tensions exist between the entities and the state-level institutions and, increasingly, between the combined authorities of Bosnia and Herzegovina and the international community. In our view, periodic events--such as the government reshuffle earlier this year within the entities--undermine confidence that political cohesion is developing. Such events detract from important issues.
For instance, progress on a key constitutional amendment to allow members of other communities to be elected to higher government positions, a prerequisite for EU candidacy, has been pending since a 2009 ruling by the European Court for Human Rights. Bosnia's current constitution only allows Bosniaks, Serbs, or Croats to be elected to the Presidency of the State. A stalemate between the entity governments regarding meeting the EU's sanitation standards has prevented Bosnia's agricultural sector from preparing for Croatia's accession to the EU; at the end of 2012, Croatia was Bosnia's second-largest export market.
More recently, the European Commission (EC) canceled two agricultural projects worth €5 million (0.02% of GDP) after the entity governments failed to reach a decision on the implementation of the projects. While €5 million isn't of itself a large amount, Bosnia risks losing funds for other EC-backed projects if the entity governments fail to set up a coordination mechanism to deal with EU funds.
We view the IMF Stand-By Arrangement (the Program) secured by Bosnia and Herzegovina in September 2012 as an important policy anchor. We believe that disbursement conditionality will continue to help stabilize fragile public finances at the entity level, while also boosting the government's ability to meet its increasing external debt repayments. To date, Bosnia and Herzegovina has successfully completed three reviews and received three disbursements (totaling €155 million; 0.6% of GDP) so far under the Program; the fourth review is now underway.
To be eligible for each successive disbursement, the IMF requires the entity governments to meet structural benchmarks by certain deadlines: the adoption of laws on privileged pensions for war veterans is one example. Other ongoing stipulated reforms involve the pension and healthcare sectors, improvements to the business environment, and greater control and monitoring of the finances of lower levels of government. We note that the strained finances of both the Federation and the Republika Srpska, coinciding with economic stagnation since the global financial crisis, have increased Bosnia and Herzegovina's reliance on the IMF for budgetary and external financing.
Broadly speaking, we believe risks to IMF program implementation and delays to reforms may persist given the complex institutional set-up and potential political disruptions. General elections next year could also potentially, and protractedly, shift political focus away from the reform agenda. We expect the general government deficit to narrow to 1% of GDP and the net general government debt stock to reduce to 36% of GDP by 2016, after peaking at an estimated 39% in 2013. In addition to the risks already mentioned, lower-than-anticipated economic growth, pre-election spending, or spending overruns from the lower levels of government could derail planned fiscal targets.
That said, we believe that the need to secure ongoing financing from the IMF will sufficiently motivate the entities to keep consolidation on track. We expect economic growth to remain subdued, which will further challenge reform implementation. We anticipate that, after contracting by an estimated 0.7% in 2012, real GDP will increase by 0.5% this year.
We forecast real GDP to grow at an average of 1.9% over 2013-2016, well below the average 5.0% of 2004-2008. Assuming a slow recovery in the eurozone, we expect investment to remain below its 2008 peak of 28% of GDP over the next few years. Bosnia and Herzegovina's 2013 GDP per capita is modest at an estimated $4,700. In our opinion, the banking system represents a limited contingent liability for the government. It is largely owned by foreign parent banks and has a moderate degree of financial intermediation (claims on the resident non-government sector are estimated at 55% of 2013 GDP).
Though the banking system appears well-capitalized--with reported Tier 1 capital equal to 15.3% of risk-weighted assets at June 2013--nonperforming loans (NPLs) have continued to increase steadily since early 2012. NPLs reached 14.3% of total loans at the end of June 2013, from 5.9% at the end of 2009, and may rise further. As a result, we expect that banks (mostly owned by Austrian and Italian parents) will continue to be cautious in extending credit even when the demand for loans starts to pick up.
External vulnerabilities have arisen from persistent current account deficits (estimated at 8.5% of GDP in 2013), though financing from the IMF and other multilateral lending institutions has somewhat reduced external funding challenges. While the large trade deficit (estimated at 32% of 2013 GDP) is offset partially by net remittances (we estimate net transfers flow of nearly 14% of 2013 GDP), we expect the current account deficit to remain above 5% of GDP over 2013-2016. We anticipate that direct investment inflows will continue to amount to about one third of the current account deficit, and therefore expect an increase in external indebtedness over the forecast horizon.
Bosnia and Herzegovina's large current account deficit, along with its external repayments, will keep its gross external financing needs high at an average of 150% of current account receipts and usable reserves from 2013-2016. Bosnia has a currency board regime and the convertible marka is pegged to the euro. While the currency board provides stability, it limits monetary flexibility. Bosnia, like other regional peers, has a high level of euroization; nearly two-thirds of all loans are in or indexed to a foreign currency, mostly euros.
The stable outlook balances our view of the risks to Program implementation posed by the complex institutional set-up, the general elections in 2014, and the weak external environment against the Program's role in guiding policy direction and providing financing. We could lower the ratings if we see a significant deterioration in Bosnia's external position or if the government fails to meet IMF conditions and thereby jeopardizes disbursements.
If we see delays in payments to official creditors--as happened in January 2012 amid ambiguity over the extension of temporary financing--we could lower the ratings by more than one notch. In our opinion, if tensions between the two entities abate, and if their relations with state institutions improve, this would gradually enable autonomous reform implementation that does not rely on international pressure and policy conditionality. We believe this would strengthen the business environment and pave the way for more sustainable growth and better external performance. This could lead us to consider raising the ratings." FIPA
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