Business

Transforming BiH into a modern market economy

"The key to Bosnia and Herzegovina's viability under the Dayton Peace Agreement is economic growth. Refugees will return to their pre-war homes only if they have reasonable opportunities to earn their living. The Government will function only if a stable tax base exists. A stable tax base will exist only if businesses thrive and prosper. And businesses will thrive and prosper only if the government creates stimulating economic policies and regulations. In the end the long term success of the Dayton Peace Agreements depends on Bosnia and Herzegovina's ability to develop a self sustaining economy, which creates jobs, keeps inflation in check, and provides fertile ground for investment" says James Lyon of the International Crisis Group.

Four years since the end of the war, Bosnia and Herzegovina (BiH) continues to face formidable challenges to secure sustainable economic growth. Continued mass population displacement, either internally or abroad as refugees (50% of total pre-war populations) mean that there is a fragile and dislocated social situation. The collapse of traditional markets in former Yugoslavia, the demise of old state owned companies combined with the war damage to companies and infrastructure led to a dramatic fall in industrial output (90% of original levels). Standards of living consequently declined to an average of 1,000 DM/year, while unemployment raised to 30%.

Although BiH economy staged a come back with a growth rate of 18% last year, this growth has started from a very low economic base and has been primarily fuelled by the large injection of donor aid to BiH (5.1 billion $ over the last four years). Moreover, much of this aid has been focused on post war reconstruction. In the Madrid Declaration, December 1998, the donor community stressed the importance for BiH to adopt policies to promote sustainable economic growth and the development of the private sector, and to rely less on foreign assistance. The challenge facing Bosnia today is therefore to move from reconstruction to sustainable economic development.

Priority structural policies

The economic policies currently being encouraged need not only to create a stable currency and low inflation but also to actually modernise and reform the fundamental structures of the economy. The priority structural policies that have been identified include:

• privatisation of state owned industries and development of the private sector;

• introduction of a modern banking and payments system;

• improving the business environment to attract foreign investment and stimulate growth of the private sector and small businesses;

• improving tax policy and tax collection.

In line with the efforts of the government of BiH and the donor community to support BiH's economic reform the European Commission (EC) is funding a package of assistance worth 10.7 million EURO aimed at transforming BiH into a modern market economy.

Modernisation of the Payments System

The restructuring and modernisation of the Payments System is considered to be a critical area for the reform of BiH's financial sector. Under the present system, a single central body - the Payment Bureaux - administers all payment operations, tax and statistics collection, treasury and cash management and accounting services. These Payment Bureaux actually carry out all the functions that banks, Clearing Houses and the Ministry of Finance and Statistics would separately deal with in a modern economy. This system lacks transparency and accountability and undermines the banking system. For instance, if commercial banks can not perform payments services and collect savings, banks can not mobilise the country's savings, which are a critical source for domestic investment and fuel for economic growth.

Modernisation of the Payments System will therefore involve transferring these functions to the relevant public and private agencies. Tax Collection and Treasury functions will be transferred to the Ministry of Finance; statistics to the Ministry of Statistics while payment operations will be undertaken by banks and Clearing Houses. The challenge of dismantling the payments system is further complicated by the fact that there are three separately managed Payment Systems. In the Federation there are two central payments bureaux: Zavod za Platni Promet (ZPP) and, in the Croat majority area, the Zavod za Platni Promet (ZAP) while in the Republika Srpska the Payment Bureau is Sluzba za Platni Promet (SPP).

The European Commission and other Donors (World Bank, IMF, US AID) have formed an International Advisory Group to co-ordinate efforts to support the complex task of modernising the payments system. A strategic study outlines the different steps necessary for dismantling the payments system and provides the basis for donor co-ordination. With a contribution of 700,000 EURO the European Commission will be involved in two important aspects of this joint effort: transferring the statistical function to the Ministry of Statistics and providing a training programme to reintegrate 2,500 employees from the Payment Bureaux into both the public and the private sector, i.e. tax collection in the Ministry of Finance and banking.

Promoting business

A critical pre-condition to promote sustainable economic growth is to put in place a regulatory framework which encourages businessmen to do business. However, the business climate today in BiH is far from encouraging for local businessmen often confronted with a whole range of obstacles from high taxes, cumbersome and often contradictory business regulations, to time consuming bureaucratic registration procedures. For instance, a businessman reported that his company's accountant spends an entire day every two weeks simply filling out the forms necessary to meet payroll for a staff of eight employees. The situation is further compounded by the differences in regulations and trade tariffs between the two Entities. A businessman in the Federation trying to sell goods in the RS faces different regulations and tariffs that make it increasingly difficult to do business between the two Entities.

"BiH's economy remains crippled by a bureaucratic mind-set and a static system. The economic potential of Bosnians is being held back by restrictive legislation ­ the society does not lack entrepreneurs but the system stifles them. If the Bosnian businessman is allowed sufficient freedom, he will create job growth and increase economic activity through his own initiative" says James Lyon from the International Crisis Group.

Creating a uniform commercial code

The European Commission will therefore aim to help improving the business environment in BiH by contributing to the creation of a uniform Commercial Code between the two entities, thus encouraging free movement of goods between the two entities, streamlining legislation to make it more user-friendly to businessmen and helping set up the necessary institutions to enforce legislation. With a budget of 600,000 EURO the EC will finance European lawyers to:

• introduce a standard International Insurance System for traded goods which is compatible across the two entities. This will encourage trade between the two entities and contribute to the creation of a single economic space in BiH;

• develop a State Level Competition Council and Office for Competition and Consumer Protection which will be responsible for monitoring companies against monopolistic practice and protecting the rights of consumers;

• develop an Arbitration Centre to implement recently established arbitration rules in order to facilitate business and trade disputes, particularly between the two entities;

• support the OHR in improving different aspects of the administrative system in the judiciary such as business registration.

Attracting Foreign Investment

Political uncertainty and security risks have undoubtedly been major disincentives for foreign investment in BiH. A recent study "Why will no one invest in BiH?" published by the ICG has identified a number of other factors which are obstacles for potential investors in BiH. These range from the high tax system to bureaucratic and cumbersome business regulations and an inefficient banking system. Improving the regulatory framework for business is therefore not only important for stimulating the development of the private sector but it is also an important factor in helping to attract foreign investment.

Not only is foreign investment a way to bring in much needed capital and provid a source of employment but it is also a way to transfer know-how and make Bosnian companies more competitive in the global economy. Unfortunately the levels of foreign investment in BiH to date are very low: only a total of 134 million DM has been invested.

As part of an effort to attract foreign investment to BiH, the government, with the help of an EU expert, passed legislation to set up a Foreign Investment Promotion Agency (FIPA). This agency will be responsible for promoting BiH as a location for investment and helping potential investors once they are in the country. The European Commission will support the set up of this agency with a budget of 1 million EURO which will be used to prepare strategy and business plans, fund marketing and promotional activities abroad, train the personnel of the agency and help provide services to potential investors.

Mobilising the Private Sector in BiH ­ Industrial Co-operation with European Businessmen

The European Commission believes that the private sector will be the real driving force in stimulating economic recovery in the country. European businessmen are better placed than public donors to help the development of Bosnia's embryonic private sector. The EC-funded Industrial Development Programme -set up by the European Commission's DG III- is based on this approach of European businessmen sharing their know-how with Bosnian businessmen.

This is exemplified in the wood sector project. Wood and Furniture is one of the most promising sectors in Bosnia which fell apart during the war and now has to face up to the challenges posed by the transition to a market economy. Ten high ranking European experts in the wood sector, from five different European countries are currently involved in restructuring and developing this sector. Following an identification of most viable companies, a range of assistance has been provided in finding potential joint ventures, training in product management, quality control and marketing and development of an Industrial Association. This project has had tangible results in attracting EU partners and so far five commercial arrangements have been made with EU companies. Thanks to the success of this project the EC will carry out similar projects in 2 other sectors: the agribusiness sector and the textile and leather sector.

Providing credits

One of the major constraints undermining the development of the SME sector is the general shortage of capital in the banking system and lack of financial credit to SMEs. In order to meet this need, the Micro-Enterprise Bank (MEB) was established to on-lend to the SME and Micro-Enterprise Sector. The EBRD is its largest shareholder and sponsor. Through an Investment Co-operation Fund -set up between the EC and the EBRD- the EC has provided 6.0 million EURO for loan finance and 1.2 million EURO to finance a management team. The MEB has been effective in mobilising credits to this sector and has disbursed 1,300 loans so far, worth 9.6 million DM with a low rate of arrears (less than 1%).

The MEB is now of expanding its activities to reach more SMEs in new regions. Its goal is to develop its loan portfolio to DM 18.5 million by the end of the year 2000 and to grow by 15% from the year 200 EURO. It plans to do so:

• expanding its branch network into different regions, with two branches planned to be opened this year, and another 2-3 in the next two years;

• increasing the staff and its productivity by augmenting the number of loan officers to 25 in 1999 and continuing with their training;

• introducing new services for its clients such as payment facilities, deposit and current accounts, which are to complement its core lending activities.

In order to support MEB's goals to expand its credit finance to more SMEs in different regions, the EC will provide further 5 million EURO for credit finance to be lent to SMEs. This funding will be provided, interest free, to the MEB as a 10 year credit line via the EBRD in accordance with the provisions of the Investment Fund Agreement between the EBRD and the EC. In addition, the EC will also fund regional economic regeneration projects in the Tuzla region and in Brcko.

Europe for BiH
Quarterly newsletters published by the European Commission on its actions in Bosnia and Herzegovina
No 8, October 1999

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