2.1  POLITICAL SITUATION

2.1.1  Bilateral Relations between the European Union and Bosnia and Herzegovina

In April 1997, the General Affairs Council established political and economic conditionality for the development of bilateral relations with Bosnia and Herzegovina in particular in the fields of trade, financial assistance and economic cooperation. Progressive implementation of these conditions based on the regional approach will lead to improvement of relations.

At present Bosnia and Herzegovina continues to benefit from autonomous trade preferences by the European Community. Assistance is funded through the Phare and Obnova programmes.

The EU Declaration on Bosnia and Herzegovina of June 1998 represents an important step in the bilateral relations. It emphasizes that the future of Bosnia and Herzegovina is in Europe and provides the framework for a closer co-operation. The Member States have also created the "EU/Bosnia and Herzegovina Consultative Task Force" (C.T.F.). The C.T.F. provides a joint EU/Bosnia and Herzegovina vehicle for technical and expert advice in the fields of administration, regulatory framework and policies. This forum could in particular provide guidance for the economic legislation of the two Entities and therefore contribute to its harmonization. The CTF could also make a contribution to the institution building related initiatives. In the Madrid Declaration (December 1998) the Peace Implementation Council welcomed the intention of the EU to intensify the dialogue on political and economic issues with Bosnia and Herzegovina and supported the efforts of the CTF to develop Bosnia and Herzegovina's administrative and legislative institutions in order to bring Bosnia and Herzegovina closer to European standards.

The CTF has already held meetings and addressed joint recommendations to the Bosnia and Herzegovina authorities at high level. The recommendations focused on Foreign Direct Investment legislation, industry strategy, Common Institutions, Constitutional Court, Judicial reform, Bosnia and Herzegovina internal market and other more specific issues. Working groups and coordination points have been established at the European Commission Representation Office in Sarajevo and at State and Entity level to ensure an adequate follow-up to the CTF meetings and a proper implementation of CTF recommendations.

2.1.2  Implementation of the Dayton/Paris Peace Agreements

Under the recommendations of the Peace Implementation Council and the guidance of the High Representative, civilian implementation entails the rehabilitation of infrastructure, economic reconstruction, the establishment of political and constitutional institutions, promotion of respect for human rights, return of refugees and displaced persons and free elections.

From December 1995 to December 1996, NATO's first out-of-area deployment, the 60,000-strong IFOR, was given the task of implementing the provisions of the Dayton Agreement aimed at separating the warring parties in former Yugoslavia and maintaining the cease fire. The second deployment, SFOR, has focussed on further stabilisation of the situation.

The implementation of the Dayton Agreement can be considered a success as far as its military dimension is concerned (separation of the warring parties, transfer of heavy weapons) but is still unsatisfactory on the civil side. However, it should be stressed that civilian implementation started later and is much broader than the military one.

2.1.3  Recent political developments

The situation before the September 1998 elections had made the prospects for peace and at least partial Dayton implementation look better than at any time since the Peace Agreement signature. However, resistance to integration persisted, especially in the eastern part of the RS and in some parts of the Federation. Furthermore, the work of Bosnia and Herzegovina common institutions, although improved, seemed still hampered by the lack of political will to take decision. The judicial system reform is still awaited. Serious obstacles also remained on refugee return.

2.2  SOCIO-ECONOMIC SITUATION

2.2.1  Macroeconomic developments

Despite a difficult post-war situation in Bosnia and Herzegovina there has been considerable progress with regard to economic revival. External assistance fuelled a strong economic recovery in 1995-97, during which GDP growth averaged around 35% per year. Inflation has fallen to moderate levels in both entities, mainly thanks to the tight fiscal discipline maintained by the entity authorities. Although progress has been made, GDP stands at about half of its pre-war level, and the GDP per capita at less than half of its pre-war level. Overall unemployment stands at 30-40%, and in the RS it is reported to be as high as 50-60%. In the coming years, the authorities hope to continue investment-led real GDP growth in the range of 20-30%. Inflation is expected to average 10% or less for the country as a whole during 1998, mainly as a result of changes in administered prices. The fiscal strategy of the Bosnia and Herzegovina government is tied closely to the currency board arrangement, and based on balancing budgets on a cash basis in order to avoid any further accumulation of domestic arrears. On the basis of the projected consolidated fiscal revenues, total fiscal expenditures are expected to increase from an estimated 33% of GDP in 1997 to about 35% of GDP in 1998, mainly due to an increase in budgetary expenditure in the RS for the first time in several years.

2.2.2  Support by multilateral institutions

In the context of the current IMF-supported country-wide macro-economic and structural reform programme, which was adopted by the Bosnian authorities in May 1998, important progress has been achieved with regard to promulgating an appropriate legislative framework which encompasses common institutions suited to a market economy. Key achievements so far include: (a) the introduction of a new common currency, the Convertible Marka, in late June 1998 which will standardise the settlement of transactions throughout the country by creating a unified payment system, (b) the adoption of a common State Budget in the spring of 1998 which greatly improves efforts towards establishing a framework for sound and sustainable fiscal management, (c) the promulgation from 1st January 1999 of a new uniform Customs Code, drafted with the assistance of the EC-funded CAFAO programme and consistent with EU standards.

Bosnia and Herzegovina authorities still need, however, to ensure that the institutional reforms undertaken so far are properly implemented at all levels. Notably, a number of key issues need to be addressed in the short-term: (a) the proper and timely execution of automatic transfer of resources from Entities to the State Budget, (b) harmonisation of entity debt laws and entity trade regimes, (c) a new uniform state pension law, (d) country-wide promotion of the use of the new currency in all economic transactions, and (e) the establishment of a State Satistical Co-ordination Agency.

In the medium-term, key structural reform priorities include: (a) the development of a sound banking sector including an adequate legal framework, (b) the promotion of private-sector development through restructuring and privatisation of firms and an improvement of the legal framework, in particular the implementation of the foreign investment law in order to encourage foreign capital inflows, and (c) public finance reforms.

The World Bank is, through IDA, providing substantial assistance to Bosnia and Herzegovina within the framework of the reconstruction programme. Aid is channeled into key priority areas such as infrastructure, education and health. In the context of the present IMF programme, the World Bank is implementing a loan for a structural adjustment operation in the area of public finance reform (US $51 million). With the operation of Public Finance Structural Adjustment Credit, total World Bank commitments to Bosnia and Herzegovina will have reached US $535 million. The Bank is hence shifting its focus, in conjunction with the IMF programme, towards policy- based lending. In the case of Bosnia and Herzegovina, key priorities remain economic policy reforms and institution building.

The European Bank for Reconstruction and Development, EBRD, has participated in major reconstruction projects in Bosnia and Herzegovina since 1996. During 1997, the EBRD started to shift its focus from emergency infrastructure reconstruction towards private sector development. The EBRD pioneered equity investments in Bosnia and Herzegovina, and has established itself as a major actor in the strengthening of the country's financial sector. By mid-June 1998, the EBRD's total financial commitments to Bosnia and Herzegovina amounted to 74 MECU. In the future, the EBRD is planning to focus on three key areas: (a) support of private-sector activity, notably by way of equity investment or loans to companies targeted for privatisation, (b) continued emphasis on strengthening the banking sector, and (c) selective financing of infrastructure-utilities projects.

The European Investment Bank (EIB) is planning over the period 1999-2000 to support infrastructure projects within a EURO 100 million credit line.

2.2.3  Future reform priorities

In order for Bosnia and Herzegovina to achieve a self-sustained growth process and to reduce the dependence on external aid, assistance will need to shift focus from reconstruction and humanitarian aid to activities fostering 'economic regeneration'. The International Community hence needs to support the building of institutions suited to a market economy and a coherent policy framework for the conduct of sound macro-economic policies. Assistance that aims at promoting economic development in Bosnia and Herzegovina will be most efficient if implemented in the context of a country-wide macro-economic reform programme. The main priorities of such a programme should be:

• Enhancing transparency and accountability in government finance. (Budgetary reforms are needed to ensure the proper and timely funding of State budgets as is an appropriate legislative framework for managing fiscal affairs of the central state, the entities and the local governing bodies).

• Harmonisation of the Entity taxation laws and improvement in co-ordinating tax collection. (Reforms in these fields remain essential to fighting fraud and tax evasion, as well as to enhance the efficiency of the EC-sponsored CAFAO initiative to ensure fiscal stability in Bosnia and Herzegovina).

• To improve the conditions for private-sector development, in particular with regard to foreign direct investment and property market, and the restructuring and privatisation of state-owned enterprises. (This remains crucial in order to stimulate new private investments and to attract foreign capital so as to create employment, and to increase output and

• Development of a sound banking sector including an adequate legal framework as well as the reform of the opaque payments system, the ZPP. (A sound and vibrant financial sector remains is indeed crucial to ensuring a well functioning market economy, as well as for restoring confidence among savers and investors).

• Ensuring an adequate social protection targeted at the most vulnerable sections of society.

2.3  RETURN

The slow return and re-integration of the many displaced persons and refugees remains the main obstacle to political stability and economic and social normalisation in Bosnia and Herzegovina.

As in previous years, the return process moved slowly forward in 1998, with a total of 140,000 returns, of which over 100,000 from abroad and only 35,000 to areas of origin where their ethnic community is now a minority. This leaves some 400,000 refugees without permanent solutions abroad, half of whom in FRY (190,000) and Croatia (30,000), with most of the rest in the EU (Germany is for example still hosting the highest number of refugees with an estimated 100,000 people).²

Furthermore, almost 800,000 people remain displaced within Bosnia and Herzegovina, most of whom would find themselves in the situation of a minority, should they choose to return to their home of origin.

Opposition to minority return remains widespread among dominant nationalist parties, and even stronger international pressure and aid conditionality than in 1998 will thus be necessary for a real breakthrough in the return process in 1999.

The OHR-led Reconstruction and Return Task Force (RRTF) has therefore adopted a comprehensive 1999 Action Plan focusing on the main bottleneck in the return process, i.e. minority returns inside Bosnia and Herzegovina. This plan, which was endorsed by the Madrid PIC³ and for which donors undertook to provide the appropriate funding, describes in detail the many remaining obstacles to minority return, and outlines international action necessary to overcome the most pressing of them. The RRTF has estimated that at least 120,000 refugees and displaced persons would be prepared to return rapidly if the conditions were created to make such return possible.

Crucially, the plan sets the return process as the top priority for the entire peace implementation effort in 1999. This should leave both donors and displaced persons and refugees in no doubt as to the determination of the international community to make a renewed effort in support of the return process.

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