Financial and Economic Crisis: effects on BH economy Financial and Economic Crisis: effects on BH economy Marco Mantovanelli Country Manager The World Bank Sarajevo, 24 February 2009.

Financial Crisis in the EU and the Western Balkans ► Financial sector in EU and the region on the way to stability, BUT surprises are still possible ► EU economies going into recession:  Eurozone growth 1.1% in 2008 and -0.7% in 2009 (UN Global Outlook 2009). ► Western Balkan countries can expect a significant growth slowdown

Financial system in BH is relatively stable ► No bank operating in BH has invested in toxic mortgage backed securities or other risky investment instruments ► Banks have held a conservative lending policy and the rate of non- performing loans in BH is very low ► Deposit withdrawals in October were significant (around 600 million KM), but far from enough to undermine system stability. Deposits have since stabilized ► Central Bank suffered no losses on its investments ► Central Bank foreign exchange reserves are sufficient to absorb sudden stops of foreign private capital inflows for more than a year.

…but other channels bring crisis into BH ► Capital inflows and FDI are decreasing  Higher cost of borrowing and credit crisis on markets outside BH, have not only slowed down credit expansion, but harder loan access conditions for corporate and mortgage lending can also be expected.  In absence of large company privatization, the FDI inflow will be much reduced in ► Recession in the EU and the US is expected to reduce inflow of remittances sent back by the Diaspora  Even if remittances do not decrease, the growth trend will not be continued ► Exports will decrease due to market demand drop (EU and the region), and fall in commodity prices  Primary commodities account to 42% of BH exports (base metals: 27%); commodity prices and demand have falled drastically.  EU and the region account of around 90% of BH exports, all hit by crisis.

Export changes for main product categories (same month of the previous year) BiH Export Growth (2008, year-on-year) -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 70% PREPARED FOODSTUFF CHEMICAL PRODUCTS WOOD & WOOD PRODUCTS TEXTILE & TEXTILE ARTICLES FOOTWARE BASE METALS & ARTICLES THEREOF MACHINERY & MECHANICAL APPLIANCES FURNITURE Product category 8-Sep8-Oct8-Nov

Key impact of the economic crisis in BH: 2008, 2009…? ► Stock markets plunged by around 65% in Recovery will be slow ► Private investment rate is falling ► Industrial production dropped substantially in January ► GDP growth will fall from 6% in 2008 to ….. hard to tell, but it could be to zero growth in 2009! ► Inflation will fall considerably as well as current account deficit but the deficit financing will be difficult! ► Stagnant public revenues (a problem particularly for the Federation) ► Companies hit by crises will be making redundancies (see metal industries) ► Poverty rate in certain communities could increase ► Rate of non-performing loans will increase

Adequate measures for mitigating the impact of the crisis 1 WELL COORDINATED MEASURES ACROSS BH ARE NECESSARY FOR: ► Maintain the stability of the banking sector ► Minimize the impact of the crisis on the economy ► Strengthen social safety nets and better social assistance targeting

Adequate measures for mitigating the impact of the crisis 2 ► Maintain the stability of the banking sector:  Continue with measures for increased bank liquidity  Consider the adequacy of the deposit insurance system  Improve banking supervision  Improve the running, control and transparency system of the development banks  Leave unchanged the role of the Central Bank as the Currency board

Adequate measures for mitigating the impact of the crisis 3 ► Mitigating the impact of the crisis on the economy:  In case there is a sudden drop of total demand, the well planned, targeted and temporary fiscal stimulus for increase of the public investment rate should be considered. COORDINATION AND ADDITIONAL EXTERNAL FINANCING SOURCE ARE NECESSARY!  Improve the public expenditure structure, and in particular: rationalise transfers to private entitites, decrease the participation rate in public expenditures.  Undertake systemic efforts to ensure additional financing for key infrastructure projects and credit lines for the private sector, as well as faster implementation of the approved development loans  Enhance enterprise competitiveness: improve business environment (reduce regulatory framework)  Enhance taxation policy: decrease the burden on economy and impose taxes on luxury expenditures ► Decreased contributions, higher accise payments, custom’s tariffs harmonized with the EU, leave VAT unchanged

Adequate measures for mitigating the impact of the crisis 4 ► Strengthening of the social protection measures and better targeting of social assistance, so as to:  Protect the most vulnerable categories of the population  Decrease the budgetary pressures and increase fiscal space for a more productive public expenditure categories in basic infrastructure/services  Stimulate employment

BH has an exceptionally ineffective social benefit system!!!

How to speed up the growth after the crisis: Measures to improve economic and social cohesion, support to accelerated growth and EU integration ► ► Build a true single economic space   Improve fiscal coordination and strengthen fiscal policy   Improve financial sector supervision   Harmonize direct taxation systems   Harmonize Labor registration   Strengthen national economic planning process   Improve inter-entity coordination of infrastructure investments of significance for the whole BH (transport and energy as key) ► ► Improve business environment by enhancing regulatory environment and strengthening the mechanisms for enterprise restructuring and exit ► ► Complete the privatization process ► ► Develop an economic strategy for the whole BH and work towards enhancement of energy efficiency ► ► Improve efficiency and quality of education and invest in ‘out-of-school’ skill development ► ► Continue to strengthen systems of social protection of pension funds in a sustainable and efficient manner

How can the WB help? Mitigate impact on the real economy: ► Continue to provide consultancy services upon request (Privatization, Social Spending etc.) ► Acceleration of already approved projects, particularly in infrastructure ► Line of credit for SMEs and other new projects ► Doing Business memorandum and follow up actions to improve business environment ► Possible budget support only under the condition that appropriate macroeconomic framework reforms are undertaken Support the most vulnerable population categories: ► Policy note on targeted social benefits ► New project for support of implementation of targeted social benefits