Bosnia and Herzegovina: On the Road to EU Accession

• Author: Milan Cuc
• Position: IMF European Department
• Pages: 199

Page 199

Anew agreement signed by Bosnia and Herzegovina opens the door to membership of the European Union (EU).

But after years of solid growth and sound policies the country has to prepare for EU accession during a time of global economic crisis.

Bosnia and Herzegovina signed a Stabilization and Association Agreement (SAA) with the EU on June 16, 2008, opening the door for EU membership. This agreement represents a watershed for the country. It marks the end of a period of about 12 years, during which the country made significant strides toward rebuilding its economy after the ravages of the 1992-95 war.

But the new agreement also means that after years of economic growth underpinned by sound macroeconomic policies, reforms in key sectors, and a favorable external environment, Bosnia and Herzegovina is facing a fresh test: how to get ready for EU accession at a time of extreme turmoil in the world economy.

Bosnia and Herzegovina has made great strides. Postwar reconstruction and expanded public consumption and investment have boosted living standards, with real wages rising 44 percent between 2000 and 2007. The country's currency board has been instrumental in bringing down inflation to a level close to that of the euro area. The banking system has been largely privatized, and international reserves have been boosted substantially.

But economic imbalances have begun to emerge, with capital inflows and rapid credit expansion increasingly driving the domestic demand boom. The current account deficit rose to 12.7 percent of GDP in 2007, and is set to widen further.

Until now, the real effective exchange rate has been stable, and export growth has remained strong. However, inflation accelerated to 10 percent in July 2008. While this largely reflects the effects of global food and energy price shocks, underlying inflation has crept up as well, to about 4 percent. A procyclical fiscal policy has added to these imbalances.

Bosnia and Herzegovina also lags other countries in the region when it comes to creating a friendly business climate. At close to 50 percent of GDP, the public sector is large, and many companies still need restructuring. Privatization has been uneven, and the labor market is characterized by high, mostly structural, unemployment (amounting to 23 percent of the labor force) and low participation rates.

The complex political system complicates decision making. The Dayton Peace Agreement created two largely autonomous...