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Can EU ambitions power a harmonious future for Bosnia-Herzegovina?

Bosnia-Herzegovina applied to join the EU in 2016 but slow progress in answering questions over corruption, as well as weaknesses stemming from a complex political structure, threaten to thwart its hopes. Peter McGill reports.
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Sarajevo

A long queue has formed of Balkan countries seeking to follow in the footsteps of Slovenia and Croatia in joining the EU. Bosnia-Herzegovina would appear to be at the back of this queue but commands global attention for the circumstances of its birth as a fragile multi-ethnic state that emerged from the ravages of its civil war in the 1990s.

May's annual meeting of the European Bank for Reconstruction and Development (EBRD) in Sarajevo, Bosnia-Herzegovina’s capital, will focus attention on the country's progress as well as its unique problems. 

Slow progress

The dream of one day gaining admittance to the EU is a powerful driver for change, as well as “the anchor of political stability” in Bosnia-Herzegovina, as it encapsulates a “hope for future prosperity”, explains Ian Brown, head of the EBRD’s office in Sarajevo.

Bosnia-Herzegovina applied for EU membership in February 2016, and the European Commission is currently preparing a formal opinion on whether it qualifies as an official candidate. In 2016 the commission gave a list of 3242 questions to complete. Answers were delivered in February 2018, but the commission requested clarification on 655 responses.

There are important political criteria to be fulfilled, such as the stability of institutions guaranteeing democracy; the rule of law; and issues surrounding human rights, and respect for and protection of minorities. Bosnia-Herzegovina's economic reforms have signalled a heavily qualified – if not formal – approval from the commission.

European Commission spokesperson Maja Kocijancic says that despite “ups and downs” some “important and often painful decisions” have been taken with regards to Bosnia-Herzegovina's prospective EU membership, such as creating a more flexible labour market and better aligning financial regulations to international standards. “The current macroeconomic situation is quite positive,” she adds. Thanks to better tax collection and “strong” economic growth of 3% since 2015, the public finances of Bosnia-Herzegovina are “largely balanced, which would offer a great opportunity to invest in the country’s long-neglected infrastructure, or to start lowering the high labour taxation in support of new jobs”, she says.

Ms Kocijancic is quick to hedge this endorsement by pointing out these improvements “have yet to be felt by the majority of people" and that "the pace of progress remains slow, partly due to frequent political disputes and stalemates”. She adds that the country is far from realising its economic growth potential.

“Significant challenges remain: Bosnia-Herzegovina's [population] is ageing rapidly, too many citizens are victims of widespread corruption, and young people are leaving the country in search of a better future," adds Ms Kocijancic "From the commission’s point of view, key priorities should be to improve the weak rule of law; to strengthen the business environment, which suffers from an overly complex and fragmented regulatory and institutional environment; and to modernise the oversized and inefficient public sector, which currently provides inadequate services for the taxpayers' money.”

Complicated arrangements

The ‘Dayton Accords’ that ended the 1992-95 Bosnian War – named after a US air base in Dayton, Ohio, where peace talks were held – ​created a uniquely complex structure in Bosnia-Herzegovina, intended to reduce ethnic tension between mainly Muslim Bosniaks, Catholic Croats and Orthodox Serbs.

The rebel Republika Srpska (Serbian Republic) kept its name but has ragged new borders. A Federation of Bosnia and Herzegovina is home predominantly to Bosniaks, and in Herzegovina, to Bosnian Croats. Both autonomous entities, the Federation and the Republika Srpska, have their own presidents, vice-presidents, prime ministers and elected assemblies. At the state level, executive power rotates every eight months between a Bosniak, Croat and Serb president. There is also a central council of ministers, and a bicameral legislature with the number of seats divided along ethnic lines. On top of all this, the Federation of Bosnia and Herzegovina has 10 regional cantons with their own elected governments, plus there are 143 municipal administrations in the Federation and Republika Srpska.

“The complicated system of checks and balances hampers the efficient functioning of the state”, as well as multiplies weaknesses such as “the low capacity of public administration, excessive politicisation and a lack of meritocracy in civil service, weak judiciary, corruption and red tape”, the EBRD noted in a report.

Francisco Parodi, the International Monetary Fund’s (IMF's) resident representative in Sarajevo, likens negotiations with the various players to “three-dimensional chess”. October 2018’s elections, contested by 28 different political parties, have made the game even more frustrating. The Republika Srpska formed a new government in December but there is still no government at either federation or state level. With municipal elections due in 2020, Mr Parodi voices his concerns that there is “only a very limited time for pushing for reform”.

The waiting game

Gunter Deuber, head of economics at Raiffeisen Bank International, points out that it took Cyprus 14 years to join the EU from submitting its application, and considers that would be “a good scenario for Bosnia-Herzegovina” given the current pace of progress. “It would allow new and younger people to come in who are interested in solving some of the issues,” he adds.

Recent economic growth in Bosnia-Herzegovina has proved resilient if unspectacular. The country's real gross domestic product (GDP) grew by 3% in 2018 and 3.5% is predicted for 2019. Average growth between 2001 and 2008 was 5.7% but following the global financial crisis it slowed to an average of 1% between 2009 and 2016, barely above the EU level, and even lower than more developed central European and Baltic economies.

“A country at Bosnia-Herzegovina’s stage of development should have grown much faster,” says Peter Tabak, a regional economist at the EBRD.

Unemployment has been decreasing steadily since 2012 but in 2018 still stood at 18%, according to Mr Tabak. Close to 40% of those aged 15 to 24 years old are jobless, one of the highest rates in the world. The average monthly salary is $484, though in the financial services sector it is $800.

Mr Tabak concurs with the European Commission on the parlous state of infrastructure in Bosnia-Herzegovina being “in general underdeveloped and outdated”. The EBRD calculates that about 10% of GDP needs to be invested in infrastructure between 2018 and 2022, similar to countries in central Asia and north Africa.

“It’s all about connectivity. The country is relatively isolated from the rest of Europe because its road infrastructure is deficient, airport connectivity is really inadequate, and the telecom service is really expensive and slow,” says the IMF’s Mr Parodi.

Infrastructure issues

Key to improving connectivity is a major highway project called Corridor 5C, which runs from the Adriatic port of Ploče to the border with Croatia in the north. The 337-kilometre section in Bosnia-Herzegovina is part of a 700-kilometre central European route that extends to Hungary. Completion of the Bosnian corridor is expected in 2030 at a total cost of €3bn. 

The EBRD and European Investment Bank are lending most of the money, to be repaid out of a hypothecated fuel levy. Political opposition to the excise tax led to a tense stand-off with the EBRD and IMF and a halt in highway construction, which resumed after the tax was passed into law in December 2017. So far, 105 kilometres of the 337 kilometres have been built at a cost of €900m, of which 45% has come from the EBRD.

State-owned Sarajevo International Airport handles only 10 to 15 flights per day, to Croatia, Serbia, Slovenia, Austria, Germany, Turkey, Sweden, the United Arab Emirates and Qatar. More flights operate from Pristina’s airport, even though Kosovo has less than half the population of Bosnia-Herzegovina.

Given the robust state of central government finance – total public debt was only 40% of GDP in 2017 – few doubt that more could be invested.

“This is one of the few countries in the world where the IMF is asking the government to spend more, but on the right things, on improving infrastructure and investing in the health sector,” says Mr Parodi. The reason the IMF has disbursed only €150m out of the €553.3m in concessional loans pledged to Bosnia-Herzegovina up to 2020 is because “they are not investing enough in infrastructure, and there are signs that fiscal discipline is slipping away”, with recent increases in veteran spending and government salaries, according to Mr Parodi.

State dominance persists

The other focus of EBRD and IMF pressure and concern is what many consider to be Bosnia-Herzegovina's dismal progress in implementing a privatisation strategy since the end of the Bosnian War. The state sector, including 548 companies majority owned by the government, accounts for 27% of total employment in Bosnia-Herzegovina. The average wage at the state-owned enterprises (SOEs) is 40% higher than in the rest of the economy, even though total debts of the SOEs exceed their revenues, according to the IMF.

Access to sought-after jobs at SOEs is a principal means of political and ethnically based patronage. “The SOEs are run by, and for, political parties,” says Mr Brown of the EBRD. This includes in the Federation the Bosniak telecom operator, called BH Telecom, and the Croat operator, HT Econet, that so far have fended off attempts at privatisation and reflect the country’s ethnic fissures. “If you have got the Croat operator and you are in Republika Srpska, don’t expect the best coverage,” adds Mr Brown.

The country's economy is dominated by small and medium-sized enterprises, which often lack access to finance. “You don’t have any large companies that are innovative or are leading in a particular product,” says Mr Parodi. Bosnia-Herzegovina ranked 89th out of 190 countries in the World Bank's 2019 Doing Business report, the lowest ranking of all the countries in the western Balkans.

“SOEs must be reformed as a priority, and corruption addressed; privatisation processes must be advanced in full transparency in the whole region. Growth potential and competitiveness continue to be hampered by weaknesses in the rule of law and the poor functioning of institutions,” says Ms Kocijancic of the European Commission.

None of this has deterred foreign banks located in Bosnia-Herzegovina, however, which now account for 90.5% of the country's total banking assets. The market leader in 2018 was UniCredit with a 26.6% share, followed by Raiffeisen with 14.2%. 

Mr Deuber of Raiffeisen says foreign control of the market is due to acquisitions and domestic consolidation. “If you look back when we entered the market in Bosnia-Herzegovina in 2000, there were 55 banks operating in this country, which is incredible. Now you have 23,” he says. Mr Deuber attributes the relatively high profitability of foreign banks – Raiffeisen has a net interest margin of 3.46% in Bosnia-Herzegovina – to there being less competition than in central Europe, where spreads are significantly thinner.

Paola Angeletti, head of the international subsidiary banks division of Intesa Sanpaolo, says: “The number of banks in Bosnia-Herzegovina is still considerable for country of its size. It’s true that foreign banks control the majority of the banking sector. Banking in Bosnia is quite profitable, and this explains the banking interest it has drawn from elsewhere in Europe.” Intesa has 6.8% of banking assets in the country but is looking to expand. “The fixed peg to the euro as well as prudent fiscal policy have contributed to a stable economic environment,” says Ms Angeletti. She adds that the brain-drain is less of an issue for Bosnia-Herzegovina than it is for the likes of Slovakia and Croatia, making it “less difficult to find local competencies”.

Disunity fears

Ms Angeletti is understandably guarded when it comes to discussing Bosnian politics. “The IMF, the EBRD and the European Commission are right in saying that the pace of development could be even higher if political and legal reforms were implemented more quickly. We realise though that the reform process reflects political issues, and a fragmentation of authority has created a lot of overlap and complexity,” she says.

One vexing example of such an overlap is having two banking regulators, one for the Federation, the other for Republika Srpska. At times, the dense and delicate web of checks and balances that the Dayton Accords spun for the new country seems stretched almost to breaking point by residual ethnic nationalism.

“I am a Serb… Bosnia is only my place of employment,” Bosnia-Herzegovina’s current head of state, Milorad Dodik, proclaimed on the day following his inauguration. For the past eight years, Mr Dodik has been leader of Republika Srpska, and has called for its secession from Bosnia. He refuses to use his Bosnian passport and boasts of ties to Russian president Vladimir Putin.

Such behaviour helps explain the continued existence of another relic of Dayton, the Office of the High Representative (OHR), which reports to the UN Security Council and retains sweeping powers befitting a colonial governor or a proconsul. With Bosnia-Herzegovina applying to join the EU, it had been expected that the OHR would be abolished, and the country given full sovereignty.

“The fact that the high representative with his mandate has remained in Bosnia-Herzegovina reflects the fact that the international community wants to see more persuasive evidence from the country’s leaders that they are ready to make the country’s institutions functional, break with the divisions of the past and move towards reintegration of the country,” the OHR told The Banker

“The lead on everything is the European Commission and the EU, but the OHR is still needed as a backstop, as a benevolent dictator, in case of emergencies,” an official explained. “This place is volatile. No one can guarantee what will happen. In three months, we could be talking about the break-up of this country.”

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