Proposal for a COUNCIL DECISION amending Council Decision 1999/325/EC providing macro-financial assistance to Bosnia and Herzegovina

(presented by the Commission)

EXPLANATORY MEMORANDUM

1. Background

On 10 May 1999, the Council of the European Union decided to provide to Bosnia and Herzegovina (BiH) macro-financial assistance of up to EUR 60 million, comprising a loan facility of up to EUR 20 million and a grant facility of up to EUR 40 million (Decision 1999/325/EC).

The objective of this assistance has been to support the balance of payments and help ease the country's external financial constraints, as well as to comfort reform efforts and the implementation of common institutions and policies, consistent with the Dayton peace agreement. The assistance has been conditional upon a satisfactory track record in the adjustment and reform programme of BiH in the framework of an IMF Stand-by Arrangement.

After the signature of the Memorandum of Understanding (MoU), the first tranche of the assistance (EUR 25 million) was released in December 1999. Subsequently, there were delays of the BiH authorities in implementing the required policy reforms, which also forced the IMF Stand-by-Arrangement to be extended three times (in May 1999, March 2000 and December 2000). As a result, disbursement of the second tranche (EUR 20 million) was only made in December 2000, when a Supplemental Memorandum of Understanding (SMoU), which outlines the conditions attached to the third tranche of EUR 15 million grant, was also signed.

2. Recent developments and outlook

General elections took place in November 2000; however, only after protracted negotiations and the intervention of the OHR could governments be formed in both Entities and the State. They were formed in January 2001 in Republika Srpska (RS,) February in the State and March in the federation of BiH (FBiH). The elections and the ensuing protracted period of negotiations delayed substantially economic reform and led to an extended legislative paralysis. Yet, new governments appear reform-oriented and eager to regain momentum.

GDP growth has decelerated from 10% in 1999 to an estimated 5% in 2000, from an original forecast of around 12%. Adherence to the rules of the currency board arrangement, with the Konvertible Marka (KM) pegged on a 1:1 basis against the deutsche mark (Euro), has helped to moderate inflationary pressures; the country-wide average inflation rate increased in 2000 from 31/4 to 51/2 %.

Weak fiscal discipline and poor expenditure control continue to be a major source of macroeconomic risk, as recently revealed by OHR/OSCE special audits conducted at the level of Entity budgets. General government expenditure remains very high (at about 56% of GDP). Reducing unproductive expenditure and downsizing the public sector, while protecting social expenditure and increasing capital expenditure are key elements in the strategy towards a sustainable fiscal stance.

The recovery of exports initiated in 2000, coupled with imports decline, continues. As a result, the current account deficit (excluding transfers) is expected to narrow further in 2001 - to 20.8% of GDP, from 22.2% in 2000. Very little changes are expected in foreign reserves for 2001, while transfers for reconstruction and capital inflows (including some foreign direct investment) are estimated to finance most of the current account deficit. However, the IMF estimates for 2001 a financing gap (after IFIs programmes) of USD 60 million.

In May 2001 BiH completed the IMF stand-by-arrangement approved in May 1998. The policy measures to be included in a Letter of Intent for another stand-by programme have already been identified and notified to the authorities in mid-June, and an agreement could be in place before year-end.

3. Extension of the legal base beyond the year 2000

Bosnia and Herzegovina requires continued financial support from the Community and other bilateral and multilateral donors in support of its economic stabilisation and reform efforts. However, the underlying Council decision (1999/325/EC of 10 May 1999) was founded on the expectation that the economic stabilisation and reform programme of the BiH authorities, as agreed under the IMF stand-by-arrangement, would be implemented by the first half of 2000. Accordingly, Article 1(3) of the Council Decision stipulates that the grant component of a maximum of EUR 40 million of this assistance covers the period from 1999 to 2000.

Against this background, it now appears necessary to amend the existing legal base, i.e. Council Decision 1999/325/CE, so as to allow the continued implementation of this assistance, and in particular the remaining grant component of EUR 15 million beyond the year 2000. In line with budgetary requirements, the amended Council decision would stipulate an expiry date of funds by 31 December 2002.

2001/0250 (CNS)

Proposal for a COUNCIL DECISION amending Council Decision 1999/325/EC providing macro-financial assistance to Bosnia and Herzegovina

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community, and in particular Article 308 thereof,

Having regard to the proposal from the Commission [1],

[1] OJ C [...], [...], p. [...].

Having regard to the opinion of the European Parliament [2],

[2] OJ C [...], [...], p. [...].

Whereas:

(1) Council Decision 1999/325/EC [3] provides macro-financial assistance to Bosnia and Herzegovina comprising a loan component of a maximum principal of EUR 20 million and a grant component of a maximum of EUR 40 million;

[3] OJ L 123, 13.5.1999, p. 57-59

(2) Due to delays in the implementation of the required policy reforms as agreed within the Stand-by Arrangement with the International Monetary Fund, so far only a first (EUR 25 million) and a second tranche (EUR 20 million) could be released. A third and final tranche of up to EUR 15 million is still outstanding;

(3) Bosnia and Herzegovina is committed to a continued economic stabilisation and reform path and continues to require external financial support in addition to what can be provided by International Financial Institutions;

(4) The existing Council decision 1999/325/EC does not permit the commitment of grant funds beyond the year 2000;

(5) The Commission has consulted the Economic and Financial Committee before submitting its proposal.

HAS DECIDED AS FOLLOWS:

Sole Article

Decision 1999/325/EC is hereby amended as follows:

1. Article 1 (3) shall be replaced by the following: "The grant component of this assistance shall amount to a maximum of EUR 40 million."

2. A new Article 6 shall be inserted: "This decision expires on 31.12.2002."

Done at Brussels, [...]

For the Council

The President

[...]

FINANCIAL STATEMENT

1. Title of operation

Macro-financial assistance to Bosnia and Herzegovina.

2. Budget heading involved

Grant component of the assistance

B7-548: Macro-economic assistance in favour of Western Balkan Countries.

Loan component of the assistance

Heading B0-211 reflecting the European Community guarantee for borrowing programmes contracted by the Community to provide financial assistance for non-member countries in Central and Eastern Europe.

3. Legal basis

Article 308 of the Treaty.

4. Description and justification for the action

a) Description of the action

Provision of a Community loan (to be financed by Community borrowing in the international capital markets), in the amount of up to EUR 20 million, and a grant of up to EUR 40 million (to be financed by the general budget) to Bosnia and Herzegovina.

A first tranche of EUR 25 million (comprising EUR 15 million grant and EUR 10 million loan) was released in December 1999, while the second tranche of EUR 20 million (EUR 10 million grant and EUR 10 million loan) was disbursed in December 2000. The third tranche (EUR 15 million grant) is expected to be released before the end of 2001.

b) Justification for the action

The action is in support of Bosnia and Herzegovina's reform efforts and the implementation of common institutions and policies, consistent with the Dayton peace agreement. The sustainability of the beneficiary country's macro-economic stabilisation efforts and economic and institutional reforms heavily depends on external financial assistance from official sources, at concessional terms.

5. Classification of the expenditure

Grant component: non compulsory expenditure, differentiated.

Loan component: compulsory.

6. Nature of the expenditure

Straight grants (100% subsidy), which would be released in at least two successive instalments.

Potential activation of budget guarantee for the Community borrowing aimed to fund the loan to Bosnia and Herzegovina.

7. Financial impact

a) Method of calculation

The evaluation of the amount of the assistance deemed necessary was based on the estimates of Bosnia and Herzegovina's residual external financing needs.

For the loan component of this assistance, a token entry is proposed because it is expected that the budget guarantee will not be called, and in any case the amount and timing of any call on this budget line cannot be calculated in advance.

b) Effect of the action on intervention credits

The budget entry corresponding to the grant component of this assistance will be activated subject to compliance with a number of policy conditions to be agreed with the authorities of Bosnia and Herzegovina.

The budget entry reflecting the budget guarantee for the loan component of this assistance will be activated only in the case of an effective call on the guarantee.

c) Financing of the intervention expenditure

(i) Grants

- The financing of the expenditure is available at B7-548.

The following schedule of appropriations is proposed (in million EUR):

>TABLE POSITION>

The budget appropriations necessary to implement the third tranche of this assistance, both in commitment credits and in payment credits, are already available on the relevant budget line (B7-548).

(ii) In case of call on the budget guarantee:

- Recourse to the Guarantee Fund established by Council Regulation (EC, EURATOM) n° 2728 of 31 October 1994.

- In case the Guarantee Fund did not contain sufficient resources, additional payments would be called up from the budget by transfer:

- of any margin remaining in the Reserve for guarantees;

- of any late payments to the budget for which the budget guarantee has been activated (under article 27(3) of the Financial Regulation);

- of any margin available under the ceiling of category 4 of the financial perspectives or redeployment therein.

- In order to fulfil its obligations, the Commission can provisionally ensure the debt service with funds from its treasury. In that case, Article 12 of the Council Regulation (EEC, EURATOM) n° 1552/89 of 29.5.1989 will apply.

8. Fraud prevention measures

The funds will be paid directly to the Central Bank of the beneficiary country only after verification by the Commission Services, in consultation of the Economic and Financial Committee and in liaison with the IMF and World Bank Services, that the macro-economic policies implemented in Bosnia and Herzegovina are satisfactory and that the specific conditions attached to this assistance are fulfilled.

9. Elements of cost-effectiveness analysis

a) Grounds for the operation and specific objectives

By supporting Bosnia and Herzegovina's macroeconomic reform efforts and complementing financing by the International Community provided in the context of the IMF-supported programme, this assistance would ease the country's external financing constraints, would improve its growth prospects and would help its transition towards a market economy

b) Monitoring and evaluation

This assistance is of macro-economic nature and its monitoring and evaluation is undertaken in the framework of the IMF-supported adjustment and reform programme that Bosnia and Herzegovina is implementing.

The Commission services will monitor the action on the basis of a genuine system of macro-economic and structural policy indicators to be agreed with the authorities of the beneficiary country. They will also remain in close contact with the IMF and World Bank services and will benefit from their assessment of Bosnia and Herzegovina's reform achievements.

An annual report to the European Parliament and to the Council is foreseen in the proposed Council decision, which will include an evaluation of the implementation of this operation.

10. Administrative expenditure

This action is exceptional in nature and will not involve an increase in the number of Commission staff.