Report from the Commission to the Council - The possibility of the European Investment Bank lending in Bosnia-Herzegovina
Date: 1998-03-04
Institutions: European Commission
Subjects: Bosnia and Herzegovina, European Investment Bank, aid for restructuring, financing policy

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 04.03.1998 
COM(1998) 95  final 

REPORT FROM THE COMMISSION TO COUNCIL 

THE POSSIBILITY OF THE EUROPEAN INVESTMENT BANK 

LENDING IN BOSNIA-HERZEGOVINA 

.•is 
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THE POSSIBILITY OF THE EUROPEAN INVESTMENT BANK 

LENDING IN  BOSNIA-HERZEGOVINA 

1.  Introduction 

In  the  light  of  recent  developments  in  Bosnia-Herzegovina  (BiH),  ECOFIN 
requested  the Commission  on February  16 to examine,  in collaboration  with  the 
European  Investment  Bank (EIB), the possibility  of the  Bank providing  loans  in 
this country. 

Besides  humanitarian  aid,  BiH  together  with  other  ex-Yugoslav  republics, 
receives reconstruction  aid under the Council  Regulation No  1628/96 of 25 July 
1996  and  under  the  PHARE  Regulation. 
In  view  of  the  urgent  needs  for 
reconstruction  in BiH however, the Commission  is in favour  of inviting  the EIB 
to extend its lending activities to BiH, while taking into account the particularities 
of  the  political  economic  and  financial  environment  of  the  country.  The 
possibility of mobilising Bank loans in this country must be seen as a special and 
exceptional  action  whose  main  objective  would  be  to  contribute  to  the  speedy 
reconstruction  of the country and, in the process, to facilitate  the  communication 
and the integration of the different  communities living in the area. 

The  EIB  has  expressed  its  willingness  in  principle  to  start  operations  in  BiH 
provided  there  is  a  formal  Council  Decision  granting  a  Community  Budget 
guarantee  for  these  operations  and  subject  to  a positive  decision  of  its  Board  of 
Governors.  The  EIB  indicated  having  undertaken  preparatory  work  to  identify 
the  areas  of  possible  Bank 
the 
Reconstruction  Programme agreed by the International  Community  at  successive 
Donors'  Pledging  Conferences  sponsored  by  the  Commission  and  the  World 
Bank. 

intervention  within 

the  framework  of 

2.  Political, economic and financial  background 

2.1.  Political background 

According  to  the  Dayton/Paris peace  agreement  signed  on  December  14,  1995, 
BiH was to remain a single state being composed  of two Entities, the Federation 
of  Bosnia-Herzegovina  and  the  Republika  Srpska  (RS).  The  implementation  of 
Dayton  involves  military  and  civilian  aspects  contributing  in  parallel  to 
regenerate  confidence  and  stability,  which  are  monitored  annually  by the  Peace 
The  military  aspects  have  been  dealt 
Implementation  Council  (PIC). 
successfully.  However, a military presence will remain necessary  for  some time. 
Civilian  implementation  has  been  much  slower.  It  is  coordinated  by  the  High 
Representative whose mandate was reinforced  at the last PIC conference  in Bonn 
on December  9-10,  1997.  The appointment  of a pro-Dayton  government  in the 
RS  has  paved  the  way  for  an  improved  cooperation  by  this  entity  with  the 
international  community,  making  the  political  and  economic  outlook  more 
favourable  for the country as a whole. 

In  the  absence  of  a  Protocol  on  Financial  Cooperation  between  BiH  and  the 
Community,  which  usually  provides  with  the  framework  (objectives  and 
conditions) of the EU financial cooperation with third countries, the  involvement 
of  the  EIB  in  BiH  should  be  consistent  with  the  policy  of  the  Union  in  this 
country  and  supportive  of  the  objectives  of  the  Dayton/Paris  agreement  and 
subsequent obligations. 

2.2.  Economic developments 

By  1995, GDP in BiH had shrunk to less than a third of its pre-war level and per 
capita  GDP  had  fallen  to  US$500.  The  population  was  23%  smaller  than  in 
1991, over 50 % of the population had been displaced, and more than  1.2  million 
inhabitants  were  forced  to  flee  abroad,  mainly  to the  EU.  Physical  capital  and 
infrastructure  had  been  devastated.  With  the  end  of  the  war,  the  economy 
recovered strongly, fuelled  by external assistance, mainly in the Federation. Real 
GDP growth reached  50% in  1996 for the country as a whole, but decelerated  to 
about  30% in  1997 owing to a slower pace of financial assistance. In  particular, 
the  RS  has  suffered  self-imposed  isolation  from  the  internationally-sponsored 
Reconstruction  programme  and  has  benefited  only  from  humanitarian  aid. 
Unemployment  is reported  high  in both the Federation  and RS (up to  50%) and 
represents  a serious threat to  social  stability  and peace.  Considering  the  deficit 
of the trade balance  (estimated  at about US$ 2 billion  in  1997 by the IMF  with 
imports  as  high  as  US$  2.7  billion),  the  recovery  of  economic  activity  and 
employment will continue to heavily rely on the availability  of official  financial 
flows. 

In  1995,  the  international  community  endorsed  a  medium-term  programme  for 
reconstruction  and peace implementation activities in BiH amounting to US$  5.1 
billion  for  the  period  1996-99  which  included  the  following  areas  among  its 
priorities:  basic  infrastructure,  housing,  energy,  telecommunications,  transport, 
and  water  and  waste  management. 
Following  three  Donors'  Pledging 
conferences, US$ 1.6 billion of aid had been donated to BiH by the end of  19971, 
of  which  45%  originated  from  the  Community  and  the  Member  States.  In 
January  1998, the Council welcomed the formation  of the new government in the 
RS  and  decided  to  immediately  support  it  in  the  form  an  initial  emergency 
budgetary  grant  in  the  amount  of  up  to  ECU  6  million  and  to  examine  the 
possibilities  for  further  assistance.  Moreover,  in  view  of  weak  implementation 
capacities  in  both  Entities,  the  Council  is  presently  discussing  a  Commission 
proposal  aiming  at  streamlining  the  financial  regulation  governing  its  financial 
assistance to BiH. 

2.3.  External financial  situation and prospects 

The  external  debt  of  BiH  was  estimated  at  US$4.6  billion  at  end-1996, 
equivalent  to over  160 % of GDP.  Against  an  accumulation  of  external  arrears 
of  some  US$  2  billion,  the  authorities  have  tried  to  normalise  relations  with 
external  creditors.  Arrears  to  the  IMF  and  the  World  Bank  were  cleared  in 

1  See Bosnia  and  Herzegovina:  Implementation  of the Priority  Reconstruction  Program,  Status  Report 
to the Donor Community, November  1997. 

December  1995  and  June  1996,  respectively.  An  agreement  with  the  London 
Club  creditors  was  reached  in  July  1997  on  the  restructuring  of  over  US$1 
billion debt.  Negotiations with Paris club creditors are expected to be concluded 
soon  after  the  authorities  reach  agreement  on  an  IMF-supported  programme. 
Clearance  of  arrears  to  the  EIB,  which  amounted  to  approximately  ECU  6 
million  (including  penalties)  at  end-1997,  will  also  have  to  be  dealt  within  the 
framework  of the  IMF-supported  programme  as  a precondition  for  an  effective 
involvement of the EIB in BiH. 

Prospect  for the early conclusion of an IMF-supported  programme  have  recently 
improved, pending the adoption of satisfactory  and mutually-consistent  State and 
Entity  budgets  for  1998, including  the  establishment  of  automatic  mechanisms 
for external  debt service payments. In particular, a number of essential  legislation 
establishing  common  foreign  trade  and  debt  policies  was  adopted  in June  1997. 
The  new  Central  Bank  of  BiH  launched  its  operations  in  August  1997  and  the 
design of the new common currency  (the convertible marka) was imposed  on all 
parties  in  January  1998.  Despite  these  achievements,  much  more  needs  to  be 
done  to  effectively  implement  open  and  market-oriented  economic  policies  and 
ensuring  good  governance,  transparency,  and  accountability  in the  use  of  donor 
fund. 

3.  Prospects for Bank operations 

3.1  As  a  rule,  the  EIB  intervenes  outside  the  Community  in  the  framework  of 
protocols, co-operation or association agreements signed between the Community 
and  a  particular  country.  In  the  absence  of  a  Financial  Protocol  or  Agreement 
between  BiH and the Community,  the involvement of the EIB in BiH should be 
consistent with the policy of the Union in this country. 

3.2  The Bank's  involvement  in BiH  would  require a Council  Decision, on the  basis 
of a Commission  proposal,  under  Article  235  with  consultation  of the  European 
Parliament,  indicating  the  Community  guarantee  arrangements  as  well  as  the 
amount  for  the  new  commitment.  The  Council  Decision  would  indicate  that  the 
new  lending  mandate  is  in  addition  to  that  defined 
in  Council  Decision 
97/256/EC of  14 April 1997. 

The EIB operation in BiH would be of exceptional  nature.  An amount of  about 
ECU  100 million  could  be  envisaged  on  EIB  lending  on  own  resources.  This 
amount could be reconsidered  on the basis of the experience.  Towards this  end, 
the Commission  and the EIB will present to Council  a report with the evaluation 
of  the  situation  no  later  than  one  year  after  the  entry  into  force  o'f the  eventual 
Council Decision. 

3.3  The  conclusion  and  implementation  of  a  Stand-By  IMF  programme  and 
subsequent  arrangements will be crucial  for ensuring BiH's capacity to repay  the 
EIB, including through the mobilization  of large scale external  assistance, with a 
high degree of concessionality . 

3.4  In view of the low income and BiH's eligibility to IDA, EIB loans would need to 
be combined with a substantial grant element from the Community Budget for the 
Bank to intervene effectively.  This could take the form of interest subsidy and/ 
or  cofinancing  on  a  case-by-case  basis.  Moreover,  the  Bank  could  consider 
granting longer then the usual grace period. 

3.5  Further  to  a  decision  on  a  specific  mandate  and  the  appropriate  guarantee 
arrangements,  the  Bank's  intervention  in  BiH  is  also  subject  to  the  previous 
clearance of all arrears (see section 2.3). 

3.6  The Bank would operate, within the framework of the Reconstruction programme 
agreed at the various Donors' conferences, in sectors where its contribution and 
expertise can play a meaningful  role and with its intervention aim to the regional 
integration  of  the  area.  The  sectors  that  could  benefit  from  possible  Bank 
financing  are  general  infrastructure  including  transport  (in  particular  the 
reconstruction  of  roads and bridges), energy, telecommunications,  environment 
(with focus on the water, waste water and sanitation projects).  At a later state, 
when  structural  reforms  are  implemented,  the  industrial  sector  could  also  be 
considered. 

3.7  Projects  to  be supported  by the  Bank would  have to  meet  the Bank's  lending 
criteria notably those concerning economic, technical and financial viability and 
be in line with the relevant Community  legislation.  The Bank's  usual  lending 
conditions will apply. 

3.8  As for other lending mandates, the possible EIB loans in BiH would be subject to 

the arrangements set out in the Guarantee Fund Regulation. 

4.  Conclusion 

hi the light of the above, should the Council be favourable to the EIB carrying out 
its operations in Bosnia-Herzegovina, the Commission would prepare a proposal 
for  a  decision  granting  the  Community  Budget  guarantee  to  the  EIB  for  its 
operations in this country. 

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COM(98) 95 final 

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