Commission staff working document - Ex ante evaluation statement – Macro-financial Assistance to Bosnia and Herzegovina - Accompanying document to the Proposal for a Council Decision providing macro-financial assistance to Bosnia and Herzegovina {COM(2009)596}
Date: 2009-10-29
Institutions: European Commission
Subjects: Bosnia and Herzegovina, EU aid, aid evaluation, economic situation, economic stabilisation, financial aid, macroeconomics

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COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 29.10.2009 
SEC(2009) 1459 

COMMISSION STAFF WORKING DOCUMENT 

Ex ante evaluation statement – Macro-financial Assistance to Bosnia and Herzegovina 

Accompanying document to the 

Proposal for a COUNCIL DECISION providing macro-financial assistance to Bosnia and 
Herzegovina 

{COM(2009)596} 

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Table of Contents 

1. 

1.1. 

1.2. 

1.3. 

1.4. 

2. 

2.1. 

2.2. 

3. 

3.1. 

3.2. 

4. 

5. 

6. 

6.1. 

6.2. 

7. 

Problem analysis and needs assessment....................................................................... 3 

Background .................................................................................................................. 3 

Recent economic developments and prospects ............................................................ 4 

The Government's economic and fiscal reform agenda ............................................... 6 

External and budgetary financing needs in Bosnia and Herzegovina .......................... 8 

Objectives and Related Indicators of the macro-finantial assistance ........................... 9 

Objectives..................................................................................................................... 9 

Indicators.................................................................................................................... 10 

Alternative delivery mechanisms and risk assessment .............................................. 10 

Delivery mechanisms ................................................................................................. 10 

Risk assessment.......................................................................................................... 10 

Added value of Community involvement .................................................................. 11 

Genval criteria ............................................................................................................ 11 

Planning future monitoring and evaluation................................................................ 13 

Monitoring.................................................................................................................. 13 

Evaluation................................................................................................................... 13 

Achieving cost-effectiveness...................................................................................... 13 

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1. 

PROBLEM ANALYSIS AND NEEDS ASSESSMENT 

1.1. 

Background 

Bosnia  and  Herzegovina  relies  on  external  macro-economic  assistance  to  face  the  current 
crisis and to restore the sustainability of its fiscal and external accounts. In recent years, the 
country followed an unsustainable growth model characterised by high domestic demand, fed 
by high credit growth, external financing and expansionary pro-cyclical fiscal policies. This 
was  increasingly  accompanied  by  macroeconomic  imbalances,  in  particular  a  widening 
current account deficit, which exacerbated Bosnia and Herzegovina's exposure to the global 
economic  and  financial  crisis.  As  in  most  emerging  economies,  medium-term  growth 
prospects have been severely dampened, and the economy will be in recession in 2009. 

Economic activity started to fall in the final quarter of 2008 and continued this fall in the first 
half  of  2009.  Trade  dynamics  slowed  significantly  and  only  the  re-opening  of  a  large  oil 
refinery  in  December  2008  prevents  country-wide  industrial  output  to  fall  into  double-digit 
negative year-on-year growth rates. Annual inflation rates turned negative in May 2009 and 
the country's official foreign exchange reserves shrank fast. Financial stability was threatened 
in  October  2008  when  some  12%  of  deposits  were  withdrawn  in  only  one  month. 
Nonetheless, the situation in the domestic financial market stabilised quickly. Credit growth 
has been flat since September 2008 and deposits have been shrinking.  

The constitutional set-up of the country following the Dayton/Paris peace agreement with two 
largely autonomous entities, the Muslim-Croat Federation of Bosnia and Herzegovina and the 
Serbian Republika Srpska, has important impacts on the fiscal framework of the country, as 
the main fiscal competence lies with the entities. Due to a more ambitious privatisation and 
structural  reform  agenda,  the  fiscal  space  was  larger  in  the  Republika  Srpska  than  in  the 
Federation.  Nevertheless,  fiscal  policy  has  been  pro-cyclical  in  both  entities  and  fiscal 
discipline was loosened in previous years when especially social transfers and public sector 
wages  were  unsustainably  increased.  The  system  of  generous  non-targeted  benefits  for  war 
veterans, demobilised soldiers and other social groups and their wide-spread misuse continued 
to  be  a  drag  on  the  budget,  especially  in  the  Federation  where  social  transfers  absorb 
approximately one third of the budget.  

In early  2009,  the repercussions  of  the economic slowdown were increasingly felt in public 
budgets.  In  an  attempt  to  mitigate  this  effect,  the  National  Fiscal  Council  unblocked  some 
EUR  90  million  from  succession  funds  of  former  Yugoslavia's  assets  which  are  part  of  the 
central  bank's  reserves.  Nonetheless,  this  proved  to  be  insufficient  as  public  finances 
increasingly  came  under  stress  on  the  back  of  falling  revenues  and  high  spending 
commitments.  Faced  with  the  deteriorating  economic  environment  and  the  legacy  of  poor 
fiscal  policies,  the  authorities  of  all  government  levels,  represented  by  the  National  Fiscal 
Council, therefore concluded in early May 2009 negotiations with the International Monetary 
Fund on a Stand-By Arrangement. The authorities committed to rebalance the budgets and to 
adopt  a  three-year  budget  framework  as  prior  action  before  the  EUR  1.15  billion  loan  for  a 
three-year  period  was  approved  by  the  IMF  board  on  8  July  2009.  The  first  instalment  of 
around  EUR  203  million  was  disbursed  immediately  afterwards  and  was  channelled  to  the 
budgets  of  the  Federation  (2/3)  and  the  Republika  Srpska  (1/3).  The  proposed  Community 
macro-financial  assistance  will  contribute  to  covering  Bosnia  and  Herzegovina's  residual 
external financing needs in 2010 as identified by the International Monetary Fund and may be 
channelled to the budgets in order to alleviate acute budgetary needs. 

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According to the latest household budget survey from 2007 18.6% of the population in Bosnia 
and  Herzegovina  can  be  regarded  as  poor,  virtually  unchanged  since  the  beginning  of  the 
decade despite robust economic growth. The projected decline in GDP is likely to affect poor 
parts  of  the  population  particularly  hard.  However,  in  the  context  of  the  IMF  programme  it 
was  agreed  to  replace  the  highly  inefficient  system  of  non-targeted  social  transfers  by  a 
means-tested  scheme  over  the  medium-term  which  is  meant  to  target  those  really  in  need. 
This may alleviate the impact of the crisis on poor households over the medium term. 

1.2. 

Recent economic developments and prospects 

Between 2003 and 2008 real GDP grew by 6% in an annual average. This strong economic 
growth was accompanied by a widening current account deficit and increasing private sector 
debt.  Although  exports  grew  rapidly,  domestic  demand  grew  even  faster  which  resulted  in 
very high import levels and consequently a trade deficit reaching about 38% of GDP in 2008. 
Foreign  direct  investments  (FDI)  were  quite  volatile  in  recent  years,  closely  linked  to  the 
privatisation agenda. In 2008, FDI accounted for 5.5% of GDP, declining sharply (by 55%) 
compared  to  2007,  mainly  as  the  result  of  a  high  base  due  to  major  privatisation  deals 
implemented in 2007. Domestic overheating and external imbalances have been exacerbated 
by expansionary fiscal policies and a worsening fiscal position since 2006. The fiscal balance 
of  the  consolidated  government  sector  moved  from  a  surplus  of  2.2%  of  GDP  in  2006  to  a 
small deficit of 0.1% of GDP in 2007 and then further to a deficit of 4% of GDP in 2008. 

In 2008, real GDP growth fell to 5.5% from 6.8% in 2007. The global economic and financial 
crisis  started  to  reveal  its  impact  on  Bosnia  and  Herzegovina  in  the  last  quarter  2008. 
Economic  activity  in  the  construction,  metal  and  automobile  industries,  but  also  in  the 
services  sector  slowed  down  and  companies  started  to  lay  off  workers.  The  slowdown  of 
economic activity continued in 2009, as domestic demand contracted. Nonetheless, available 
short-term indicators such as industrial production suggest a rather mixed situation: While in 
the  Federation  of  Bosnia  and  Herzegovina  (which  accounts  for  roughly  two  thirds  of  the 
country's economy)  industrial  production fell by 10.4% annually in the first half of 2009, it 
grew by 17.1% in the Republika Srpska (which accounts for roughly the remaining third of 
the economy). However, the increase in the Republika Srpska is almost entirely due to the re-
opening of an oil refinery in December 2008.  

The  current  account  deficit  widened  to  14.7%  of  GDP  in  2008,  up  from  12.7%  in  2007, 
mainly driven by developments of global prices and internal demand during the first half of 
2008. It was more or less equally financed by foreign direct investments and drawings of new 
loans from abroad. While the trade deficit was still slightly growing in 2008, the development 
of other components of the current account showed somehow reversing trends as compared to 
previous  years:  The  income  balance  increased  by  only  3.5%  (24%  in  2007)  and  current 
transfers  fell  by  6.7%  (after  an  increase  of  11.3%  in  2007),  mainly  because  of  falling 
remittances that dropped by 4%. However, trade dynamics slowed down towards the end of 
2008 on the back of reduced demand, with imports shrinking faster than exports. The monthly 
trade deficit improved for the first time in more than two years in November 2008. In the first 
half of 2009, the drop in imports (25.3%) exceeded the one in exports (23.4%), resulting in an 
improvement  of  the  trade  deficit  by  26.7%.  Consequently,  the  current  account  deficit  more 
than halved year-on-year in the first quarter, falling to only around 10% of GDP. This drop 
was  mainly  due  to  developments  in  trade  described  above,  but  also  a  slightly  rising  current 
transfer balance contributed to it, as remittances were 6.4% higher year-on-year. In the first 
half of 2009, FDI shrank by 32% year-on-year as a result of worsened investors' sentiments in 

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the  context  of  the  global  economic  crisis.  Official  foreign  exchange  reserves  declined  by 
16.8% until June 2009 since their peak in September 2008. However, they still stand at 23% 
of GDP, covering more than five months of imports. 

Tensions on the  global  financial markets spilled over to the country and resulted in a "mini 
bank-run" in October 2008 when some EUR 420 million of deposits (some 12% of the stock 
of deposits) were withdrawn. Foreign parent banks injected liquidity to their local subsidiaries 
and the Central Bank of Bosnia and Herzegovina reacted firmly and adequately by inter alia 
gradually  reducing  the  minimum  reserve  requirements  for  banks  so  that  the  situation 
stabilised  quickly.  The  value  of  guaranteed  bank  deposits  was  more  than  doubled  in  a  first 
step to around € 10,200 in early 200 9 and a further increase is planned with the support of the 
EBRD.  Despite  the  repercussions  of  the  global  financial  crisis  on  Bosnia  and  Herzegovina, 
the  financial  sector  remained  sound  and  well-capitalised  and  its  liquidity  position  was  not 
seriously  undermined.  It  is  based  on  a  relatively  conservative  business  model  and  has 
weathered the effects of the global financial crisis well. 

Annual  credit  growth  is  still  positive  (5.6%  in  June  2009)  but  has  come  down  significantly 
from  the  excessive  rates  of  between  25%  and  30%  recorded  until  July  2008.  Between 
September 2008 and June 2009 the stock of loans grew by only 1%. Both private enterprises 
and households reported a moderation of their indebtedness' growth. Restrictions came from 
both  the  demand  and  supply  side.  Total  deposits  decreased  by  9.8%  from  their  peak  in 
September 2008 until June 2009, after the monthly deposit growth had always been positive 
since  the  introduction  of  the  currency  board  in  1997.  The  drop  was  mainly  caused  by 
withdrawals  from  private  sector  agents.  As  a  result,  deposits  fell  by  6.2%  year-on-year  in 
June. Due to the falling deposits, the loans to deposit ratio increased from 110% in September 
to 124% in June.  

Bosnia and Herzegovina's monetary policy is based on a currency board arrangement with the 
euro  as  the  anchor  currency.  The  arrangement  enjoys  a  high  level  of  confidence  and 
credibility  and  has  functioned  smoothly  since  its  induction  in  1997.  It  has  so  far  also 
succeeded under the hard peg to the euro in sheltering the economy from balance sheet risks 
caused by fluctuations in the exchange rate and a currency mismatch in the loan portfolio. 

The  annual  country-wide  change  of  the  consumer  price  index  turned  negative  in  May  2009 
and  fell  to  -1.8%  in  June,  down  from  its  peak  of  nearly  10%  in  July  2008.  The  12-month 
moving average inflation rate fell to 3.8% in June, compared to 7.4% in 2008.  

The outlook for the current year and beyond remains difficult. The macroeconomic scenario 
depicted in the IMF programme for 2009 is characterised by zero credit growth, low FDI and 
fiscal retrenchment, leading to a sharp drop in domestic demand, equally distributed between 
investment  and  consumption.  GDP  is  expected  to  contract  by  3%  in  2009  and  only  slightly 
pick up by 0.5% in 2010. This is on account of a sharp drop in external and domestic demand 
(limited  access  to  credit,  recession  in  the  EU).  According  to  IMF  calculations,  the 
consolidated  fiscal  deficit  will  reach  4.7%  of  GDP  in  the  current  year  and  then  gradually 
decrease to 4.0% in 2010 and 2.7% in 2011. The current account deficit will fall from 14.7% 
of GDP in 2008 to 9.7% in 2009 and 9.5% in 2010. Both imports and exports will decrease, 
and so will remittances and capital inflows, including FDI which are set to reach 50% of their 
2008  level  and  roughly  one  third  of  the  average  of  the  years  2004-2008.  No  privatisation 
proceeds are foreseen for 2009. A drop of official foreign exchange reserves by 9% year-on-
year is assumed and inflation is expected to be low at 1.6%, roughly in line with the euro area. 

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Table 1: Key macroeconomic data 

Indicators 

GDP real growth 

Investments, % GDP 

CPI inflation (average), % 

Public Finance 

Revenue and grants (% GDP) 

Expenditure (% GDP) 

Fiscal Balance, after grants (% GDP) 

External Position 

2008

2009

2010 

2011 

2012

5.5

24.4

7.4

45.8

49.9

-4.0

-3.0

20.2

1.6

45.0

49.7

-4.7

0.5 

4.0 

23.1 

24.8 

2.3 

2.5 

45.9 

49.9 

-4.0 

45.9 

48.6 

-2.7 

6.0

24.9

2.5

45.7

47.3

-1.5

Current account balance (% GDP) 

Gross reserves (months of imports) 

-14.7

5.5

-9.7

4.7

-9.6 

4.5 

-9.5 

4.4 

-9.1

4.5

Debt 

Public Debt (% GDP) 

External debt service (% of exports) 

Source: IMF 

27.8

8.0

34.7

11.3

39.8 

12.3 

40.3 

12.5 

38.0

11.5

1.3. 

The Government's economic and fiscal reform agenda 

The  strategic  setting  for  reforms  in  Bosnia  and Herzegovina has been and is to large extent 
defined by the ongoing work on Bosnia and Herzegovina’s integration into the EU. The EU 
provides guidance to the authorities of Bosnia and Herzegovina on reform priorities as part of 
the  European  Partnership  which  was  adopted  in  February  2008.  The  Stabilisation  and 
Association Agreement (SAA) was signed in June 2008, together with an Interim Agreement 
which focuses on trade and trade-related areas. The Interim Agreement entered into force on 1 
July 2008. Bosnia and Herzegovina has developed an Action Plan and established joint bodies 
between the State level and Entity institutions for implementation of the SAA and the Interim 
Agreement.  The  National  Fiscal  Council  started  operating  in  September  2008  and  has 
gradually taken over a coordinating role for fiscal policies.  

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The programme with the IMF that was negotiated by the National Fiscal Council included a 
set of prior actions: a) the adoption of rebalanced budgets in the Federation and the Republika 
Srpska  and  savings  in  the  2009  state  budget;  b)  the  increase  of  excise  taxes;  and  c)  the 
adoption of a global budgetary framework. Fiscal adjustments are aimed at bringing down the 
consolidated  budget  deficit  from  7.8%  of  GDP  without  modification  to  4.7%  of  GDP. 
Adjustments  amount  to  2.3%  of  GDP  on  the  expenditure  side,  the  bulk  of  which  (1.7%  of 
countrywide  GDP  or  EUR  212  million)  is  to  be  borne  by  the  Federation,  while  the  Serb 
Republic  contributes  0.5%  of  GDP  (EUR  60  million,  including  municipalities  and  health 
funds) and the state level 0.2% of GDP (EUR 20 million). Corrections take place mainly via 
reductions  of  wages,  allowances  and  social  transfers.  Current  spending  is  reduced  by 
approximately 10% while capital expenditures are not affected. On the revenue side, a law of 
increased excises on tobacco, coffee and petroleum was adopted and entered into force as of 1 
July 2009. It has an estimated impact of EUR 83 million in 2009 (0.7% of GDP).  

Box 1 – Short-term measures of fiscal adjustment under the IMF programme 

Measures on the expenditure side are intended to save EUR 292 million (2.3% of GDP). These include:  

-  On the state level (EUR 20 million): a reduction of spending on wages by 8%, meal allowances by 

- 

- 

35% and vacation allowances by 20%; 
In the Federation (EUR 212 million): a 10% reduction of all budget users and of all transfers to 
different social groups; a ceiling of 1% of the average wage on meal allowances; a reduction of the 
vacation allowance to 50% of the average wage from 75% of the individual wage; a suspension of 
allowances for participation in commissions, overtime work and contractual services, additional 
savings by cantons, municipalities and social funds; 
In the Republika Srpska (EUR 60 million): a reduction of the salaries of highest paid civil servants by 
10%; lowering daily allowances for business trips; unifying the rulebook on compensation; a hiring 
freeze for one year; reduction of veteran and disability benefits; expenditure cuts on wages in 
municipalities and health funds; a redefinition of early retirement requirements. 

Measures on the revenue side are intended to raise an additional EUR 83 million (0.7% of GDP): 

- 

Increased excises on tobacco, coffee and petroleum 

In addition, the global medium-term budgetary framework was adopted by the National Fiscal 
Council  on  29  June  despite  opposition  from  the  state  level  that  voted  against  it.  The  state 
Minister  of  Finance  and  Treasury  explained  his  refusal  in  a  letter  to  the  international 
community,  stating  that  the  adopted  document  was  not  a  real  fiscal  framework  because 
relevant  data  were  missing,  and  that  the  share of  the  state  level  from  indirect  taxes  in  2010 
would be too low. 

Additional commitments to be implemented after the adoption of the SBA include structural 
reforms, especially in the Federation where needs are highest while the Republika Srpska had 
already  carried  out  more  ambitious  structural  reforms  in  recent  years.  Public  administration 
reforms in both entities will be pursued and the coordinating National Fiscal Council will be 
strengthened.  It  was  agreed  that  the  Federation  would  move  forward  with  privatisation, 
reform its system of rights-based transfers to a means-tested system, pursue pension reforms 
and  centralise  its  system  of  registration,  control  and  collection  of  taxes  and  social 
contributions.  Concerning  the  financial  sector  supervision,  the  authorities  will  set  up  a 
Standing  Committee  for  Financial  Stability  comprising  the  Banking  Agencies,  the  Central 
Bank, the National Fiscal Council and the Deposit Insurance Agency, in order to improve the 

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exchange  of  information,  the  analytical  capacity  and  crisis  preparedness  and  management. 
Last  but  not  least,  the  authorities  will  continuously  adhere  to  the  Currency  Board 
Arrangement as constituted under the law.  

1.4. 

External and budgetary financing needs in Bosnia and Herzegovina 

Under  the  assumptions  of  the  IMF  programme,  aiming  at  keeping  the  official  foreign 
exchange  reserves  at  their  level  of  end-May  2009,  gross  financing  needs  of  EUR  1,411 
million in 2009 will produce a financing gap of approximately EUR 433 million. For 2010, a 
strong  adjustment  programme  will  reduce  the  budget's  financing  needs  substantially,  thus 
allowing maintaining reserves to the equivalent of 4.5 months of prospective imports of goods 
and  services.  With  the  current  account  continuing  to  adjust  and  roll-over  rates  and  FDI 
improving due to enhanced confidence in economic policies and the projected recovery in the 
world economy, gross financing needs during 2011 and the first half of 2012 are projected to 
decline substantially. The total financing gap under the program would amount to EUR 1,488 
million.  The  IMF  will  provide  about  EUR  1,145  million  (600%  of  quota)  during  the 
programme period, while the World Bank has indicated commitments of EUR 189 million.  

In this context the Commission is proposing an MFA operation for Bosnia and Herzegovina 
amounting  to  a  maximum  of  EUR  100  million.  Given  Bosnia  and  Herzegovina's  moderate 
level of indebtedness it is deemed appropriate to provide this assistance in the form of loans. 
The assistance is intended to contribute to covering the residual financing needs in 2010 — 
beyond  World  Bank  and  IMF  assistance  —  and  would  correspond  to  77%  of  the  projected 
EUR  130  million  needed  as  identified  by  the  IMF.  The  remainder  of  EUR  30  million  will 
come  from  other  sources,  including  London  Club debt  deferment.  Given  the  time  profile  of 
the  needs,  the  IMF  support  will  be  more  or  less  equally  distributed  during  the  programme 
period,  while  more  than  half  of  the  World  Bank  support  will  be  disbursed  in  2009  and  the 
macro-financial assistance is planned in two tranches for 2010.  

Table 2: Summary of Financing Needs 

 (in millions of euro) 

Gross financing requirement 
Current account deficit 
Amortisation 
Government (excl. IMF) 
Other 

Financing 
Capital transfers 
Foreign direct investments 
Net bank financing 
Foreign loans 
Government 
Other 
Gross international reserves (- = increase) 
Other 

Financing gap 

2008 

2009* 

2010* 

1,986 
1,842 
143 
60 
83 

1,986 
202 
529 
655 
590 
380 
210 
206 
-199 

… 

1,411 
1,201 
211 
114 
97 

1,411 
218 
258 
82 
210 
215 
-5 
287 
-76 

433 

1,471 
1,234 
237 
117 
120 

1,471 
230 
500 
50 
315 
245 
70 
-75 
-111 

563 

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Fiscal 
Augmentation of reserves 
IMF 
World Bank 
EU 
Other (including London Club) 

Memorandum Item: 
Gross Domestic Product (in millions of euro) 

Source: IMF staff estimates 

*2009 and 2010 data are forecasts. 

… 
… 
… 
… 
… 
… 

433 
0 
305 
103 
0 
24 

292 
271 
382 
51 
100 
30 

12,550 

12,423 

12,801 

Besides  the  external  financing  gap,  the  IMF  also  identifies  uncovered  budgetary  financing 
needs:  Without  adjustment,  the  consolidated  budget  deficit  would  reach  7.8%  of  GDP  in 
2009. The IMF and the authorities have agreed to reduce it to 4.7% of GDP in the current year 
(EUR 584 million) and to 4.0% of GDP in 2010 (EUR 512 million). Available domestic and 
foreign financing adds up to 1.2% of GDP in 2009 (EUR 150 million) and to 1.7% of GDP in 
2010  (EUR  220  million).  This  would  leave  an  uncovered  budgetary  financing  gap  as 
calculated by the IMF of 3.5% of GDP in 2009 (EUR 435 million) and 2.3% of GDP in 2010 
(EUR 294 million), before the intervention of the international community. 

The IMF funds will be disbursed to the Central Bank. The first tranche of around EUR 200 
million was disbursed in July and the second one of almost EUR 100 million is planned for 
December  2009.  These  funds  are  expected  to  be  allocated  entirely  to  the  budgets  of  the 
Federation (2/3) and the Republika Srpska (1/3). As the heavy burden on the budget will ease 
out,  in  2010  only  part  of  the  EUR  375  million  that  will  be  disbursed  is  expected  to  be 
channelled  to  the  budgets,  while  the  remainder  would  be  kept  at  the  Central  Bank  to 
strengthen foreign reserves. 

2. 

OBJECTIVES AND RELATED INDICATORS OF THE MACRO-FINANTIAL ASSISTANCE  

2.1. 

Objectives 

The objectives of the proposed macro-financial assistance operation are the following: 

•  Contribute  to  covering  Bosnia  and  Herzegovina's  external  financing  needs; 

alleviate budgetary financing needs; 

•  Support the fiscal consolidation effort in the context of an IMF programme; 

•  In  this  respect,  help  Bosnia  and  Herzegovina  reduce  the  financial  constraints  on 
the implementation of its comprehensive socio-economic reform programme; 

•  Facilitate  and  encourage  efforts  of  the  authorities  of  Bosnia  and  Herzegovina  to 

implement measures identified under the European Partnership; 

•  Reinforce  the  EU's  role  in  the  economic  policy  dialogue  with  the  authorities  of 

Bosnia and Herzegovina on the programme of reforms. 

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Detailed  macro-economic  and  structural  reform  objectives  will  be  further  defined  in  the 
context of a Memorandum of Understanding, to be agreed with the authorities. 

2.2. 

Indicators 

To monitor the fulfilment of the objectives of the programme throughout the implementation 
period of the assistance, the Commission will use two types of indicators: 

•  Adherence to the IMF-supported programme; it will be a condition sine qua non 

for the implementation of the assistance; 

•  Progress  in  the  implementation  of  specific  actions  that  will  be  part  of  the 
conditions for disbursement. Those actions will be specified in the aforementioned 
Memorandum  of  Understanding.  They  will  be  consistent  with  the  policy  lines 
anchored in the IMF programme, as well as the European Partnership Priorities. 

3. 

ALTERNATIVE DELIVERY MECHANISMS AND RISK ASSESSMENT 

3.1. 

Delivery mechanisms 

Given Bosnia and Herzegovina's moderate level of indebtedness it is deemed appropriate to 
provide the foreseen macro-financial assistance in the form of loans. 

Macro-financial assistance is an untied and undedicated macroeconomic support, which helps 
the beneficiary meet its external financing needs, and may contribute to alleviating budgetary 
financing  needs.  The  loan  will  be  denominated  in  euro  and  transferred  to  the  Central  Bank 
which converts it into local currency. The loan may then be fully or partly transferred to the 
budgets of the  Federation and the Republika Srpska.  Moreover, as experienced with similar 
operations, including in Bosnia and Herzegovina, the economic policy conditionality attached 
to this support strengthens the stabilisation and reform process. 

3.2. 

Risk assessment 

There are both fiduciary and policy risks related to this macro-financial assistance operation.  

There  is  a  risk  that  this  assistance,  which  is  not  dedicated  to  specific  expenses  (contrary  to 
project  financing,  for  example),  would  be  used  in  a  fraudulent  way,  like  any  other  type  of 
assistance. Generally speaking, this risk is related to factors such as the independence of the 
central  bank,  the  quality  of  systems  and  procedures  related  to  the  management,  control  and 
oversight functions in the financial circuits and processing of such assistance, IT security and 
internal/external audit capacity of the beneficiary authorities.  

To mitigate the risks of fraudulent use, several measures will be taken. The Memorandum of 
Understanding and the loan agreement will comprise a set of provisions on inspection, fraud 
prevention, audits, and recovery of funds in case of fraud or corruption. Also, the assistance 
will  be  paid  to  clearly  identified  accounts  at  the  Central  Bank  of  Bosnia  and  Herzegovina. 
Moreover,  before  the  agreement  on  the  Memorandum  of  Understanding  is  reached,  the 
Commission  services  will  assess  the  reliability  of  financial  circuits  and  administrative 
procedures  that  are  relevant  to  this  type  of  assistance  and  will  determine  whether  the 
framework  for  sound  financial  management  of  macro-financial  assistance  is  sufficiently 
effective  in  Bosnia  and  Herzegovina  (for  details,  see  Financial  Statement,  section  7).  In  the 

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light of this assessment, specific mechanisms applying to the management of the funds by the 
beneficiaries may be introduced in agreement with the national authorities. The Commission 
may  also  use  other  assistance  instruments  at  its  disposal  to  help  the  beneficiary  authorities 
improve their public  finance management systems if this area is  not  sufficiently covered  by 
other donors. 

Finally, the assistance will be liable to verification, control and auditing procedures under the 
responsibility of the Commission, including the European Antifraud Office (OLAF), and the 
European Court of Auditors. 

As  regards  policy  risks,  the  main  assumption  is  that  the  Governments  of  the  different  state 
levels of Bosnia and Herzegovina will remain committed to fiscal adjustment and remain in 
compliance with their agreement with the IMF. This will be validated on the basis of IMF’s 
quarterly monitoring of performance indicators and structural benchmarks. There is a risk that 
the political will to pursue agreed reforms at one or the other level of government may fade as 
the pressure from lobby groups that are affected by the adjustment measures may rise.  

While seriously taking into account these risks, the Commission services consider that there 
are  sufficiently  strong  grounds  to  proceed  with  MFA  to  Bosnia  and  Herzegovina.  The 
the 
Commission  services  will  maintain  close  contacts  with 
implementation  of  the  macro-financial  assistance  in  order  to  address  quickly  any  concerns 
that may arise. 

the  authorities  during 

4. 

ADDED VALUE OF COMMUNITY INVOLVEMENT 

By  providing  financing  complementary  to  resources  made  available  to  Bosnia  and 
Herzegovina  by  the  IMF  and  the  World  Bank,  the  Community  would  support  Bosnia  and 
Herzegovina's  domestic  efforts  of  responding  to  the  impact  of  the  current  global  economic 
crisis.  It  would  encourage  and  strengthen  the  implementation  of  the  necessary  and  overdue 
structural reform and fiscal adjustment agenda. This will be particularly important in the areas 
targeted by the programme’s conditionality, in particular the fiscal consolidation effort aimed 
at reducing public expenditures to a sustainable level.  

The  macro-financial  assistance  is  a  policy-based  instrument  and  would  therefore  also 
contribute  to  support  the  European  Union’s  strategy  towards  Bosnia  and  Herzegovina,  in 
particular in the context of the European Partnership.  

5. 

GENVAL CRITERIA 

The Commission services have given due consideration to the five Genval criteria.  

•  Exceptional character: 

Bosnia and Herzegovina's financing requirements in 2009-2011 result from the country's high 
external  and  fiscal  imbalances  that  severely  aggravated  the  impact  of  the  global  economic 
crisis on Bosnia and Herzegovina. The ongoing economic adjustment, the anchor of the EU 
perspective  and  the  conditionality  of  the  IMF  programme  will  contribute  to  reducing  these 
imbalances over the medium term.  

The exceptional character of the foreseen MFA is further stressed by the limited timeframe of 
the programme. The Commission services intend to limit the duration of the implementation 

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of the assistance to one year. When deciding about the disbursement of the funds under the 
MFA programme, the Commission services intend to take into consideration the progress in 
the implementation of the IMF programme and of the World Bank development policy loans. 

•  Scope: 

Bosnia and Herzegovina is a potential candidate country for EU membership which respects 
democracy and human rights and as such can be considered as eligible for EC MFA support. 

•  Complementarity: 

The  Community  MFA  will  be  complementary  to  the  external  financing  coming  from  the 
International  Monetary  Fund  and  the  World  Bank.  It  will  cover  the  residual  financing  gap 
over  and  above  the  support  of  these  institutions  by  77%.  The  remaining  funds  will  be 
provided by other sources, including London Club debt deferment. In this context and in the 
short run, MFA will both increase substantially the European Union's leverage on Bosnia and 
Herzegovina's policy making bringing the country onto a more sustainable path of economic 
and fiscal policies.  

•  Conditionality: 

The macro-financial assistance to Bosnia and Herzegovina will be linked to an IMF stand-by 
arrangement. As usual with this type of assistance, disbursements under this macro-financial 
assistance  will  be  subject  to  progress  in  the  implementation  of  the  IMF  arrangement,  in 
particular  related  to  macroeconomic  performance  and  structural  adjustments.  It  will  also  be 
conditional  upon  further  reform  measures  that  will  be  defined  in  the  context  of  a 
Memorandum  of  Understanding  to  be  jointly  agreed  between  the  Commission  and  the 
Bosnian authorities. 

Given  the  nature  of  the  planned  operation,  in  defining  the  conditionality  in  the  area  of 
structural policies, particular attention will be paid to public finance management with a view 
to strengthening efficiency, transparency and accountability, and because of its importance for 
fiscal  consolidation.  As  Bosnia  and  Herzegovina  is  a  potential  candidate  country,  some 
measures  with  high  priority  on  the  EU  integration  agenda  may  also  be  included  in  the 
conditionality  framework.  In  addition,  the  Commission  may  consider  targeting  specific 
sectoral policies of particular importance, identified as such in the European Partnership and 
2009 Progress Report. 

•  Financial discipline: 

The  Commission  services  propose  to  limit  the  macro-financial  assistance  to  Bosnia  and 
Herzegovina to up to EUR 100 million. This corresponds currently to 77% of the amount (ex-
ante) of the residual financing gap foreseen after IMF and World Bank support as identified 
by the IMF for the year 2010. Forward looking data on the balance-of-payments gap are by 
their very nature volatile. Additional bilateral financing may materialise in the course of the 
programme that cannot yet be included in the current programme assumptions. 

Concerning sound financial management, the Commission services are taking action in order 
to  fulfil  the  requirements  of  the  Financial  Regulation.  The  Commission  will  launch  an 
Operational  Assessment  (OA)  of  the  reliability  of  financial  circuits  and  administrative 
controls  at  the  Ministries  of  Finance  of  the  state  level,  the  Federation  and  the  Republika 

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Srpska, and the Central Bank of Bosnia and Herzegovina. Based on the OA report's findings, 
the  Commission  services  will  determine  whether  the  framework  for  sound  financial 
management is sufficiently effective in Bosnia and Herzegovina. Also, the results of the OA 
will  contribute  to  the  definition  of  appropriate  conditionality  in  the  area  of  public  finance 
management. 

6. 

PLANNING FUTURE MONITORING AND EVALUATION 

This  assistance  is  of  exceptional  and  macro-economic  nature  and  its  monitoring  and 
evaluation will be undertaken in line with the standard Commission procedures. 

6.1.  Monitoring 

The monitoring system will be ensured by the provision of reports and data by the authorities, 
as  to  be  set  out  in  the  Memorandum  of  Understanding,  and  the  organisation  of  review 
missions  to  Bosnia  and  Herzegovina  by  Commission  staff.  This  assistance  will  be  managed 
centrally.  The  Commission  Delegation  will  also  be  called  to  provide  additional  reporting, 
where appropriate. 

In particular, the monitoring of the action by the Commission services will take place on the 
basis  of  a  system  of  macro-economic  and  structural  policy  indicators  to  be  agreed  with  the 
authorities  of  Bosnia  and  Herzegovina.  In  this  process,  the  Commission  services  may  also 
monitor key areas to be identified in the above-mentioned Operational Assessment on public 
finance management.  

An annual report to the European Parliament and to the Council on the implementation of this 
assistance  is  foreseen  in  the  proposed  text  of  the  Council  Decision  on  MFA  to  Bosnia  and 
Herzegovina. 

6.2. 

Evaluation 

In  the  context  of  DG  ECFIN's  Multi-annual  Evaluation  Programme,  two  to  three  ex-post 
evaluations  of  MFA  operations  are  planned  per  year.  It  is  in  this  framework  that  an 
independent evaluation of the assistance will be carried out by duly authorised representatives 
of  the  Commission  in  due  course.  A  provision  foreseeing  an  ex-post  evaluation  will  be 
included in the Memorandum of Understanding. Financial resources for this evaluation would 
be drawn from the corresponding MFA budget line.  

7. 

ACHIEVING COST-EFFECTIVENESS 

In implementing the programme, the Commission will be guided by the following principles:  

•  The  assistance  will  be  made  available  by  the  Commission  to  Bosnia  and 
Herzegovina in principle in two instalments. Each instalment will be released on 
the  basis  of  a  satisfactory  track  record  in  implementing  the  macro-economic 
agenda  under  the  IMF-supported  programme  and  the  specific  economic  policy 
conditions  attached  to  the  assistance.  The  latter  will  be  negotiated  with  the 
authorities as soon as possible and laid down in a Memorandum of Understanding 
concluded to this effect.  

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•  As soon as the Council has adopted the proposal, the Commission will negotiate 
with  the  Bosnian  Authorities  a  Memorandum  of  Understanding  laying  out  the 
conditions for the release of the EU assistance, as well as a loan agreement. The 
disbursements  of  the  proposed  assistance  by  the  Commission  will  further  be 
conditional  upon  a  satisfactory  track  record  of  the  implementation  of  the  IMF 
programme  and  the  economic  policy  and  financial  conditions  attached  to  the 
assistance. 

•  In  negotiating  specific  policy  conditions,  the  Commission  will  draw  on  all 
available  expertise,  including  of  the  IMF,  the  World  Bank  and  of  bilateral  and 
multilateral  aid  agencies  active  in  the  same  areas.  In  addition,  the  Commission 
will aim at synergies with other Community policies and instruments (notably the 
Instrument  for  Pre-Accession)  that  could  be  used  to  support  the  implementation 
by the beneficiary of the relevant measures (notably in the area of public finance 
management). Where appropriate, links to any related action under the European 
Partnership or findings of the Progress Reports can also be established.  

•  This action is exceptional by nature and will not involve an increase in the number 

of Commission staff.  

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