Bosnia and Herzegovina - Country Assistance Strategy

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This public Country Assistance Strategy (CAS) report outlines recent developments in Bosnia and Herzegovina, and successful reconstruction efforts resulting in growth and sound macroeconomic performance. It analyzes two specific challenges coming in the period Y2000-02. The need to take control of its economic future can occur by assuming increased responsibility for economic and policy outcomes, strengthened governance, and reduction in dependence on the international community. The need to promote sustainable growth and employment opportunities in an inclusive way, will provide increasing income opportunities for the population. The CAS recommends private sector led-growth, building deeper structural reforms to accelerate privatization, continued banking sector reform, and labor market reforms. Social sustainability needs to be built, to improve poverty, and social protection, particularly in the education, and health sectors. Reconstruction needs to be completed, to address physical infrastructure, and community services. The Bank will focus efforts to strengthen weak and fragmented governance, foster sustainable growth and employment through the private sector, and, build equitable social services, including a social safety net for the most vulnerable.
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Report No.: 20592 BIH MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR BOSNIA AND HERZEGOVINA June 14,2000 Southeast Europe Country Unit Europe and Central Asia Region CURRENCY EQUIVALENTS (as of March 31, 2000) Unit of currency: Konvertible Marka (KM), equivalent to 1: ] to Deutsche Mark 1 KM=US$0.50 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Assistance BH Bosnia and Herzegovina BAC Business Environment Adjustment Credit CAS Country Assistance Strategy COM Council of Ministers EBRD European Bank for Reconstruction and Development EDS Economic Development Strategy EIB European Investment Bank EBPAC Enterprise and Bank Privatization Adjustment Credit EU European Union FRY Federal Republic of Yugoslavia FYROM Former Yugoslav Republic of Macedonia GDP Gross Domestic Product IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund I-PRSP Interim Poverty Reduction Strategy Paper KM Konvertible Marka LSMS Living Standards Measurement Survey MFTER Ministry for Foreign Trade and Economic Relations MIGA Multilateral Investment Guarantee Agency MTEF Medium Term Expenditure Framework PFSAC Public Finance Structural Adjustment Credit PRGF Poverty Reduction and Growth Facility PRRP Priority Reconstruction and Recovery Program PRSP Poverty Reduction Strategy Paper SAA Stabilization and Association Agreement SBA Stand-by Arrangement SFRY Socialist Federal Republic of Yugoslavia SP Stability Pact FISCAL YEAR January 1 - December 31 Vice President: Johannes F. Linn Country Director: Christiaan J. Poortman Task Team Leaders: Mary Sheehan and Simon Gray BOSNIA AND HERZEGOVINA WORLD BANK GROUP COUNTRY ASSSISTANCE STRATEGY (FYOD-02) Table of Contents Executive Summary ........... I. Introduction ................1....................................... II. Recent Developments.1 A. Political Context ................................................... 1 B. Economic Performance .................................................. 2 C. Social Context ....... ......................................... .. 3 D. The External Environment .................................................. 5 III. Bosnia and Herzegovina's Development Challenges and Priorities ...............................6.........6 A. Development Challenges .................................................. 6 B. Economic Development Priorities ...................................................6 Strengthening Institutions and Governance ......................................................8 Fostering Private Sector-Led Growth and Employment ............ ...................................10 Building Social Sustainability ....................................................... 12 Completing Reconstruction . ...................................................... 14 IV. Economic Outlook and External Environment ........................................................ 15 A. Base Case Economic Scenario ................................................... 15 B. Low Case Scenario .................................................. 17 V. The FYOO-02 Country Assistance Strategy .................................................... 17 A. Formulating the Country Assistance Strategy ................................................... 17 B. Objectives of the FYOO-02 Country Assistance Strategy .................................................. 20 C. Planned FYOO-02 World Bank Group Program .................................................. 21 Strengthening Institutions and Governance . ................................................. 21 Fostering Private Sector Led Growth and Empioyment .................................................. 23 Building Social Sustainability . ................................................. 25 D. IDA Lending Levels and Triggers .................................................. 26 VI. Country Program Risks and Monitoring ...................................................... 29 . Tables: Table 1. Progress Toward Reform in the Real Sector in the SEE Region Table 2. Key Economic Indicators, 1996-2005 Table 3. Lending Triggers Table 4. Lending Program and Major AAA Under the Base and Low Cases Table 5. Key Policy Outcomes to be Achieved Under Base and Low Cases Charts: Chart 1. BH: Evolution of GDP Chart 2. SEE Region: GNP Per Capita, 1998 Chart 3. BH: Donor Commitments and Disbursements, 1996-2004 Boxes: Box 1. The Legacy of War on Everyday Lives Box 2. Framework for Economic Development in Bosnia and Herzegovina, 2000-2004 Box 3. Dayton Governance Arrangements Box 4. Constraints to Private Investment and Business Development Box 5. The CAS Participatory Process: A Bosnian Vision of the Future Box 6. Lessons Learned During FY98-99 Box 7. Working in Partnership Toward Greater Transparency Box 8. The Balkan Enterprise Facility: Promoting SMEs in the Region Annexes: Bosnia and Herzegovina at a Glance Annex 1. Achievements of the Priority Reconstruction and Recovery Program Annex 2. Bank Support to Encouraging Participation in Bosnia and Herzegovina Annex 3. Coordination and Partnerships in Bosnia and Herzegovina Annex B2. Selected Indicators of Bank Portfolio Performance and Management Annex B3. Bank Group Program Summary Annex B4. Summary of Non-Lending Services Annex B5. Key Social Indicators Annex B6. Key Economic Indicators Annex B7. Key Exposure Indicators Annex B8. Status of Bank Group Operations Annex B9. CAS Program Matrix Annex B 10. CAS Summary of Development Priorities . . BOSNIA AND HERZEGOVINA WORLD BANK GROUP COUNTRY ASSSISTANCE STRATEGY (FYOO-02) Executive Summary Bosnia and Herzegovina is now at a crossroads. Over the next two to three years it must begin to generate a sustainable growth momentum. Postwar growth of the last four years has been strong - brought about by a successful reconstruction effort and sound macro performance - but it is not yet sustainable. And while recovery has brought a generalized increase in incomes, many Bosnians remain worse off than before the war and unemployment is painfully high. Fragmented postwar governance continues to make consensus difficult and has been at the root of a slower than hoped for reform effort. Two external factors will also affect the development outlook in the next two to three years: With completion of the postwar Priority Reconstruction and Recovery Program (1996-1999) at hand, donors will now begin to phase down their programs of support. This will require fiscal and external adjustment as well as other less tangible adjustments over this critical two to three year period. Finally, the recently- announced Stability Pact for Southeast Europe presents an opportunity for closer integration with European institutions. Accelerated structural and institutional reforms to bring the country closer to European standards will be needed to take advantage of this opportunity. Thus, Bosnia and Herzegovina faces two specific challenges in the period ahead: First, it must begin to take ownership of its economic future by assuming increased responsibility for economic policies and outcomes. This will mean strengthening governance at all levels and reducing dependence on the international community. Second, it must promote sustainable growth and employment in an inclusive way that provides increasing incomes and opportunities for al Bosnians. Reforms aimed at increasing private sector activity, and, in parallel, measures to ensure that growth is inclusive and that safety nets are in place for those who cannot feel its full benefits are needed. As a key step in taking increased ownership for economic outcomes, the Bosnian authorities are now preparing a first Economic Development Strategy (EDS) for the period 2000-2004. The EDS will be a Bosnian-owned strategy that is intended to replace the donor-led Priority Reconstruction and Recovery Program as the basis for policy and spending decisions, and serve as a framework to guide external development assistance. A Poverty Reduction Strategy Paper (PRSP) will build on the EDS and set out, inter alia, a strategy to ensure growth is sustainable and inclusive, and a plan to overhaul social protection systems to more effectively meet the needs of the poorest.! In the course of preparing the CAS, we have discussed with the authorities and other stakeholders the country's development priorities. There is broad consensus on four main components of the reform agenda the government needs to tackle over the next several years (set out in greater detail in Section IlI of the CAS): Key Medium-Term Challenges Strengthening governance and public sector management. Strong and accountable institutions and good governance are pre-conditions to sustained success in other reform areas. There have been significant achievements over the last CAS period, supported by IDA adjustment lending. But BH's newly-established institutions, fragmented government structures and competition between BH's three constituent groups mean developing good governance will be a long-term objective requiring As a first step in this process, the authorities are currently preparing an Interim Poverty Reduction Strategy. 111 consistent, well-sequenced efforts. The key medium-term priorities center on enhancing the transparency of public institutions, and developing and implementing a medium-term fiscal adjustment strategy in a climate of lower and less concessional donor resources. * Fostering private sector led-growth. Progress on structural reforms aimed at building a market- oriented economy has been slower than hoped; privatization in particular has been delayed. Deeper and more consistent structural reforms are needed for sustainable growth and employment. Growth that generates substantial employment, particularly in the SME sector, will be a key element of BH's poverty reduction strategy. The key reform measures needed are a transparent and predictable enabling environment, accelerated privatization, continued banking sector reform and labor market reforms to help create productive employment opportunities. * Building social sustainability. A growth strategy alone is not sufficient to address the needs of the poorest. Social sustainability implies broadly increasing incomes, but also improved human and social conditions, and reduced risk and vulnerability. Targeted programs and policies are required to complement better governance and sustainable, inclusive growth. Together, these factors can also generate movement towards political reconciliation. Medium-term priorities include improving poverty and social sector data and capacities, reforming social protection systems, developing education and health finance and governance, and spurring greater participation and inclusion in an environment where the legacy of war includes discrimination among ethnic groups. * Completing reconstruction. Finally, needs remain in housing, community services such as water and solid waste services, and demining. While the reconstruction effort produced remarkable achievements - e.g., returning most services to their prewar levels in just four years - addressing the remaining physical impacts of war in selected sectors is likely to take many more years. The FYOO-02 Country Assistance Strategy The FYOO-02 CAS is formed on the basis of consultations with stakeholders in Bosnia and H-erzegovina. It is consistent with, and builds on, the major thrusts of our previous CAS and the lessons of implementation. Discussions with the many other international partners involved in Bosnia and Herzegovina's development effort on their plans and programs have also contributed to developing an appropriate role for the Bank Group, based on our comparative advantage. Finally, the CAS also fits within the broader framework of a recent Regional Strategy Paper for Southeast Europe, developed by the Bank and the European Union in consultation with other partners, in the context of the Stability Pact. The reform agenda set out in this CAS is one to which all partners in Bosnia and Herzegovina's development effort will contribute. The World Bank Group's support (Section V), will continue to be selective. We have been asked by the authorities as well as by other key partners, to continue the policy reform supportive role we played during the last CAS, and which few other donors are able to assume. In tandem, we intend to disengage from reconstruction related activities over this CAS period. The overarching objective of the World Bank Group's partnership with Bosnia and Herzegovina is to increase economic opportunity and improve the quality of life for all Bosnians. Poverty reduction is an overarching, cross-cutting theme. In light of Bosnia and Herzegovina's development priorities, and the role that the World Bank Group can play in addressing these priorities, the strategic objectives of the FYOO-02 CAS period will be: * to help strengthen weak andfragmented governance arrangements to build a solid foundation for broad-based self-sustaining growth and democratic participation; iv * to help foster sustainable and inclusive private sector-led growth and employment as the most important means of improving economic opportunity for all Bosnians; and * to help build social sustainability by establishing affordable and equitable social services for all Bosnians, including a social safety net for the most vulnerable. In order to continue the policy-reform supportive role consistent with our comparative advantage, the FYOO-02 CAS proposes continued emphasis on policy reforms. Under a base case of strong macro performance and good progress in the reform areas set out above, a program of both adjustment and investment lending in the three main areas outlined is proposed, underpinned by a strong AAA program. Both the AAA program and policy reform dialogue will contribute to the authorities' EDS and its PRSP. Reform measures and activities important to reducing poverty in Bosnia and Herzegovina's postwar context are key elements in each of these areas. In termns of lending, our CAS Progress Report (August 1998) noted that while high postwar growth rates had brought per capita incomes near the IDA operational cut-off, we expected Bosnia and Herzegovina to be an IDA borrower during the IDA12 period (and that the earliest date creditworthiness for IBRD lending could be achievable was late in this period). This assessment remains valid. It is clear, though, that the extraordinary level of IDA resources provided to Bosnia and Herzegovina over the last several years must now decrease to levels consistent with other IDA recipients. Sufficient resources are nevertheless required in order for the Bank to be able to continue to carry out its strong policy-reform leadership role in this critical next two to three year period. Thus an IDA allocation that declines to normal per capita levels by the outset of the next CAS in FY03 - which could coincide with the timing of creditworthiness - is warranted. Risks of an internal and external nature during this CAS period remain similar to the key risks highlighted in the CAS Progress Report. The most serious internal risk relates to continued weak and fragmented governance in Bosnia and Herzegovina and the implications for the authorities' commitment to reform. We believe that the lessons learned in the previous CAS have helped us to design a program that takes into account this risk and mitigates it to the extent possible. The Stability Pact for Southeast Europe provides a framework for potential increased stability in the Region, helping to reduce the key external risk of continuing political uncertainty in the Region. Suggested Topics for Board Discussion Among the topics for Board discussion could be: * The development challenges and priorities highlighted for Bosnia and H-erzegovina over the next several years; The policy-reform supportive role proposed for the World Bank Group, and the appropriateness of the mix of planned instruments and activities; and * The risks identified and the mitigation measures proposed. v BOSNIA AND HERZEGOVINA WORLD BANK GROUP COUNTRY ASSSISTANCE STRATEGY (FYOO-02) I. Introduction 1. This Country Assistance Strategy (CAS) covers the period FYO0-02.' It builds on the strategic priorities set out in the first full CAS for Bosnia and Herzegovina (BH) covering FY98-99, discussed by the Board of Directors in August 1997, and the FY99 Progress Report discussed in August 1998.2 This CAS was prepared on the basis of consultations with the authorities, donors and a range of stakeholders (para. 42). 2. BH's over-riding challenge as it enters the first decade of the 21st century is self-sustainability. This is the path to a future of greater opportunity for all Bosnians. Four years of devastating war have been followed by four years of substantial dependence on external technical and financial assistance. While this assistance brought successful reconstruction and recovery, BH now must begin to stand on its own economic feet. It must look to the international community not for aid flows but for investment resources, management know-how and trading partners in a Europe that is expanding in the context of the Stability Pact for Southeast Europe. To do this, it must commit to deeper, more unified and consistent reforms. With recovery, a tenuous healing process has also begun, but it needs to be nurtured. Greater voice and participation of Bosnian citizens are needed to help build social and political consensus, create stronger governance and reduce ethnic divisions. As a step toward greater self-sustainability, the BH government is preparing its first Economic Development Strategy which will set out reform measures and priorities for 2000-2004. While strategy formulation is underway, it has been broadly discussed in BH and there has been a substantial meeting of the minds between the Bank and the authorities on its key elements (Section III). The next two years will be critical in establishing the policy reform framework needed to ensure that this Development Strategy brings BH closer to the vision of a stable and prosperous future for all. II. Recent Developments A. Political Context 3. BH's political institutions and inter
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