S&P keeps Bosnia at B after IMF deal


Standard & Poor's maintained on Friday Bosnia and Herzegovina's sovereign credit ratings at B, saying it expects the country's recent 553.3 million euro ($623.2 million) three-year arrangement with the International Monetary Fund (IMF) to alleviate government financing concerns and provide both an anchor and financial backing for reform implementation.

The global agency retained also its stable outlook on the ratings, based on expectations of continuing foreign financing inflows coupled with ongoing fiscal consolidation.

S&P's full statement follows: “On Sept. 9, 2016, S&P Global Ratings affirmed its ‘B/B’ long- and short-term foreign and local currency sovereign credit ratings on Bosnia and Herzegovina (BiH). The outlook is stable.


The ratings on BiH are supported by the finalization of BiH's arrangement with the International Monetary Fund (IMF), in the form of a three-year €550 million extended fund facility (EFF).

In our view, BiH's institutional set-up and persisting divisions between the different entities’ governments complicate policymaking. Although we continue to consider the fragility of the multilayered institutional structure as a rating constraint, we anticipate that the need and preference to access international concessional funding should provide for a status of minimal consent to meet loan conditionality.

Beyond its support for BiH's balance of payments, with persistent current account deficits, the EFF arrangement bears the potential to strengthen reform implementation efforts, especially regarding the business environment, which could help to attract foreign direct investment (FDI), thereby strengthening growth prospects. The program will also unlock sizable additional EU and World Bank funding and technical assistance.

We expect World Bank funds will become available in late 2016 and anticipate EU budget support from 2017 onward. Although the authorities made progress on their reform agenda–for example both entities adopted new labor laws last year–we think implementation risk remains high.

Progress on structural reforms would be a main condition for improving the business environment and boosting economic growth. In the absence of larger foreign investment inflows, we expect growth to be driven by the absorption of foreign funds, with investment mainly financed by multilateral institutions.

Exports and remittance-driven consumption will also support GDP growth, which we now project at 3% on average in 2016-2019. We expect the import content of foreign-financed investment projects will also lead to a gradual widening of the current account deficit to 7% of GDP in 2018 from 6.2% of GDP in 2016.

In 2016, we estimate debt-creating inflows (net of amortization) and net FDI will finance US$530 million and US$250 million, respectively, with inflows to the capital account making up the rest. The public sector will contract the bulk of the borrowing, in our view. FDI in the private sector will likely be in the field of energy production over our forecast horizon through to 2019.

Having said that, risks related to program implementation could delay disbursements under the EFF, which could in turn challenge the external financing of BiH's structurally large current account deficit. Perceived political risk remains a deterrent to FDI.

Standoffs along party lines and between the country's constituent entities remain frequent and the political climate is confrontational ahead of the local elections in October 2016. Several political issues have been resolved in the past few months, however, including those that were causing the delay of the IMF agreement.

BiH's two entity governments have also adopted a coordination mechanism for EU matters. Reform progress and institutional stability would also be crucial to any meaningful progress toward being granted European Union candidate status, following BiH's membership application earlier this year. The IMF arrangement will also provide the fiscal space for needed reforms and infrastructure investments.

We expect that it will anchor fiscal discipline for the authorities and aim to improve revenue collection and the efficiency of government spending. However, given our view of remaining implementation risk, we project the consolidated general government fiscal deficit will narrow to 2.0% of GDP in 2019, compared with slightly above 2% in 2016. General government debt will stabilize at 46% of GDP by 2019. We expect that the majority of government debt will continue to be denominated in foreign currency over our forecast horizon. The banking system appears relatively well-capitalized and represents a limited contingent liability for the government, in our view. Nonperforming loans (NPLs; overdue 90 days or more), although on a slightly decreasing trend over the past 12 months, remain at 8.9% of total loans as of June 30, 2016. We understand that while BiH's banking system is stable, some banks are undercapitalized. Vulnerabilities at smaller domestic banks with weaker corporate governance practices have surfaced over the past two years, for example Bobar Banka in late 2014 and Banka Srpske (owned by the Republika Srpska government) in late 2015.

For the new IMF agreement, an important pre-condition was the resolution of Banka Srpske. BiH has a currency board regime and the konvertibilna marka is pegged to the euro. While the currency board provides stability, it restricts monetary flexibility. We also view the high share of loans denominated in or indexed to foreign currency (more than 50% of total system loans) as constraining the Central Bank of Bosnia and Herzegovina's monetary flexibility.

Although reserves covered monetary liabilities by 1.07x as of December 2015, the central bank cannot act as a lender of last resort under BiH law. We understand that BiH is committed to maintaining the independence of the central bank and preserving the stability of the currency board, which entails adequate coverage of the monetary base by the central bank's foreign currency reserves.


The stable outlook on BiH reflects our assessment of the balance of risks between BiH's complex institutional set-up and policy-making on the one hand, and our expectation of ongoing international support on the other. We could lower our ratings if the availability of external financing for BiH's twin fiscal and current account deficits was called into question and subsequent government financing constraints emerged.

This could be coupled with a failure to comply with loan conditionality. Although the state's external debt repayments are funded by indirect tax receipts, under such a scenario the debt servicing risks could rise. If we see delays in payments to official creditors, we could lower the ratings by more than one notch. An easing of tensions between BiH's two entities, improved relations with state institutions, and increased effectiveness of policymaking would, in our view, gradually enable reform implementation, reduce dependence on foreign financing, and ultimately benefit the business environment. If such developments were to translate into more sustainable growth, we could in turn consider raising our ratings on BiH. Significant progress on fiscal consolidation beyond our forecast assumptions, alongside better external performance, could also be positive for the ratings.”