BOSNA I HERCEGOVINA

VIJEE MINISTARA DIREKCIJA ZA EKONOMSKO PLANIRANJE

BOSNIA AND HERZEGOVINA

COUNCIL OF MINISTERS DIRECTORATE FOR ECONOMIC PLANNING

Outlook 2011- 2013

Sarajevo, April 2011

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Table of contents

Introduction.....................................................................................3 1. Economic growth......................................................................4 2. Industrial production.................................................................5 3. Labour market...........................................................................6 4. Prices.........................................................................................7 5. Banking sector...........................................................................7 6. Foreign exchange reserves and money stock............................9 7. Indirect tax................................................................................10 8. External sector..........................................................................11 9. Foreign trade.............................................................................13 10. Direct foreign investments........................................................15 Abbreviations..................................................................................16

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Introduction

The Directorate for Economic Planning has prepared the Outlook for 2011 2013, which gives an overview of forecasts of key economic trends in Bosnia and Herzegovina on the basis of analysis of economic trends in Bosnia and Herzegovina, as well as international factors affecting the countrys economic growth. This is an analytical document, which has been made for the purpose of facilitating the work of the Council of Ministers of Bosnia and Herzegovina. The document is based on official data obtained from statistical systems and agencies in Bosnia and Herzegovina.

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1. Economic growth
Despite the partial recovery of most of the key trade partners of Bosnia and Herzegovina (BiH), 2010 was mainly the year of economic consolidation of the country and stopping of the degradation from 2009. Gradual increase in exports, accompanied by a slight rise of domestic demand and real stagnation of import, led to a modest economic growth of 0.5% in BiH in 2010. This was further supported by indicators of activity in the real sector, where only a modest real growth was generally registered. The small increase in industrial production by 1.6%, real retail trade growth of 3.6%, stagnation of financial sector and double-digit decline in construction sector and investments in general are most noticeable in this regard. The slight growth of the European economy (1% EU27) in 2010 should significantly reflect on Bosnia and Herzegovina no sooner than in 2011. According to DG ECFIN's forecasts, the positive trends in the European Union should be further strengthened in 2012, with the real growth rate being nearly doubled (1.8%). At the same time, the full economic recovery is expected to be achieved in Germany and Austria, which are BiH's most important trade partners. Already in 2012 the level of economic activities in those countries should be higher than the level recorded at the beginning of the crisis in 2008. However, the recovery of other key trade partners should go at a much slower pace. This particularly refers to Italy and the countries in the region, which may need many years to achieve the pre-crisis levels of activities. Nevertheless, despite the slow recovery of the surrounding countries, the gradual growth of the world and European economies should strengthen not only BiH's export demands, but also the foreign cash inflow, both in terms of current and financial flows. These are actually the key factors of Bosnian economic recovery in the coming years. In fact, the real export growth of 7.6% in 2011 and 11% in 2012 should stimulate an increase in domestic production and employment rates, which, accompanied by the expected increase in foreign inflows, should lead to gradual strengthening of private expenditures and investments. At the same time, private expenditures should achieve real growth of approximately 4% per year in 2011-2012, while the real growth of private investments should rise from 5.1% in 2011 to nearly 10% in 2012. The said growth of economic activities should result in an increase in tax revenues, as well as public expenditures and public investment expenditures. The said growth of domestic demand is expected to lead to a significant increase in import, amounting to approximately 8% per year and re-growth of foreign trade deficit at a rate of 9.3% in 2011 and 2.7% in 2012. The final result of the increase in export and domestic demand, as well as the strengthening of foreign trade deficit, should lead to economic growth of 3.2% in 2011 and 5.5% in 2012. In light of the global economic recovery trends, the positive trends from 2011-2012 should continue during the course of 2013 and 2014. In other words, the increase in export demands and stable trend of foreign monetary inflow should continue to act as catalysts of the domestic demand and import growth. Hence, the investments and private expenditures are expected to give an increasingly strong contribution to the growth, while the negative impact of foreign trade deficit is expected to fall, which should help Bosnia and Herzegovina achieve an economic growth rate of 5.3% in 2013 and 5.6% in 2014.

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2. Industrial production
Results of previous industrial production research confirm that the industrial trends in Bosnia and Herzegovina are determined by the interaction between domestic and export demands. Besides that, the research has determined that the domestic demand factors are chiefly noticeable in mining, electric energy production sector and some processing industry branches, such as the food-processing industry. On the other hand, the processing industry is largely export-oriented, so the export demand has a primary role and practically determines the industrial production trends. This was particularly noticeable during the past crisis period, when the decline in economic activities in the EU and countries in the region resulted in the fall of all industrial production parameters in BiH. At the peak of the crisis the physical volume of industrial production was reduced by more than 3%, the employment rate fell by around 4%, while the investments and export were reduced by around 20%. However, already in the second half of 2010 the recovery of the world economy and improvement of export markets in the EU and region gradually impacted the industrial production in BiH. The recovery of export markets and increase in export demand resulted in stabilization of industrial production, with the annual growth rate of 1.6% in comparison to the same period of the previous year. Provided that the positive production growth trends continue in the EU and countries in the region during the course of 2011, a significant recovery of the industrial production in BiH can be expected. Preliminary data on industrial production, gathered by BHAS, and the growth physical volume of industrial production at a rate of around 12 % in February 2011 y/y, are rather encouraging and indicate that the recovery of BiH industry is underway. The processing industry, and, particularly its export- oriented branches, should certainly be the generator of recovery in BiH. Metal sector companies, which could use their production capacities much better with the stable growth of metal price on the world market, should play an
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important role too. Besides the metal industry, the furniture production and wood processing industries have a huge potential for being bearers of the recovery of industrial production and export in 2011. In addition to the oil and oil-derivatives industry, in which investments in product quality improvement have been recorded, the chemical, automotive and machine industries, which were important bearers of BiH's industry in the pre-crisis period, should achieve positive production growth rates and contribute significantly to improvement of the total industrial production in BiH during the course of 2011. DEP assumes that, considering the overall recovery of the production industries in BiH, paired with the traditionally good results in electrical energy sector, in 2011 the industrial production may grow at a rate of around 5%, compared to the same period of the previous year. The full economic recovery in the EU and countries in the region is expected to happen in the period from 2012 to 2013. This, in turn, will enable the full recovery of industrial production in BiH. Full consolidation of EU markets, recovery of private expenditures, overcoming of issues related to financing of companies and intensifying of foreign trade exchange among the EU countries are expected to happen in this period too. This will have a positive impact on the entire region, and BiH as its part. Better utilization of capacities and an increase in the number of employed persons will result in the growth of processing industry production to its pre-crisis levels, when BiH achieved record industrial production growth rates in comparison to the countries in the region. The planned investments in infrastructure and energy industry should contribute significantly to strengthening of the construction sector and processing industry branches, which are closely linked to the construction industry. In addition, it is expected that the energy sector, which was one of the backbones of

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increase in BiHs export volume, while the expected yearly growth of industrial production will be around 7%.

industrial production in the past period, will maintain the positive production growth trends and additionally strengthen the industrial production in BiH in the mentioned period of time. According to DEP's estimates, the increase in economic activity in the period from 2012 to 2013 should result in a 15%

3. Labour market
The labour market in BiH shows modest positive changes at the beginning of 2011. In January 2011 the number of employed persons was increased by 1.1%, but the number of unemployed persons was increased by 2% in the same month. Private sector, which has suffered the biggest negative consequences of the economic crisis, scarcely employs new workers, with modest investments and moderate volume of activity. Industrial production, construction and trade are the sectors that take the lead in that sense. The number of employed persons in processing industry in January 2011 was increased by 0.2% compared to the same period of the previous year, while rate was reduced in the construction and trade sectors (3.5% y/y and 2.2% y/y respectively). Analogously, in 2011 the average number of unemployed persons could be increased by around 1% y/y. However, the assumed growth of export, modest investments and industrial production volume would still lead to a minor increase in the number of employed persons (0.5% y/y) in 2011. The average net salaries were increased by 2.2% y/y in January 2011. In 2011 salaries in the private sector, which has the lowest average salaries, should record a modest growth, induced by an increase in the work volume, while salaries in the public sector are expected to stagnate, due to budgetary restrictions. Consequently, in 2011 the average net salary in Bosnia and Herzegovina could be nominally increased by up to 2% y/y. In 2011 pensions will remain at almost the same level compared to the level recorded in 2010. The constant inflow of new pensioners and slow increase in the number of employees, who pay contributions to pension funds, which form the basis for payment of pensions, are the two key factors limiting the eventual growth of pensions in BiH. Full recovery of the labour market could be expected to happen in 2012. GDP growth rate of 3.2%, more intensive export, bigger investments and increased volume of activity in the construction sector and industry should have positive effects on the labour market. The number of employed persons in BiH would increase by 2.1%, while the number of unemployed persons could decline by 2.3%. Private sector should be the main accelerator of the increase in the number of employed persons. In general, better business environment would have a positive effect on the growth of net salaries (2.8% y/y). Bigger inflow of cash from the income generated on pension fund contributions might lead to the growth of pensions at a rate of 3-5% y/y. However, the reform of the pension and disability funds will eventually determine the level of pensions in BiH. The outlook of the labour market in 2013 has been made on the basis of a presumably strong economic growth. The number of employed persons in the said year would be increased by 2.2%, accompanied by a 2.9% decline in the number of unemployed persons and a 3% annual growth of net salaries.

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4. Prices
The growth of prices, which was primarily induced by the growth of oil and food prices on the world market, was recorded in Bosnia and Herzegovina at the beginning of 2011. The growth of demand for oil in the World in the second half of 2010, accompanied by limited supply, influenced the oil price trends in 2011. On the other hand, natural disasters (floods and droughts) in 2010 intensified the food price growth, as well as the growth of costs of food production and transportation. The annual inflation rate of 3% was recorded during the first two months of 2011. In the same period the prices of food and soft beverages were increased by 5.3% y/y, while the transportation price was increased by 6.4% y/y. Internal factors affecting the price changes will continue to influence the price trends in 2011. The increase in the excise tax on tobacco products at the beginning of the year, increase in the price of telecommunication services and possible increase in electricity and gas prices are the key internal factors that will lead to increase of prices in BiH. According to DEP's estimates, the expected inflation rate in BiH in 2011 will be around 4.5% y/y. However, in case the price of oil and food on the world market continues to grow until the end of 2011, the inflation could even be up to 2% higher than expected. A more moderate grow of prices is expected in 2012 and 2013. External factors that determine the growth of prices in BiH, will be stabilized. The world market is expected to be characterized by a markedly slower growth of oil prices (0.8%), normal weather conditions and better yield, which would normalize the food prices, in 2012. This means that the inflation rate in BiH could be lower, compared to 2011, and be around 2% in 2012 and 1.7% in 2013.

5. Banking sector
In BiH the banking sector is the biggest sector on the financial market. Sectors like insurance market, capital market, cash market and micro-finance market are smaller and less developed parts of the financial market in BiH. Banking sector assets amounted to KM 20.1 billion in February 2011. Total loans amounted to KM 14.6 billion in the first two months. In comparison to the same period of the previous year, the amount is higher by 3.9%. Loans to non-financial companies (53.7%) and household loans (42.6%) form the biggest part of the total loans. Over the first two months loans to nonfinancial companies amounted to KM 7.9 billion. Their annual growth rate was 5.9%. In the same period retail loans amounted to KM 6.2 billion. Unlike the loans to non-financial companies, their growth was more modest 0.2% y/y. In the first two months of 2011 the total deposits amounted to KM 12.5 billion, which is by 5.2% higher compared to the first two months of the previous year. Household and non-financial companies sectors have the biggest share in the total deposits, as is the case with credits. The share of household deposits in the total deposits is 52.3%. These deposits have given the biggest contribution to the growth of total deposits. Over the course of the first two months the growth rate of household deposits was 12.8% y/y. They amounted to KM 6.6 billion. The share of nonfinancial companies deposits in the total deposits is 29.3%. Unlike the household deposits, their growth was negative.

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In February 2011 these deposits amounted to KM 3.7 billion. They decreased by 1.0% compared to the same period of the previous year. The general government deposits follow the non-financial companies deposits, with 13.2% share in the total deposits. Over the past couple of years these deposits have recorded negative growth trends, which is probably a result of non-liquidity of entity governments. Gradual recovery of BiH economy is expected to happen by the end of 2011. Due to improvement of economic conditions in the Euro zone and countries in the region, BiH's foreign trade volume is expected to grow. Besides that, the growth of investments and end consumption are expected to grow by the end of the year, which will eventually lead to a real growth of GDP at a rate of 3.2%. It is estimated that, by the end of 2011 the number of unemployed persons should be increased, but the growth rate will be lower compared to 2010. While the growth rate of the number of employed persons was negative in 2010, a modest increase in the number of employed persons and net salaries, as well as growth of the inflation rate, are expected to happen in 2011. Money transfers from abroad constitute an important part of the population's income. Those transfers are expected to have positive trends in the upcoming period. The positive trends in economy should reflect on the banking sector in BiH. The increase in the economic activity (growth of industrial production, foreign trade etc.) will lead to an increased demand for loans by companies. On the other hand, positive trends on the labour market and increase in private expenditures, should lead to an increased demand for loans by household, which was not the case last

year. However, over the past year the BiH banking sector recorded negative financial results and increase in non-quality loans in its portfolio. It will therefore probably maintain the existing rigid loan conditions. For this reason, by the end of the year we can expect the growth of loans at a rate of around 5% y/y. The rate is still much lower than the loan growth rate registered prior to the economic crisis in BiH. The trends of total deposits will continue to be positive, primarily thanks to the retail sector. By the end of the year the total deposits growth rate is expected to be between 4 and 6% y/y. In the period from 2012 to 2013 the economic trends will continue to be positive, in terms of growth of industrial production, increase in import and export volume, growth of investments and private and public expenditures. Besides that, the labour market conditions will continue to be improved, as the number of employed persons will rise and the number of unemployed persons will fall. Average net salaries are expected to continue to grow in that period. BiH banks should offer more favourable loan conditions in this period in order to meet the increased demand for loans. Therefore, in 2012 and 2013 the loan growth rates are expected to be between 10 and 15% y/y. On the other hand, the increase in total deposits (by more than 10% y/y) will be continued thanks to the household sector, but at a slower pace. Also, in 20122013 the general government deposits may grow due to the sale of government's shares in companies, like Hidrogradnja, Energoinvest, HT Mostar etc.

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6. Foreign exchange reserves and money stock

Available data for the first two months of 2011 indicate that the recovery of BiH economy, which began last year, continues. The recovery and improvement of the external sector, which has the biggest impact on the foreign exchange reserves trends, is expected to happen. The growth of export volume would lead to the growth of foreign exchange reserves. The foreign exchange reserves trends are directly affected by the modest growth of resources related to direct foreign investments, as well as other investments. Also, investments would be increased through the growth of foreign assets due to a modest grow of loan activity. The inflow of cash through money transfers to private persons from abroad, which was significantly reduced over the past period, is expected to be increased again. In addition, direct reserves are directly affected by the growth of foreign liabilities, through the increased withdrawal of loans from various foreign financing sources (mainly IMF). The annual foreign reserves growth rate, as recorded at the end of February, was 4% y/y (or around KM 6.3 billion). In line with the above mentioned facts, the foreign exchange reserves growth rate may be around 6% y/y at the end of 2011. The modest grow of foreign exchange reserves on one hand and the minimal growth of total deposits on the other will lead to a proportionate increase in the total money stock. This assumption is based on the money stock coverage with foreign exchange reserves (about 45%) and the share of total deposits in the money stock (around 80%). On the basis of data gathered in the first two months of 2011, it can be noticed that the money stock has reached the level of about KM 13.9 billion, which means that its growth rate was 7.1% y/y. It is assumed that the money stock will continue to grow at a modest rate, which will be around 9% y/y at the end of 2011. On the basis of the outlook of key macroeconomic indicators in 2012, it can be assumed that the full recovery of our economy and a slightly bigger increase in the economic activity will happen in that year. Foreign trade trends are an important factor for the foreign
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exchange reserves. One of the factors that will lead to an increase in foreign reserves in the mentioned period is the assumption that export growth will be slightly bigger than import growth. At the same time, new inflow of resources related to all types of investments is supposed to happen. New inflow of investments in BiHs economy refers to the growth of direct foreign investments, as well as other investments (i.e. increase in foreign assets) through strengthening of the banking sector and increase in loan activity. At the same time, the resources based on investments in foreign liabilities are expected to be increased. This type of investments would be increased assuming that BiH liabilities to foreign financing sources grow. The mentioned increase in liabilities would be conditioned by an increase in borrowing from various sources abroad and all types of monetary assets (both cash and deposits), which the mother banks invest in their branch offices in BiH. Also, it should be pointed out that, in 2012 the stand-by arrangement payoff is due to begin, which shall increase BiH's financial obligations, thus slowing down the foreign exchange reserves growth. Another presumption that would have an indirect impact on the growth of foreign exchange reserves, is the growth of income of the population in world economies. The said income growth would lead to a modest increase in cash transfers to private persons in BiH from abroad. In line with that, the foreign exchange reserves are expected to grow during 2012 at a rate of around 10% y/y. The increased inflow of cash would primarily lead to an increase in total deposits, but also the cash outside of the banking sector, albeit to a smaller extent. The positive growth of deposits and foreign exchange reserves would lead to an increase in the total monetary stock (around 12% y/y) in 2012.

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reserves might grow at a rate of around 8% y/y compared to last year. The increase of all types of monetary inflows to BiH economy would lead to an increase in total deposits, which, accompanied by foreign exchange reserves, would actuate the strengthening of BiH monetary sector. The key characteristic of such monetary sector would be the total monetary stock growth rate of around 20% y/y.

Our projections for 2013 are based on positive trends in BiH economy. The stable and continuous increase in foreign trade, accompanied by an increase in exports over imports, as well as expansion of all other branches of economy, would lead to a more significant inflow of investments. In addition, it is assumed that a significant growth of the banking sector and new monetary inflow from various foreign sources of financing will occur. That said, the total foreign exchange

7. Indirect tax
Indirect tax revenues form over 80% of the total tax revenue generated in Bosnia and Herzegovina. Hence, the prospects of their trends have a big significance, particularly for annual and mid-term planning of budget at all levels of government. The perspectives of macro-economic indicators trends, made by the Directorate for Economic Planning, further implementation of the Stabilization and Association Agreement, which implies the gradual reduction and abolition of customs duties on goods imported from the European Union, and continuous harmonization of excise rates in BiH with the minimal standards in the European Union, were the foundations for preparation of indirect tax revenue projections for 2011 2013.
Projection of indirect tax revenue for the period from 2011 to 2013 (millions of KM)

to 2013. As shown in the chart, the indirect tax revenues are expected to amount to KM 4.9 billion in 2011, which means that they will increase by 6% in comparison to 2010. In view of the expectation that BiH economy will come out of recession within the next three years, the projected growth rate of indirect tax revenue will be 7% in 2012 and 2013. Also, the growth rate of VAT revenue, which has the biggest share in the total structure of indirect tax revenues in 2011, is expected to be 6% compared to 2010. Likewise, the VAT revenue is expected to be increased by 7% in 2012 and 2013. These prospects encompass the effects of an increase of a special tobacco excise in 2011 from 0.30 to 0.45 KM per pack, as well as the planned excise increase by 0.15 KM per pack of cigarettes in each of the subsequent years. Due to the aforementioned revision of legal regulations in the field of tobacco and tobacco products, the prognosis of excise revenue for the upcoming period is very precarious due to scarce data and market and cigarette supply analysis, price elasticity and structure of demand, behaviour models and psychology of cigarette consumers. In this particular segment, special attention should be paid to other significant risks that affect the outlook correctness, like the increased quantities of smuggled cigarettes and growth of black market. Considering the aforementioned, the excise revenue is expected to grow at a rate of 12% in 2011, 13% in 2012 and 10% in 2013.

Customs duties Road tolls Excise VAT

The chart shows the projected trends of indirect income tax for the period from 2011

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The projections of road toll revenue are linked to projections of the real growth of gross domestic product. It should be pointed out that further harmonization of the excise on oil derivatives with the European Union standards is not expected to happen in the near future. For that reason, the outlook of road toll revenue for the period 2011 2013 has been made on the basis of gross domestic product outlook. The related revenue is expected to grow at a rate of 3% in 2011, while the

average growth rate in the two subsequent years is expected to be 5%. Irrespective of the projected increase in imports in each of the subsequent years, due to effects of liberalization of EU markets and substitution of import from third countries with import from the EU, the customs duties revenues are expected to decline by 7% in 2011, 11% in 2012 and 7% in 2013.

8. External sector
International context The recovery of global economy is becoming more and more evident after the danger of double-bottom recession was avoided. The growth governed by the demand for replenishment of stocks and fiscal support packages, is losing primacy over the growth governed by domestic expenditures. In less developed economies, the growth is still governed by foreign demand for export products, while the growing prices of food industry products and energy-generating products will have a significant effect. The world GDP is expected to grow at a rate of around 4.5% in 2011 and 2012 (as per the IMF's latest projections from April 2011), which is by 0.5% lower than the rate recorded in 2010. The growth rate of the Euro zone countries will be between 1.6 and 1.8% in the period from 2011 to 2012. As always, developing countries will be the leaders of growth, with growth rates of 6.5%, while developed economies will grow at a rate of 2.5% only. Unequal economic growth, high unemployment rate, fiscal consolidation and inflation will pose a huge problem to economic policy-makers in the upcoming period. The political turmoil in the Near East and Africa, devastating earthquake and Tsunami in Japan and the ballast of high budgetary deficit and debt crisis in some members of the European Union further complicate the prognosis of economic trends. Balance of payments in BiH The deficit on the current account of the balance of payments in BiH is expected to be about 7% of GDP in 2011-2013, which is significantly higher than 5% of GDP as recorded in 2010, but, at the same time, significantly lower than 10% of GDP as recorded in the period from 2007 to 2009. The 31% increase of the current account deficit in this year will come as a result of an increase in import of goods and services by 15%, which will be caused by the recovery of domestic demand for consumables and capital and investment products, as well as the increase of prices of oil and food industry products. The export of goods and services is expected to grow at a rate of 14% in 2011, owing to the increase in foreign demand for low technology level products, while the export of services will grow at a rate of 1% only. The low projected rate of services export growth is justified by expected significant decrease in income from construction services performed abroad (considering the situation in Libya, where the biggest part of the related income was generated), which will be compensated by an increase in tourism and international transport services income.

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Salaries will be slightly increased in the referenced period (1%), while current transfers, as an important source of cash inflow to BiH economy, will grow at a rate of 4% in 2011 due to the economic recovery of the countries in which BiH Diaspora lives (USA, EU, Switzerland, Croatia, Canada, Australia and so on). As the global capital flows have been slowed down significantly, no bigger foreign investments or increased inter-bank lending are expected to happen. Nevertheless, our debt is expected to be increased (particularly the government debt) as per arrangements with IMF, World Bank, EBRD and other creditors, who are ready to compensate for the insufficient domestic financial sources of economic growth, investments and expenditures.
Projections of increase in imports, exports and share of current account deficit in GDP in BiH (2011-2013)

expected increase in import of goods and services by around 12% and export by 1415%. The current transfers will be moderately increased, but they will not follow the increase of GDP in BiH, so their share will decline during the referenced period, and remain at a level of 10% of GDP by 2013 (which is significantly lower than 16% recorded in the pre-crisis period). A decrease in the share of net salaries from abroad is evident as well. By 2013 their share in GDP will be as low as 2% (compared to the pre-crisis share of 3.2%). Financing from the capital account becomes less and less significant (0.8% of GDP). It will mostly be provided from new borrowings (by government, private and banking sector), as well as from FDI net component and portfolio investments, whose share in GDP will remain at 4% in 2012 and 2013. The significant increase in repayment of the principal and payable interests for loans taken abroad, which will amount to more than KM 1.5 billion in 2013, will be an interesting factor in the referenced period. Finally, it should be pointed out that the macro-economic stability, from the aspect of sustainability of deficit on the current account, will not be jeopardized, since the said deficit will not be significantly deteriorated, and because a stable growth of foreign exchange reserves and satisfactory coefficient of financing of import of goods and services are expected to happen due to the inflow and outflow in the balance of payments in BiH.

Sources: DEP estimates

The current account deficit is expected to be further increased in 2012-2013, with the annual growth rate of 11% in 2012 and 4% in 2013 due to a well-known reason increased trade disequilibrium, accompanied by the

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9. Foreign trade
The recovery and stabilization of BiH economy will assumingly happen during the course of 2011. It is expected that, in 2011 the nominal growth of export of goods and services will be at a rate of 13.6%, while the import will increase by 15.1%. The increase in exports will result in full recovery of EU economies and growth of their demand for inter-medial goods, including metals, which are the most important export category in BiH. In addition, the recovery of automotive industry is expected to happen. Consequently, many BiH companies, involved in production and export of automotive industry parts, will contribute to the increase in total exports. As regards metals, most of BiH's export will comprise iron, steel and their by-products, as well as aluminium. According to DEP's estimates, the export of iron and steel will grow at a rate of 35% in 2011. The noticeable increase in iron and steel export will come as a result of integral production in Mittal Steel Company from Zenica that bought Arcelor Mittal mine in Prijedor from which it will buy ores, so the Company will not need to import them, but the export of metal minerals will be significantly reduced. The import of iron and steel will be increased by 30%, which will contribute to the reduction of trade deficit in this category of products. The export of aluminium will be increased by f 18%, due to production increase and growth of prices on the world market. The aluminium import will follow the export with a growth rate of 18%. In the machinery, appliances and equipment sector, the export will be increased by 15% in 2011, while the import of machinery, appliances and equipment will also grow, but the growth rate will be slightly lower 10% in 2011. The wood industry sector demonstrates a deteriorating performance. Export is expected to be increased by 12% in 2011, but this is a very modest increase considering that its basis is small. However, DEP's forecasts, which say that furniture export will grow at a rate of 20% in 2011, are encouraging. The export of mineral products, predominantly the export of electrical energy, will grow at a level of 20%. The import of mineral products, predominantly oil and oil derivatives, will grow at a rate of 25% due to a 20% increase of prices, as well as the economic recovery and growth of industrial production in BiH, which will increase the need for crude oil. Import of vehicles will be increased by 10% in 2011 due to effects of the reduction of customs duties on used cars and abolition of customs duties on new cars following the signing of the Stabilization and Association Agreement. The increase in import of cars will be less pronounced than the increase in import of other products, because cars have a high price elasticity and fall within the category of luxury goods, the buying of which will grow with the full recovery of BiH economy from the consequences of the economic crisis. The full recovery of BiH economy will happen in 2012. Export of goods and services will grow at a rate of 14.4%, while import of goods and services will grow at a slightly lower rate of 11.9%, which will contribute to further reduction of trade deficit, which was one of the biggest problems facing BiH economy over the course of the past years. The increase in export in 2012 will be mainly induced by the export of electrical energy, which will grow at a rate of 18%, provided that the thermal power plant in Stanari starts operating. The plant will be exclusively used for export of electrical energy. The export of iron and steel in 2012 will grow at a rate of 14.5% due to the said integral production in Mittal Steel in 2011. The export of iron and steel products will grow at a slightly lower rate of 11%. The import of iron and steel will grow at a rate of 1%, while the trade deficit in this category of products will be further reduced, or maybe eliminated. However, iron and steel products import will grow at a rate of 14%, which is higher than the growth rate of export of iron and steel products.

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The positive trends of aluminium export will be continued in 2012. The export growth rate will be 8%. The fact that, according to DEP's projections, the import of aluminium will grow at a rate of 12%, is disturbing. This growth will be primarily caused by an increase in the price of alumina the basis material needed for production of aluminium. The growth of export in the wood industry sector will be continued at a modest rate of 2%, but the export of furniture will grow at a much higher rate of 12%, continuing to rise compared to previous years. It is considered that, due to the restructuring of production, so that instead of on the wood industry, it concentrates on manufacturing of furniture, furniture will be one of the key export potentials in BiH. In 2012 the export of oil and oil derivatives will have a significant growth rate of 12%. The increase in export of oil will be caused by the growth of industrial production in BiH, but also the increase of prices by 5.1%. According to DEP's assumptions and projections, in 2013 BiH economy will become steady following the turbulent changes induced by the economic crisis in late 2008, during 2009 and in early 2010, and improvement and revival of economic activity in 2011 and 2012, which will be marked by significant GDP growth rates, alterations related to export, import, trade

deficit and many other economic indicators no less significant. An increase in export of goods and services by 15.3% and the growing export orientation towards EU markets are expected to happen during the course of 2013. Import will grow at a rate of 11.6%. The fact that the import growth rate will be lower than the export growth rate will certainly influence the reduction of trade deficit, but not to a great extent, because the nominal import value will be significantly higher than the export value. Just like in the preceding years, it is expected that the trade of iron and steel, aluminium and their by-products will have the biggest share in trade volume in 2013. The export of iron and steel in expected to grow at a rate of 15% in 2013, thanks to the said integral production in Mittal Steel, Zenica. The demand for machinery, equipment and appliances will be big, so their import will cause a noticeable deficit. During the course of 2013 other product categories will not record any important changes in export and import compared to 2011 and 2012. It should be mentioned that, in 2013 the export of furniture will grow at a rate of 10%. In that way, the export will be definitely restructured, so that instead of on the wood industry, it concentrates on manufacturing of furniture, primarily due to its value effect.

Estimated import and export growth rates for major trade product categories in BiH Product category Mineral fuels, mineral oils and their distillation products, electrical energy, bituminous materials, mineral wax Machines and appliances Iron and steel Aluminium Inorganic chemical products 2011 Import 25.0% 10.0% 30.0% 18.0% 30.0% Export 20.0% 15.0% 35.0% 18.0% 20.0% 2012 Import 12.0% 18.0% 1.0% 12.0% 15.0% Export 18.0% 10.0% 14.5% 8.0% 15.0% 2013 Import 10.0% 18.0% 1.0% 15.0% 10.0% Export 22.0% 15.0% 15.0% 15.0% 10.0%

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10. Direct foreign investments

Data available to the Ministry of Foreign Trade and Economic Relations of BiH indicate that direct foreign investments amounted to KM 25 million in the first quarter of 2011, which represents a 43% decrease compared to investments in the same period of time. Considering the dynamics of average direct foreign investments over the past three years and weak recovery from global and regional economic crisis, the average investments in the upcoming period may amount to about KM 250-400 million, excluding more significant investments in energy sector and direct foreign investments (DFI) in privatization process. On the basis of the plan for 2010 and announcements for 2011, the Agency for Privatization of FBiH has planned a sale of state-owned companies, whose value is about KM 591 million. It can realistically be expected that many of those companies will be sold to foreign investors, which would contribute to an increase in direct foreign investments by between KM 250 and 590 million by 2013. It should be mentioned that the selling of BH Telecom Sarajevo public company, whose book value amounts to KM 571 million, is not considered at present. According to the RS privatization plan, eight companies, whose total value amounts to about KM 173.8 million, will be put up for sale in 2011. This too could contribute to an increase in direct foreign investments in the coming period. As per a decision made by the Government of FBiH (March 2010), reconstruction and building of thermal power plants will be based on direct foreign investments. Hence, the Government gave its approval for finding of a strategic partner (70% of investment) for building of: Tuzla Blok 7 thermal power plant, with DFI amounting to KM 1.15; Kongora mine and thermal power plant, with DFI amounting to KM 1.5 billion; In case it proves successful in finding of a strategic partner, the same model could be applied in the case of Kakanj Blok 8 thermal power plant (DFI of about KM 1 billion) and Bugojno mine and thermal power plant (DFI of about KM 800 million). Zenica thermal power plant and Stanari mine and thermal power plant are the most significant ones among the ongoing projects. KazTransGas, as a foreign partner, (75% of investment) will invest, together with Zenica municipality (25%), about KM 500 million (Euro 250 million) over the course of 4 and a half years. Depending on the dynamic of building of Zenica plant, the annual DFI would amount to KM 100-200 million. The Energy Financing Team signed concession contracts for building of Stanari thermal power plant and expansion of the existing mine (Euro 550 million), as well as a contract for building of Ulog hydro-electric plant (Euro 100 million). Provided the investments dynamic remains unchanged, the ETF would annually provide an average of around KM 200-300 of DFI from 2011 to 2013. Potential modernization and expansion of processing capacities of Brod refinery by Zarubeneft, a partner from Russia, whose planned cost will amount to around KM 1.2 billion over the course of 4-5 years, is mentioned as a significant investment too. This means that the average annual DFI would amount to around KM 200-250 million in the upcoming period. Building of Ugljevik 2 thermal power plant in RS is planned. The cost of its building will be around Euro 400 million in a 3-4 year period, which would secure around KM 200 million of DFI per year in the upcoming period, starting in 2012. The total direct foreign investments in BiH might range from KM 600 to 850 million in 2011 and between KM 1.1 and 1.5 billion in 2012 and 2013.

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ABBREVIATIONS:
LFS BATX BD GDP GVA BHAS Labour force survey Bosnian Trade Index Brcko District Gross Domestic Product Gross Value Added Agency for Statistic of Bosnia and Herzegovina IBIF Index of Bosnian Investment Funds BiH Bosnia and Herzegovina BLSE Banja Luka Stock Exchange CBBiH Central Bank of Bosnia and Herzegovina CEFTA Central European Free Trade Agreement CPI Consumer Price Index BFP Budget Framework Paper DFI Direct Foreign Investment EBRD European Bank for Reconstruction and Development EC European Commission EIR Effective Interest Rate ERS-10 The Index of 10 Power Utility Companies in Republika Srpska EU European Union FBiH Federation of Bosnia and Herzegovina FIRS Investment Funds Index of Republika Srpska FISIM Financial Intermediation Services Indirectly Measured ITASG Indirect Taxation Authority Single Account KM Convertible Mark (International Standard ISO 4217) IMF International Monetary Fund MoFTER Ministry of Foreign Trade and Economic Relations MAU Macroeconomic Analysis Unit of the Indirect Taxation Authority Governing Board MR Mandatory Reserves BoP Balance of Payments VAT Value Added Tax PIF Privatization Investment Funds PIP Public Investment Programme RS Republika Srpska SASE Sarajevo Stock Exchange SASX-10 Index designed to represent the performance of 10 best companies as listed on the Free Market of the Sarajevo Stock Exchange WB World Bank SEE South East Europe SIPA State Investigation and Protection Agency SITC Standard International Trade Classification MTEF Medium Term Expenditure Framework MTDS Medium Term Development Strategy SAA Stabilization and Association Agreement FTA Free Trade Agreement GFS Government Finance Statistics ITA BiH Indirect Taxation Authority USAID United States Agency for International Development H1 2010 First Half of 2010 H2 2010 Second Half of 2010 Q1 2010 First Quarter of 2010 Q2 2010 Second Quarter of 2010 Q3 2010 Third Quarter of 2010 Q4 2010 Fourth Quarter of 2010 M0 Reserve Money M1 Transaction Money M2 Broad Money QM Quasi Money mKM million KM y/y Growth rate that indicates changes in comparison with the same period of the previous year m/m Growth rate that indicates changes in comparison with the previous month of the current year

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