REPUBLIC OF SRPSKA GOVERNMENT ECONOMIC REFORM PROGRAMME OF THE REPUBLIC OF SRPSKA FOR THE PERIOD

Transcription

1 REPUBLIC OF SRPSKA GOVERNMENT ECONOMIC REFORM PROGRAMME OF THE REPUBLIC OF SRPSKA FOR THE PERIOD Banja Luka, December 2016

2 Contents 1. OVERALL POLICY FRAMEWORK AND OBJECTIVES MACROECONOMIC FRAMEWORK RECENT ECONOMIC DEVELOPMENTS THE MEDIUM-TERM MACROECONOMIC SCENARIO ALTERNATIVE SCENARIOS AND RISKS FISCAL FRAMEWORK POLICY STRATEGY AND MEDIUM-TERM GOALS IMPLEMENTATION OF THE BUDGET IN MEDIUM-TERM PROSPECTS BUDGET THE LEVEL OF INDEBTEDNESS... ERROR! BOOKMARK NOT DEFINED SENSITIVITY ANALYSIS AND COMPARISON WITH THE PREVIOUS PROGRAM PUBLIC FINANCE SUSTAINABILITY INSTITUTIONAL FEATURES PRIORITIES OF STRUCTURAL REFORMS IN THE REPUBLIC OF SRPSKA IN THE PERIOD OF IDENTIFICATION OF THE KEY OBSTACLES FOR GROWTH AND COMPETITIVENESS PRIORITIES OF STRUCTURAL REFORMS BY AREAS Public finance management Infrastructure Agriculture Industry Service sector Business environment, corporate governance and reducing informal economy The technology absorption and innovation... Error! Bookmark not defined Trade integration... Error! Bookmark not defined Employment and labour market... Error! Bookmark not defined Fostering social inclusion, combatting poverty and promoting equal opportunities... Error! Bookmark not defined BRIEF SUMMARY OF REFORM PRIORITIES... ERROR! BOOKMARK NOT DEFINED. 5. BUDGET IMPLICATIONS OF STRUCTURAL REFORMS... ERROR! BOOKMARK NOT DEFINED. 6. INSTITUTIONAL QUESTIONS AND INVOLVEMENT OF INTERESTED PARTIES...ERROR! BOOKMARK NOT DEFINED. 7. SUMMARY DATA... ERROR! BOOKMARK NOT DEFINED. APPENDIX 1: TABLES APPENDIX 2: EXTERNAL CONTRIBUTIONS... ERROR! BOOKMARK NOT DEFINED. 2

3 1. POLICY FRAMEWORK AND OBJECTIVES Countries that are in the process of negotiating with the European Union on the Stabilisation and Association Agreement, as well as countries that have already signed this agreement but have not yet obtained candidate status, until 2014, preparing economic and fiscal program. At the same time, economic and fiscal program was a kind of preparation for Pre-Accession Economic Program, which were made when the country candidate status, and in a broader sense, it has been preparing for the Convergence Programme, after joining the European Union. During 2014, the European Commission adopted a new strategy for expansion with a new approach to economic management, which has become a key pillar of EU enlargement. The main objective of the new approach is that countries, through economic dialogue in the enlargement process, first solve the basic economic questions and thus meet the economic criteria for accession. The new approach is based on the process of the European Semester at the EU level and aims to target specific recommendations for each country and to improve reporting on national economic policies plans, including structural reforms. Increased focus on economic governance relates in particular to the Western Balkan countries with the aim that they provide long-term growth and competitiveness. Accordingly, all countries of the Western Balkans and Turkey have submitted their first national program of economic reforms in January This year, of all the countries of the Western Balkans and Turkey are expected to prepare a program of economic reforms for 2016 that contains a medium-term macroeconomic framework and a fiscal policy framework, as well as a comprehensive programme of structural reforms. Accordingly, based on the methodology and guidelines provided by the European Commission, the Republic of Srpska has elaborated the Economic Reforms Programme of the Republic of Srpska for the period (hereinafter referred to as ERP RS ) and submitted to the Directorate for Economic Planning (DEP), that is pursuant to the Council of Ministers Conclusion tasked to consolidate parts of the text for entities in the document named Economic Reform Programme of Bosnia and Herzegovina for the period (hereinafter referred to as ERP BiH ) and to harmonize it with entities, and to submit it for approval to the Council of Ministers. Once adopted, the same shall be submitted to the European Commission no later than 31/01/2016. ERP RS is aligned with the Revised Document of the Republic of Srpska Framework Budget for the period , which was adopted by the Government of the Republic of Srpska at the 9th Special Session, held on , and the Economic Policy of the Republic of Srpska in 2016 and the Republic of Srpska Budget for 2016, which were adopted at the 15th Special Session of the National Assembly of the Republic of Srpska, held on The adoption of the RS Government policy was preceded by a comprehensive public debate. The Government of the Republic of Srpska at the 8th Special and at the 25th Working-Consultative Session discussed the draft version of the Economic Policy of the Republic of Srpska in 2016 and established the text that was distributed to all government partners. In this regard, prior to making the Draft Economic Policy of the Republic of Srpska for 2016, RS Government has invited all relevant actors to submit their suggestions and comments on the draft version of the RS Economic Policy for the year 2016, and thereafter on December 7, 2015 held a public debate with all its partners. In addition, the working version of the Economic Policy of the Republic of Srpska in 2016 was discussed on 9 December 2015 at the 34th Regular Session of the Economic and Social Council of the Republic of Srpska and with certain remarks and suggestions of the Government s social partners received the unanimous support. All acceptable written and oral proposals on the Draft version of the RS Economic Policy for the year 2016 are incorporated in the Proposal of the RS Economic Policy for the year 2016, and subsequently in the ERP RS Policies of the Republic of Srpska, given in the ERP RS , DEP should incorporate into the final document of BiH's Economic Reform Programme for the period The Economic Policy of the Republic of Srpska for 2016 defined the RS basic objective of the, which is strong, stable, democratic and prosperous Republic of Srpska, with its competences verified by the Dayton Agreement, open to the world and with institutions that can meet the needs of all its citizens. On the basis of a clear objective, detailed analysis of the situation in all areas, the Government Work 3

4 Programme for the period and the policies of the RS Government, defined by the Reform Agenda for the period and the RS Action Plan, which were agreed with the European Union and international financial institutions, a key reform areas of the RS Government for the year 2016 are based on the five pillars of reform: stable economic growth, fiscal sustainability, social security, rule of law and European integration. Stable economic growth will be based on the recovery of the economy and improving the business climate and competitiveness. Ensuring sustainable, efficient and continuous economic growth, the strengthening of administrative capacity and increasing the efficiency of public institutions at all levels, will create space for increasing and better targeting of social benefits, and create a favourable and socially equitable environment. Efforts to ensure fiscal and financial sustainability will be reinforced by measures to strengthen the rule of law and fighting corruption. At the same time, all mentioned policy of the RS Government will help the European path of the Republic of Srpska. In order to implement targeted policy guidelines adopted at the Economic and Financial Dialogue in May 2015, the Republic of Srpska emphasizes that it is carried out the improvement of the budget management framework, through the adoption of the Fiscal Responsibility Act in the Republic of Srpska, which establishes the rules and fiscal measures and founded the Fiscal Council of the Republic of Srpska. At the same time, through the budget for the year 2016, we have endeavoured to improve the system of planning in public spending, which in the forthcoming period will create fiscal space for capital investment. In addition, we are actively working on the establishment of a register of parafiscal levies in order to ease the economic strains. Adopting the new Labour Law, we opened the process of labour market reforms, and in 2016 we expect further steps on reducing the tax burden on labour, ensuring at the same time realistic and safe sources, which will compensate for the loss of revenues of extra budgetary funds. With technical IMF assistance we are preparing a new legislative framework for the banking sector of the Republic of Srpska. 2. MACROECONOMIC FRAMEWORK According to the IMF Report from October 2015, World Economic Outlook (WEO) which analyses the global economic trends, projections for global growth is 3.1%. Table 2.1: Overview of IMF projections, updated in October 2015 Projections Real GDP growth,% World 3,4 3,4 3,1 3,6 Developed economies 1,4 1,8 2,0 2,2 USA 2,2 2,4 2,6 2,8 eurozone -0,5 0,9 1,5 1,6 Developing countries 5,0 4,6 4,0 4,5 European Union 0,1 1,5 1,9 1,9 European develping countries 2,9 2,8 3,0 3,0 Growth of world trade (goods and services),% 3,5 3,3 3,2 4,1 Growth of oil prices in dollars, annual change, % -0,9-7,5-46,4-2,4 Consumer prices Developed countries 1,4 1,4 0,3 1,2 Developing countries 5,9 5,1 5,6 5,1 Source: IMF, World Economic Outlook, Update Octobеr

5 A weaker recovery in 2015 and 2016 (compared to earlier projections) is mainly a result of the impact of global factors (high public and private debt, the weakness of the financial sector, low investment, low growth rate of labour productivity, the demographic transition, the fall in prices of raw materials etc.), which also represents a risk for the realization of the projected growth. According to these projections the economic growth in Euro zone is 1.5% in 2015 and 1.6% in 2016, while in the European Union is 1.9% in 2015 and For European developing countries 1 projected growth is 3.0% in 2015 and According to the IMF, the SEE region has benefited from lower oil prices and a gradual recovery in Euro zone, but on the other hand, it was affected by the situation in Russia and under the influence of high corporate debt. Table 2.2: European economic forecasts EU, Autumn 2015 Projections for EU Real GDP growth (%, y/y) 0,2 1,4 1,9 2,0 Inflation (%, y/y) 1,5 0,6 0,0 1,1 Unemployment (%) 10,9 10,2 9,5 9,2 Budget balance (% of GDP) -3,3-3,0-2,5-2,0 Total public debt (% of GDP) 87,3 88,6 87,8 87,1 Current account balance (% of GDP) 1,5 1,6 2,2 2,2 November 2015, European Commission Similar to the previous, according European Commission projections from November is expected to continue moderate economic recovery in the future, despite the numerous challenges in the global economy. In fact, despite the fall in oil prices and the weakening of the euro, the economic recovery in 2015 was present in almost all EU countries, but remained lower intensity. The expected real GDP growth in euro zone was 1.6% in 2015 to 1.8% in 2016 and 1.9% in 2017, whereas the EU is expected to grow by 1.9% in 2015 to 2.0% in 2016 and 2.1% in Graph 2.1: Real growth rates of GDP quarterly (K/K 4 ) Comparison of the Republic of Srpska, the EU 28 and countries in which the Republic of Srpska exports mostlyизвози Source: National Bureau of Statistics of the Republic Srpska, EUROSTAT (seasonally adjusted data) Quarterly GDP growth rates of the EU28, in 2014, were 1,5%, 1,2%, 1,4% and 1,4%, and in the first two quarters of % and 1.9%. Data in Graph shows that countries that are the most important foreign trade partners of the Republic of Srpska achieve positive business trends. Among the examined country, Slovenia and Germany have achieved growth during the whole period, the recession in Italy and Croatia was reduced to a level of around 0.5% in 2014 and in the first half of 2015 these countries achieved positive growth rates. Similarly, in Serbia, after a series of negative GDP growth rates in the second quarter of 2015 recorded a positive growth of 1.0%. 1 European developing countries include: Serbia, Croatia, Bulgaria, Hungary, Poland, Romania and Turkey, including Albania, Bosnia and Herzegovina, Macedonia and Montenegro. 2 The projections have been adjusted in April by 0.1 percentage points and -0.2 percentage points respectively 3 Autumn Economic Forecast of the European Commission Source: EUROSTAT, Statistic Database, not seasonally adjusted (ESA 2010 ), data taken on

6 According to the report on investment in the world (24 June 2015) the movement of foreign investments in 2014 registered a larger decline than expected, a decline at the global level in foreign investments compared to 2013 in the amount of 16 % in relation to the expected 8.0%. Developed countries decreased by 28% compared to the expected 14%, while developing countries recorded an increase in the amount of 2.0% compared to the expected 4.0%. Countries in transition have recorded decrease of 48.3%, which is close to the expected decline. When it comes to South East Europe, according to the UNCTAD World Investment Report in 2014, we can see that almost no country has reached the level of foreign investments before the outbreak of the global financial crisis in RECENT ECONOMIC DEVELOPMENTS Although the Republic of Srpska, in 2014 has been two times affected by the floods (in May and in August), it has achieved a real GDP growth of 0.2%. In addition to poor hydrometeorological situation, economic trends influenced the decrease in the price of oil and food prices on the world market, and the Eurozone exit out of recession. Achieved GDP rates of real growth in the first two quarters of 2015 amounted to: 0.9% and 1.5%, respectively 5, which contributed to continued deflationary pressures, the recovery in Eurozone countries and in the region and growth in the areas of industrial production and construction. Industrial production with a share of GDP from 15.5% in 2014 recorded a growth of 0.7%. For the most part this is the result of growth in the areas of: manufacturing industry (5.0%), while there was a decrease in the Production area and electricity, gas and steam supply and air conditioning supply (-9.0%) and mining and quarrying (-3.3%). In the period January-September 2015 the growth rate was 3.8%, which contributed to the increase in production in the areas of: Production and supply of electric energy... (2.9%), mining and quarrying (13.9%) and Manufacturing industry (2.2%). Such trend of industrial production is indication of an increase in economic activity in 2015 in the Republic of Srpska. The average rate of deflation in the Republic of Srpska (measured by the consumer price index CPI) in 2014, amounted to 1.2%, while in January-September 2015 the same was 1.3%. This indicates continued deflationary pressures amid falling oil and food prices in the world market. So the biggest fall in prices is evident in following sections: Food and non-alcoholic beverages (-2.9%) and Transport (-1.2%), the fact that the Republic of Srpska foreign trade has a significant trade deficit in the categories of goods. The Graph shows the impact of changes in food prices and transport on the overall level of prices in the Republic of Srpska in 2014 and nine months of It is estimated that the average rate of deflation in 2015 will be at around 1.0%, while in the Eurozone the inflation is expected to be at 0.1%. The average net salary in the Republic of Srpska in 2014 amounted to 825 BAM, which is, compared to 2013, the nominal increase of 2.1% and real by 3.3% taking into account the deflation. In the period January-September 2015, the average salary was 832 BAM and it is estimated that annual will amount to 833 BAM. In 2014, the survey unemployment rate decreased (by 1.3 per cent) to the level of 25.7%, while the number of unemployed decreased by 3.6%. In the period January-September 2015, the unemployment rate decreased further to 4.2%, and there was a slight decline in the survey unemployment rate (0.5 percentage points) to the level of 25.2%. The volume of foreign trade in 2014 amounted to 7.6 billion BAM and compared to the previous year is higher for 6.7%, while the coverage of imports by exports was 54.4%. Export growth was 3.4%, while import growth was 8.5%, which is mainly contributed to the increase in exports and imports in the manufacturing industry, which in the overall structure of imports and exports accounted for about 70-80%. In the period January-September 2015 the volume of foreign trade decreased by 7.1% as a result of the decrease in exports of 4.1% and a decrease in imports of 8.7%, while export-import ratio was 58.9%. The 5 The estimated data of the RS Statistics Institute. 6 The changes are indicated by annual rates (compared to a particular month with the same month of the previous year) 6

7 drop in exports has contributed significantly to the decline in exports in the areas of: Petroleum oils and oils obtained from bituminous minerals, other than crude (-57.2%), Electricity (-45.7%) and Fuel wood(-20,0%) 7. Graph 2.1.1: Impact of food and transport price change on the overall level of prices in the Republic of Srpska in 2014 and 2015 Graph 2.1.2: Comparison of average annual inflation rate in the Republic of Srpska, Bosnia and Herzegovina and the Eurozone Source: National Bureau of Statistics of the Republic of Srpska Source: National Bureau of Statistics of the Republic of Srpska, IMF The drop of imports was largely due to a decline in crude oil imports from Russia (-33.7%), which significantly participate in the structure of imports by 15.1% (5.7 per cent less than in the same period of 2014), and thus the increase in imports. It is estimated that annually, the reduction in exports will be 2.9% and in imports 7.5%. Graph 2.1.3: Trend of crude oil electricity export and import in the period January - September 2015 Source: National Bureau of Statistics of the Republic of Srpska Source: National Bureau of Statistics of the Republic of Srpska The banking sector in the previous period has preserved stability. In the first half of 2015, the accomplished growth in total loans was 3.0%, mainly due to the growth of loans to private companies (5.0%) and loans to citizens (4.0%). After long trend of growth, total deposits record a slight decrease (1.0%), whose structure is the most significant drop of 22.0% of government institutions deposits, deposits of banking institutions 15.0%, and deposits of private companies 10.0%. However, deposits of citizens still have growth trend and increased by 7.0%, and represent a stable and significant source of funding for banks. Non-performing loans, which represent one of the key risks of the banking sector increased by 3.0%, with an increase in non-performing loans to private individuals amounted to 6% and non-performing loans of legal entities 2.0%. 7 In 2015 a planned reduction in the production of electricity for the revitalization of generators G1 in HPP Dubrovnik. Characteristic Electrical system of the Republic of Srpska is that over 50% of electricity generation comes from two thermal power plants so that when unplanned downtime in their work leads to significant disruptions in production. The Republic of Srpska balance has surplus electricity that range 20% -30% of total production on an annual basis. 7

8 According to data of the Statistical Office of the Republic of Srpska, the value of investments in fixed assets in 2014 amounted to million BAM, which compared to the previous year, represents an increase of 29.1%. In terms of the technical structure, the most significant increase was recorded in investment in buildings and facilities (66.6%), while investments in machinery, equipment and transport equipment remained at approximately the same level (0.5%) and while other investments decreased ( %). According to the investors activities, the most significant increase in investment was achieved in the fields of mining and quarrying, education and production and electricity, gas, steam supply and air conditioning.. According to the Central Bank, in 2014, realized companies foreign direct investment with headquarters in the Republic of Srpska amounted to million BAM, which is almost 2.5 times more than in 2013, when investments were at a low level (152.6 million). Public debt of the Republic of Srpska, which includes internal and external debt of the Republic, internal and external debt of local authorities, and the internal debt of social security funds and the University Clinical Centre of Banja Luka on 31 December 2014 amounted to million of BAM, while the estimation for the end of 2015 is 4,357.4 million BAM. Total debt of the Republic of Srpska, which in addition to public debt includes external debt of public enterprises and IRB RS, at 31 December 2014 amounted to million BAM, while the estimation for the end of 2015 is million BAM. Accordingly, the share of public debt to GDP ratio at the end of 2015 will amount to 48.8% of GDP, while the total debt of the Republic of Srpska amount to 60,0% 8 of GDP. If we look at what positions will be a significant growth of debt in 2015 compared to 2014, we see that it is the foreign debt of the Republic of Srpska (budget) and of local authorities, and the internal debt of social security funds. The increase in debt in 2015 is primarily a result of depreciation of BAM relative to other currencies, and investment activities in the Republic of Srpska (flood damage repairs, investment in health and education sectors, refugees and displaced persons housing, etc.). Objectives of debt management in the future are: securing necessary financing for government functioning, providing necessary financing for infrastructure development and health, as well as dealing with the consequences and flood protection of the Republic of Srpska, raise funds with minimal risk and costs, taking into account the limitations of financial resources as well as the need to strengthen the domestic securities market. In addition to criteria relating to the debt, the Maastricht criteria follow the budget deficit. The level of deficit allowed by the Treaty of Maastricht was 3.0% of GDP. The deficit in EU countries in 2013 amounted to -3.0 % of GDP. According to the calculation of deficit for the Republic of Srpska, the deficit according to GFS methodology in 2014 was -3.2% of GDP MEDIUM-TERM MACROECONOMIC SCENARIO Based on macroeconomic indicators of the Republic of Srpska in the previous period and in the period January-September 2015, economic activity in the Republic of Srpska and neighbouring countries, initiated activities and planned policies of the Government of the Republic of Srpska, estimates and projections of macroeconomic indicators of the Republic of Srpska for the period are made. Table 2.2.1: Estimates of macroeconomic indicators for 2015 and projections for the period The estimates of indicators for public (48.8% of GDP) and total debt (60.0% of GDP) for 2014 does not include loans for financing the remediation of damage from the Single Registry of damage - according to the Law on Borrowing debt and guarantees of the Republic of Srpska ("Official Gazette of the Republic of Srpska" Nos. 71/12 and 52/14), it shall be exempt from the restrictions imposed for the total (60%) and public debt of the Republic of Srpska (55%). 9 Note: Due to the official figures of GDP, in the case of Bosnia and Herzegovina to the Agency for Statistics of Bosnia and Herzegovina based on the production approach, the Ministry of Finance of the Republic of Srpska as a basis for the evaluation takes 8

9 GDP in millions of BAM - Nominal Population - in millions 1,43 1,43 1,43 1,42 1,42 1,42 1,41 1,41 GDP per capita in BAM GDP per capita in BAM 4,4% -1,1% 2,1% 1,0% 0,3% 2,9% 4,4% 5,0% % GDP growth, in real terms 0,8% -1,1% 1,9% 0,2% 1,4% 2,4% 2,7% 3,0% Inflation - annual 3,9% 2,1% 0,0% -1,2% -1,0% 0,5% 1,5% 1,7% Просјечне нето плате у КМ Import in millions BAM Import growth in% 13,0% -2,0% 1,6% 8,5% -7,5% 4,4% 5,8% 5,9% Exports in millions BAM Export growth in% 17,6% -7,3% 9,7% 3,4% -2,9% 5,0% 7,0% 8,0% The coverage of imports by exports in% 55,9% 52,9% 57,1% 54,4% 57,1% 57,4% 58,1% 59,2% Unemployment rate % 24,5% 25,6% 27,0% 25,7% 25,2% 24,7% 24,2% 23,7% Source: National Bureau of Statistics of the Republic of Srpska ( ), assessment (2015) and projections ( ) of the Ministry of Finance of the Republic of Srpska Bearing in mind developments in the region and in the Republic of Srpska (floods in 2014, drought in 2015, continued deflationary pressures, as well as planned activities in the Republic of Srpska) estimated real GDP growth in 2015 is 1.4 %. In the forthcoming period, due to the gradual strengthening of economic growth and employment in the region, expected growth in exports and domestic demand, which is partly financed by remittances from abroad. In the period from 2016 to 2018 is expected to continue economic growth with the real GDP rate of 2.4%, 2.7% and 3.0%, respectively. Also, starting from expected them to positive developments in the environment and their impact on the economy of the Republic of Srpska and the fact that industrial production in the RS is significantly export-oriented, in the coming period, we expect the positive movement of industrial production growth rate ( % ). The projections for the next year, the positive rate of core inflation indicate a positive growth rate of goods and services that are the subject of trade with foreign countries. On the other hand, international institutions predict maintaining of oil and food prices at a low level in 2016, but due to the recovery in developed countries it is expected a modest rise in prices, so that projected inflation in the euro zone will be 1.0%. Given the above-mentioned, it is estimated that in 2016 in the Republic of Srpska inflation amount to 0.5% while in 2017 and 2018 is expected to grow, as oil and food on the world market, and in those years the projected inflation in the Republic of Srpska is 1.5% and 1.7%, respectively. In the coming period, we expect a slight increase in net salary, 842 BAM in 2016, 853 BAM in 2017 and 865 BAM in 2018 and continued downward trend in unemployment, so that the projected unemployment rate amounted to 24.7%, 24.2% and 23.7%, respectively. In projections of foreign trade of the Republic of Srpska, started from these assumptions regarding the improvement in economic activity in the region, particularly in countries with which the Republic of Srpska has a significant foreign trade and on the basis of expected growth in export demand. In addition, in 2016 starts operating TPP Stanari, so that the electricity production plan has increased by 27.8% compared to the planned production in In future projected growth rates of exports amounted to 5.0% in 2016, 7.0% in 2017 and 8.0% in 2018, the import growth rate of 4.4% in 2016, 5.8% in 2017 and 5.9% in 2018, while the projected rate of coverage of imports by exports will be in the range 57.4% %. According to estimates of the Ministry of Finance of the Republic of Srpska, the share of public debt in GDP in the Republic of Srpska in 2016 will amount to 48.5% of GDP. Investment activity in the economy will be one of the most important engines of economic growth in the future. Strategic areas in which it will be invested the most are transport infrastructure, agriculture, forestry and water management, as well as energy. data on annual GDP as in the quarterly assessment in 2014, based on the production approach, and recommended by the authorized institutions of the Republic of Srpska and Bosnia and Herzegovina. 9

10 2.3. ALTERNATIVE SCENARIOS AND RISKS Substantial risks in the coming period are related to the economic indicators of the environment and the risks related to (non) realization of estimates and projections of the neighbouring countries, the uncertainty of price fluctuations on the world market, as well as natural disasters. Also, risks related to the real sector, which would be significantly reflected in the expected economic growth could occur in case of lack of planned investments. When it comes to fiscal risks, they are linked to a possible decline in revenue from indirect taxes. 3. FISCAL FRAMEWORK 3.1. POLICY STRATEGY AND MEDIUM-TERM GOALS Consolidated balance sheet "General Government of the Republic of Srpska" presented in this Document includes revenue, expenditure and financing for the level of the Central Government of the Republic Srpska" (Republic of Srpska Budget, the RS budget beneficiaries inside and outside the Treasury General Ledger which have their own banking accounts and funds under the basis of investment projects financed from abroad and funds from the escrow account) and levels of budget and local authorities and financial plans of social security funds. Based on the analysis conditions in all areas, the Government of the Republic of Srpska designated key economic policy objective of the Republic of Srpska in 2016: stable economic growth, fiscal sustainability, social security, rule of law and European integration. The Government of the Republic of Srpska adopted Revised Budget Framework Paper of the Republic of Srpska for the period and, at the session held on , defining the planned budget frameworks and financing and debt for all levels of government in the Republic of Srpska. Data for 2014 represent budget execution at all levels of government observed. Data for 2015 have been adjusted in accordance with the budget rebalance for 2015, and data for the year 2016 in accordance with the budgets at all levels of government. Data for 2017 and 2018 are consistent with changes in the budgets drawn up after the adoption of the Revised Budget Framework Paper of the Republic of Srpska for the period It should be noted that the budgets were not adopted at all levels of government so that part of the data representing the projection. When we talk about the goals of the fiscal policy of the Republic of Srpska, targeted a consolidated deficit of the general government amounted to 3.0% of GDP a. The consolidated general government deficit of the Republic of Srpska in relation to the RS GDP in 2014 amounts to about a 3.2 %. According to projections, in the period under review, it is predicted a movement of deficit/surplus in the range of -1.7% of deficit to 1.8% of surplus. Table 3.1: The fiscal framework for the period under the baseline scenario Fiscal indicators (% Of GDP) Execution Rebalance Plan Plan Plan Total revenue 41,3 42,8 41,5 40,4 39,8 Total consumption 44,5 44,1 43,1 41,3 37,9 Net borrowing / lending -3,2-1,3-1,7-0,8 1,8 Interest expenditure 1,0 1,3 1,3 1,3 1,3 Primary balance -2,2 0,0-0,4 0,5 3,1 Source: Ministry of Finance of the Republic of Srpska 10

11 Republic of Srpska remains committed to strengthening fiscal stability so that despite the nominal increase in interest expenses over the years should not led to an increase in current and total consumption. So, with the projected growth of GDP of the Republic of Srpska is expected continuous reduction of consumption of observed levels of government of the Republic of Srpska in GDP from 44.5% in 2014 to 37.9% in When it comes to the debt policy, the main objective of the Republic of Srpska is certainly linked to the process of accession to the European Union, which means that the long-term commitment of the Republic of Srpska is maintaining of public debt at a level below 60% of GDP of the Republic of Srpska BUDGET IMPLEMENTATION IN 2015 The largest part of the fiscal framework of the General Government of the Republic of Srpska makes the Budget of the Republic of Srpska. Republic of Srpska Budget for 2015, adopted by the National Assembly of the Republic of Srpska on 28 December 2014, in the amount of the budget framework of 2,033.0 million BAM. Conditions for starting budget re-balancing of the Republic of Srpska were created because of changes in the structure of realized budget funds, as well as from the realization created from obligations arising from laws and bylaws in the current year, the implementation of government policies and priorities, proper recording of budgetary expenditure and the implementation of Decisions of the National Assembly of the Republic of Srpska on long-term borrowing of the Republic of Srpska for University of Istočno Sarajevo refinancing. The most significant amendments to budgetary positions made by Rebalanced budget of the Republic of Srpska in 2015 compared to the budget of the Republic of Srpska for 2015 are: In relation to the Republic of Srpska Budget for 2015, total tax revenue in 2015 rebalanced budget increased by 30.9 million BAM (2.2%), while total budgetary revenues and receipts of non-financial assets increased by 20.3 million BAM (1.3%). Proceeds of the financing of planned revised budget increased by 29.8 million compared to the budget plan for Losses on the use of goods and services increased by 10.9 million BAM (12.4%) - as a result of amendments to the special contribution of solidarity to extending the period of validity of the said law until , providing added resources for expenditures by court rulings, judicial institutions, education and culture. Funding expenses and other financial expenses were reduced by 2.2 million BAM (3.6%) - in accordance with the plan of repayment of foreign and internal debt. Remittances from social protection that are paid from the state budget were reduced by 11.2 million BAM (4.6%) - as a result of the transfer of allocations for veterans' supplement from Current transfers for War Veterans supplement to the position of expenditures for payment of outstanding liabilities from previous years, amounting to 11.0 million BAM and to ensure proper accounting recording and executed reallocation and redistribution proposed by budget beneficiaries themselves. Acquisition of non-financial assets increased by 11.0 million BAM (67.9%) - largely as a result of the implementation of the Decision on long-term borrowing of the Republic of Srpska totalling $ 12.7 million for the University of Istočno Sarajevo debt refinancing, of which 0.7 million relates to expenditures for non-financial property. Within these expenditures, funds in the amount of 6.8 million BAM are provided with for equipment purchase and reconstruction of facilities for the Republic s institutions. Resources within the Public investments are also increased in the amount of 3.5 million BAM. Expenditures for repayment of debts increased by 33.0 million BAM (6.9%) - were planned in the amount of 12.0 million BAM in order to implement decisions on long-term borrowing of the Republic of Srpska totalling $ 12.7 million University of Istočno Sarajevo debt refinancing. 11

12 In order to properly accounting recording of allocations for veterans' supplement the funds are transferred from a position of liquid transfers to war supplement to the position of expenditures for payment of outstanding liabilities from previous years, amounting to 11.0 million. Also, within these expenditures were provided funds in the amount of 2.1 million for the payment of obligations created in the previous period. Proceeds arising from borrowing increased by 29.8 million BAM as a result of enlargement proceeds of financial assets of 3.6 million, proceeds from borrowing by 10.0 million BAM and receipts from reimbursements paid off loans in the amount of 16.2 million BAM. According to reports on the execution of the Budget of the Republic of Srpska for six months of 2015, total revenues were realized in the amount of 99% compared to the plan, taxes 100%, while non-tax revenues 88%. On the expenditure side, the achievement of total expenditures is 87%, 89% of current expenditures, and expenditures for non-financial assets of 50%. Within current expenditures, expenditures for personal incomes were executed 100%, expenses arising from the use of goods and services 65%, financing expenses and other financial expenses 90%, transfers from social protection 87% and transfers between budget units of 81%. From this, it can be seen that during the implementation of the budget, debt repayment was a priority, while current spending was harmonized with revenue performance budget. That was the way to control public spending, by limiting the expenditures for the use of goods and services MEDIUM-TERM PROSPECTS BUDGET In the Table 2. Prospects budget of the broader Government of the Republic of Srpska, are given consolidated information about planned budget funds of General Government. The Budget of the Republic of Srpska for the year 2016 was adopted by the National Assembly of the Republic of Srpska on amounting to million, which was 1,043.9 million (50.1%) more than planned by Budget rebalance for The most important innovation in the Budget of the Republic of Srpska in 2016, compared to previous years is the introduction of the Pension and Disability Insurance Fund (PIO Fund) 10 in the treasury system of operations, as budget beneficiaries of the Republic of Srpska, and the greatest divergence in income and expenditures of the Budget of the Republic of Srpska are result of these changes. If we look to consolidate budgets for the level of the General Government of the Republic of Srpska, this change will not be evident because in the previous period PIO Fund was included in the subsector social security funds. Budget of the Republic of Srpska has planned for 2016 a deficit of EUR 2.0 million, while at the level of central government budget a deficit of million BAM, and at the level of the General Government a deficit of million. The planned budget deficit at the level of the General Government in 2017 amounted to 79.4 million, while in 2018 the level of the General Government is expected a surplus of million BAM. The estimated tax revenues of the Republic of Srpska Budget for the year 2016 has increased by million (57.9%) compared to the funds reserved in the budget for the year 2015 primarily as a result of the introduction of the Pension Fund in the treasury system of operations, as a beneficiary of the budget of the Republic of Srpska. Indirect tax revenues are planned in the amount of 1,141.7 million BAM (with foreign debt), which is a growth of 5.5%. Revenues from contributions for pension and disability insurance in 2016 amounted to million BAM, based on the inclusion of the Pension Fund. Non-tax revenues amount to million KM, which represents an increase of 20.1 million (12.7%). Proceeds in the financing increased by million (28.0%), and refer to income from short-term and long-term borrowing, the proceeds of refunds paid off loans from end beneficiaries and revenues from financial assets. 10 Fund for Pension and Disability Insurance of the Republic of Srpska 12

13 Total budget costs and the problem of non-financial assets in 2016 amounted to million, which represents an increase of million KM (56.3%) compared to the funds earmarked in the budget for the year 2015: Expenditures of financing and other financial expenses rose by 19.7 million (33.5%), in accordance with the plan of repayment of foreign and domestic borrowing, an updated plan for the withdrawal by investment loans, the budget planned financing, and the calendar issuing of treasury bills and long-term bonds.. Transfers between budget units of different levels of government were reduced by million BAM (66.5%) as a result of the cease of transfers to the Pension Fund due to the introduction of the Pension Fund in the treasury system of operations, as well as reducing the transfer of the Health Insurance Fund of the Republic of Srpska. Expenditure on non-financial assets have been increased by 24.9 million (47.7%) as a result of providing funds for the purchase of the facility in Istočno Sarajevo for accommodation of representatives of the Republic of Srpska in the BiH institutions, as well as reductions in positions of purchases of plant and equipment and expenditure for non-produced assets.. Expenditure for debts formwork in 2016 amounted to million BAM, which is an increase of million BAM (31.0%). The budgets of local government units for 2016 plan spending of 5.5% of projected GDP of the Republic of Srpska and a surplus of 0.5% of the same, i.e million BAM. The financial plans of social security funds 11 in 2016, plan social payments in the amount of million BAM. The planned budget spending on social security funds is amounted to 8.6% of projected GDP of the Republic of Srpska and the predicted deficit of 0.3% of it and amounts to 27.9 million BAM LEVEL OF INDEBTEDNESS Law on borrowing, debt and guarantees of the Republic of Srpska in detail stipulate field of borrowing and issuance of guarantees of the Republic of Srpska and local government units, and the methods and procedures for borrowing, which together with the existing laws on the budget system is a comprehensive legal framework for the promotion and control of budget discipline. This law established a limit on the amount of debt so that the total debt of the Republic of Srpska 12 at the end of the fiscal year cannot be higher than 60%, while the public debt of the Republic of Srpska cannot be greater than 55% of the achieved GDP in that year. The debt of the Republic of Srpska incurred on the base of debt to finance the repair of damage from the Unified Register of Damage, stipulated in the Law on Solidarity Fund for the reconstruction of the Republic of Srpska, shall be exempt from the restrictions imposed on the overall and public debt of the Republic of Srpska. Regarding the institutional arrangements for debt management in the Republic of Srpska, this work has been entrusted to the Department for Debt Management, as well as the organizational unit of the Ministry of Finance. That Department has been created in 2007, which abandoned the previous practice of debt operating by a number of different organizational units within the Ministry of Finance. 11 Including the Health Insurance Fund of the Republic of Srpska, Child Protection Fund of the Republic of Srpska and Employment Service of the Republic of Srpska, while the Fund for Pension and Disability Insurance of the Republic of Srpska in 2016 became part of the budget of the Republic of Srpska. 12 In accordance with the Law on borrowing, debt and guarantees of RS, RS total debt consists of public debt of the Republic of Srpska, debt of public enterprises, IRB RS and public sector institutions. Public debt is the debt of the Republic of Srpska (budget), the debt of local governments and social security funds debt. 13

14 As at the external debt of the Republic of Srpska, which is serviced by the Budget of the Republic of Srpska 13 amounted to 4.649,9 million BAM. Out of this amount, the external debt is 2.887,2 million (62,1%), while , 7 million (37, 9 %) represent the internal debt. Currency structure of the observed debt of the Republic of Srpska is characterized by the dominance of 4 currencies: BAM, EUR, SDR and USD. The largest share in the currency structure of the debt has BAM (37.9 %) because the domestic debt in general has been denominated in this currency. Bearing in mind that the Central Bank of Bosnia and Herzegovina maintains monetary stability in accordance with the currency board arrangement 14, it may be reasonable to assess that the share of euros in the currency structure of debt is significant(32.5 %). The high share of EUR and BAM provides a high degree of predictability of future liabilities, and in this respect the Republic of Srpska is the under less currency risk. However, due to the significant participation of SDR (21.6%) and USD (4.1%) currencies in the currency structure of the debt, and bearing in mind the dominance of the US dollar in the structure of SDR-а 15, enhancing the value of the US dollar could affect the increase in the balance of external debt. This would also require more local currency for servicing foreign debt. When it comes to the structure of debt in terms of maturity, it is essential as a positive fact to point out that the observed debt of the Republic of Srpska is almost entirely a long-term debt. The short-term debt relates only to 2.5%, while the entire remaining debt is long-term and its share is 97.5%. From the observed debt of the Republic of Srpska in the repayment phase is 52.1%, while in the grace period is 47.9 % of the debt. On the whole, the external debt is largely in repayment, i.e. 58.5%, while the "old" debt repayment is 94.7%, while the "new" debt repayment is 48.5%. From the internal debt repayment phase is 41.6%, while in the grace period is 58.4%. Most of the observed debt i.e. 61.4% is repaying at fixed interest rates. Unlike external debt, which is largely repaid by changing conditions (53.8%), domestic debt is largely repaid at fixed conditions (86.7%). When it comes to the structure of the observed debt from the standpoint of instruments, marketable portion of debt (bonds and treasury bills) amounts to 29.2%, and non-marketable portion of debt (loans and debt that will be settled through the plan or in cash) amounts to 70.8% of the debt. Marketable debt gives the opportunity to take advantage of debt management as they are openly traded on the capital market. Contingent liabilities With the debt balance on all loans for which the Republic of Srpska Government issued a guarantee amounted to million BAM. In the Budget of the Republic of Srpska have been planned funds for the repayment of liabilities arising from activated guarantees and outstanding guarantees which are estimated to be risky. Table Servicing and total public debt of the Republic of Srpska and debt servicing from the budget of the Republic of Srpska with Category Servicing of external debt 265,0 137,4 219,8 275,0 364,2 376, Republic of Srpska 200,7 90,8 143,8 184,1 262,0 278, local governments 3,6 1,9 5,6 7,7 8,0 8,0 13 This is a unique way of expressing information at all levels, for the purposes of this document shows the debt of the Republic of Srpska, which is serviced by the budget of the Republic of Srpska, which includes the foreign debt of the Republic of Srpska (budget), local government units, public enterprises and IRB RS, and the internal debt of the Republic of Srpska (budget) and social security funds originated indirect borrowing. 14 Currency board arrangement, i.e. currency board, established publishing it in domestic currency with full coverage in freely convertible currency at a fixed exchange rate 1 BAM: 0,51129 EUR. 15 The value of SDR -a is determined by a basket of four major currencies, i.e. its value consists of USD 41.9 % JPY 9.4%, EUR %, GBP 11, 3 %. 14

15 1.3. public enterprises and IRB 60,6 44,6 70,4 83,3 94,2 90,6 2 Servicing of internal debt 352,4 320,6 397,0 517,7 506,0 593, Republic of Srpska 216,9 216,2 258,5 413,4 405,1 497, local governments 66,7 48,4 74,8 60,7 59,0 55, social security funds 68,8 56,1 63,8 43,5 41,9 40,2 3 Servicing the public debt of RS 556,7 413,4 546,4 709,4 776,0 879, external debt ( ) 204,3 92,7 149,4 191,7 270,0 286, domestic debt ( ) 352,4 320,6 397,0 517,7 506,0 593,4 4 Service of total debt of RS 617,4 458,0 616,9 792,7 870,2 970, external debt ( ) 265,0 137,4 219,8 275,0 364,2 376, domestic debt ( ) 352,4 320,6 397,0 517,7 506,0 593,4 5 Servicing the debt from the budget of RS 518,1 388,8 526,9 726,2 805,5 908, external debt ( ) 265,0 137,4 219,8 275,0 364,2 376, domestic debt ( ) 253,2 251,4 307,1 451,2 441,2 532,0 Note: Data for 2015 are in line with the Budget for 2015, for the period are in line with the Budget for 2016 and the following two years Table Condition and total public debt of the Republic of Srpska and debt condition under obligations which are financed from the Budget of the Republic of Srpska with Category Foreign debt 2.887, , , , , , Republic of Srpska 1.859, , , , , , local governments 63,5 64,6 79,3 135,9 131,5 127, public enterprises and IRB 964,7 957,3 993, , , ,8 2 Condition of domestic debt 2.168, , , , , , Republic of Srpska 1.528, , , , , , local governments 330,4 309,1 255,6 272,7 229,6 170, social security funds 309,7 325,1 356,0 152,0 113,1 73,7 3 Public debt of RS 4.090, , , , , , external debt ( ) 1.922, , , , , , domestic debt ( ) 2.168, , , , , ,5 4 Balance of total debt of RS 5.055, , , , , , external debt ( ) 2.887, , , , , , domestic debt ( ) 2.168, , , , , ,5 Condition of the debt serviced from the RS budget 4.649, , , , , , external debt ( ) 2.887, , , , , , domestic debt ( ) 1.762, , , , , , SENSITIVITY ANALYSIS AND COMPARISON WITH THE PREVIOUS PROGRAMME The sensitivity of budget projections to alternative scenarios and risks 15