VZCZCXRO0219
OO RUEHDBU RUEHFL RUEHKW RUEHLA RUEHNP RUEHROV RUEHSL RUEHSR
DE RUEHVJ #0171/01 0532317
ZNY CCCCC ZZH
O 222317Z FEB 10
FM AMEMBASSY SARAJEVO
TO RUEHC/SECSTATE WASHDC IMMEDIATE 1426
INFO RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHZL/EUROPEAN POLITICAL COLLECTIVE

C O N F I D E N T I A L SECTION 01 OF 03 SARAJEVO 000171 
 
SIPDIS 
 
STATE FOR EUR/FO, EUR/SCE, AND EEB/IFD 
TREASURY FOR OASIA - JEFF BAKER AND PETER MAIER 
 
E.O. 12958: DECL: 02/22/2020 
TAGS: EFIN ECON PGOV SOCI IMF IBRD BK
SUBJECT: BOSNIA: WORLD BANK DEADLINE LOOMS - POTENTIAL 
UPHEAVAL AHEAD 
 
REF: A. SARAJEVO 82 
     ¶B. 09 SARAJEVO 1419 
     ¶C. 09 SARAJEVO 1299 
 
Classified By: Econ Counselor Eric Luftman for reasons 1.4 (b) and (d) 
 
Summary 
------- 
 
¶1. (SBU) Federation parliamentarians face a February 26 
deadline to fix the entity's unsustainable system of social 
benefits, or risk grave financial and political consequences. 
 At stake are a $111 million World Bank budget support loan, 
an IMF disbursement worth $135 million, ten more IMF 
disbursements over the next three years, and a 100 million 
euro EU budget support loan.  These losses will translate 
into cuts of nearly 20 percent across the board in the 
Federation's 2010 budget, affecting wages, government 
operations, investments, pensions, and social benefits.  The 
Republika Srpska, though it has met all conditions to date, 
will share the pain of the Federation's failure, as 
disbursement of the assistance requires compliance of both 
entities.  Moreover, this will give RS politicians ample 
reason to push for greater autonomy of the entities.  The 
Embassy and others in the international community have 
pressed leaders of Federation ruling parties to pass the 
necessary reforms.  Though these leaders seem to be getting 
the message, their party members in Parliament worry that 
voting for the reforms will incite veterans whose benefits 
are most threatened.  It remains unclear whether the 
legislators will do the right thing.  End summary. 
 
How Did Bosnia Get into This Hole? 
---------------------------------- 
 
¶2. (SBU) For five years prior to the global financial crisis, 
when the Bosnian economy was growing at 5-6 percent per year, 
the entities -- particularly the Federation -- passed a 
series of overly-generous, poorly-structured, and unfunded 
social benefits and pension programs, largely to win votes. 
Extending to both civilian and veterans programs, the result 
has been a benefits system that is one of the most expensive 
in Europe.  Comparing 25 countries in Central and Eastern 
Europe and Eurasia, the World Bank has shown that Bosnia and 
Herzegovina's spending on social assistance, at four percent 
of its GDP is second only to Croatia's system in cost. 
 
¶3. (SBU) Yet for all the expense, Bosnia's system ranks as 
the most inequitable among the 25 countries of the region. 
Only 18 percent of benefits in the Bosnian system reach the 
poorest fifth of the population, less than what the 
wealthiest receive.  Among veterans, the disparity is even 
more stark: 27 percent of veteran-related benefits go to the 
top fifth of veterans, while less than 15 percent go to the 
bottom fifth. 
 
¶4. (SBU) The Republika Srpska pursued a similar path of 
excessive public expenditure but was better able to afford 
such programs thanks to the trust fund created with the sale 
of RS Telekom and other state-owned companies.  Nevertheless, 
the RS has eaten through most of the privatization revenues 
at an alarming rate, and by the spring of 2009, both it and 
the Federation faced unsustainable budget deficits that led 
them jointly to apply to the IMF for help. 
 
IMF to the Rescue 
----------------- 
 
¶5. (SBU) Bosnia signed a Stand-By Arrangement with the IMF 
worth $1.6 billion in the summer of 2009, to be paid out over 
three years in twelve quarterly tranches.  The money would be 
divided between the Federation and RS at a 60/40 ratio.  The 
first tranche, worth about $275 million, was disbursed in 
September 2009 upon completion of a number of conditions in 
both entities, including rebalancing of the 2009 entity and 
state budgets, and adoption of reforms of state wages. 
 
The World Bank Plays Bad Cop 
---------------------------- 
 
¶6. (SBU) Generous though it was, the IMF program wasn't 
sufficient to plug the entities' anticipated 2010 budget 
deficits.  The Bosnian government therefore negotiated a 
parallel agreement with the World Bank for a "development 
policy loan," a budget-support program of $100 million (later 
renegotiated to $111 million) to be fully disbursed in 2010. 
In return, the Bank set conditions for reform of the social 
benefits system that went beyond those set by the IMF for 
 
SARAJEVO 00000171  002.2 OF 003 
 
 
disbursement of its second tranche, and got more to the root 
of the problem. 
 
¶7. (SBU) Seventy percent of the development policy loan is on 
virtually interest-free "IDA" terms, which will expire on 
June 2011.  The World Bank announced in January that if the 
Federation did not complete the final conditions for the loan 
by February 26 -- thirty days before the next meeting of the 
World Bank board -- it would cancel the loan and reprogram 
the money. 
 
What Does the Reform Package Require? 
------------------------------------- 
 
¶8. (SBU) World Bank analysts of Bosnia's entitlements system 
observe beneficiaries double- and triple-dipping into social 
programs at the entity, cantonal, and municipal levels, or in 
some cases drawing from both Bosnian and Croat programs.  The 
main goal of the reforms is introduction of a means-testing 
mechanism, to be implemented in 2011, and starting with an 
audit of beneficiaries to clean the records.  These programs 
would exempt anyone with more than a 60 percent disability, 
and would improve coverage of the poorest citizens, 
regardless of disability level. 
 
Federation Parliament to PM: Talk to the Vets 
--------------------------------------------- 
 
¶9. (SBU) The Federation government adopted all of the 
required reform legislation and presented it to the House of 
Representatives for approval in January.  But with the fresh 
memory of veterans' organizations storming the floor of the 
legislature in November, the legislators refused to act on 
the package, telling the government to talk to the vets. 
Prime Minister Mustafa Mujezinovic negotiated with fourteen 
veterans' associations on February 12-13.  Though he claimed 
to be making headway, the talks ultimately failed.  Veterans 
remind their politicians that the benefits were promised to 
them, and the parliamentarians remain unwilling to reopen the 
issue.  Meanwhile, other groups are joining the veterans' 
ranks.  The alliance of BiH trade unions has announced that 
2500 workers will demonstrate in front of the Federation 
Parliament building on February 23, in protest against an 
IMF-driven law that cut state employees' wages by ten 
percent. 
 
Giving Dodik the Case for Entity Autonomy 
----------------------------------------- 
 
¶10. (SBU) The prospect of losing the IMF and World Bank money 
particularly rankles the Republika Srpska, which rebalanced 
its 2010 budget and enacted all the necessary wage and social 
benefit reforms by December 31.  RS officials have questioned 
why their access to these funds must be shackled to the 
Federation's failure to straighten out its own finances.  In 
Washington in early February, BiH Prime Minister Nikola 
Spiric -- an SNSD party ally of RS Prime Minister Miroslav 
Dodik -- asked the World Bank and IMF to disburse to the RS 
and withhold from the Federation.  Holding to the letter of 
their agreements with Bosnia, both the IMF and World Bank 
turned Spiric down. 
 
What Will Happen If the Package Fails? 
-------------------------------------- 
 
¶11. (SBU) Completing the necessary reforms will unlock nearly 
KM one billion in budget support funds for Bosnia, or about 
$700 million, in 2010, with a similar amount over the next 
two years through the later tranches of the IMF program. 
Divided 60/40, that would be $420 million for the Federation 
and $280 million for the RS.  Federation Finance Minister 
Vjekoslav Bevanda has said that loss of these programs will 
mean a $360 million shortfall in the 2010 Federation budget, 
necessitating an 18.7 percent cut in programs across the 
board.  The alternatives for raising revenues are not 
attractive.  Commercial borrowing would involve much higher 
rates of interest, and dangerous levels of debt.  The 
Federation has many state enterprises available for 
privatization, but unloading them under the current 
circumstances would be a fire sale. 
 
¶12. (SBU) Unlike the World Bank, the IMF has not set an 
explicit deadline for disbursement of the second tranche.  It 
is possible that Bosnia could lose the World Bank loan, but 
at some later date meet the conditions needed for 
disbursement of the IMF money.  This would still, however, 
require deep budget cuts and renegotiation with the IMF on 
tougher terms.  In any scenario other than completion of the 
 
SARAJEVO 00000171  003 OF 003 
 
 
reforms, confidence of commercial banks and private investors 
in Bosnia will take a nosedive, and tensions between the two 
entities will build. 
 
Making a Last Ditch Effort 
-------------------------- 
 
¶13. (SBU) Within the past week, the IMF and World Bank have 
raised the volume on the issue, mobilizing the international 
community.  At their urging, the ambassadors of the Peace 
Implementation Council issued a public letter on February 22 
calling on the Federation government an legislature to pass 
the reforms to try to give he local politicans some needed 
political cover. 
 
¶14. (SBU) The Ambassador meanwhile met with SDA party leader 
Sulejman Tihic on February 19 to impess on him the danger to 
the country if the legislation does not pass.  Tihic at first 
said it could not be done without cooperation from rival 
Haris Silajdzic's SBiH party.  When pressed, Tihic said that 
SDA would be "part of the solution," and would support the 
legislation despite risks.  Later the same day, SBiH leader 
Silajdzic expressed similar distrust of his rival, but 
ultimately acknowledged that the country was on the brink of 
collapse.  The two are meeting with Croat party leaders 
Dragan Covic and Bozo Ljubic on February 23, along with the 
World Bank and IMF resident representatives and High 
Representative Valentin Inzko to try to hammer out an 
agreement. (Croat parties seems fine with voting for the 
reforms since their constituencies stand to lose less.)  They 
then plan to convey that agreement to Parliament the 
following day, in hope of passage of the reforms. 
 
Comment 
------- 
 
¶15. (C)  Passing the legislation to reform social benefits is 
politically difficult for Bosniak politicians (particularly 
SDA and SBiH) -- some have called it political suicide -- but 
they set themselves up for this crisis.  As a manifestation 
of the lack of political courage exhibited so far, Federation 
PM Mujezinovic even called the HiRep privately to ask him to 
impose the needed legislation (an impossibility, of course). 
Passing the legislation is the only course right now that 
will avert economic freefall and intensified inter-entity 
tension.  For the RS to lose $280 million in budget support 
simply because of the Federation's inability to manage its 
own affairs hands Dodik a potent weapon in making the case 
for more entity autonomy. 
ENGLISH