Ian Bancroft in Belgrade -

Despite being initially agreed back in May after often-fraught negotiations, the three-year €1.2bn stand-by arrangement reached between the International Monetary Fund and Bosnia-Herzegovina remains beset by a host of impediments that delayed payment of the first tranche and threatens to curtail future financial assistance.

Gripped by political crisis and growing social unrest, the Federation of Bosnia-Herzegovina - the Muslim-Croat half of the country, due to receive two-thirds of the IMF money - has struggled to enact a series of testing reforms that were demanded by the IMF, and in the process further exposed Bosnia's vulnerability to the global economic crisis.

Approval of the stand-by arrangement was initially delayed in June after the IMF rejected the Federation's proposed budget revision for 2009. Protests by war veterans - the largest welfare category and one of the most influential social and lobbying groups - supported by trade unions and invalids' associations, forced the Federation government to exempt war veterans and their families from a planned 10% reduction in welfare payments. In seeking to extract savings from administrative expenses, however, the Federation - which is expected to contribute the bulk of Bosnia's budget savings, equivalent to more than one-fifth of its 2009 budget - violated an undertaking with the IMF to curb social transfers that have left the entity on the verge of bankruptcy and forced the government to take out a €71m short-term credit from local commercial banks in order to cover part of a backlog of payments from 2008. As the Federation's finance minister, Vjekoslav Bevanda, then surmised, "politics have got entangled with the IMF arrangement."

Though the head of the IMF mission to Bosnia, Costas Christou, previously warned that achieving the budget savings required by the IMF would require a "decisive package of measures," the Federation government has failed to formulate a cohesive and coherent strategic response, relying instead upon a series of sporadic and haphazard measures designed to eke out savings without offering fundamental and sustainable reform.

As Svetlana Cenic, former finance minister of Republika Srpska, the other half of Bosnia, warns, the country has an "unsustainable system with huge public spending, stalled reforms and insufficient attractiveness to foreign investors, and these can no longer be justified amid the global recession."

Postponed privatisation

Whilst the Federation government is prepared to privatise some of the better-performing public companies - such as engineering company Energoinvest and pharmaceuticals manufacturer Bosnalijek - the current economic malaise has persuaded Mustafa Mujezinovic, the Federation's new prime minister, to put such plans on hold until both buyer interest and potential prices are more buoyant.

Although Bevanda recently confirmed that each of the entity's 10 cantons had adopted the revised budget re-balance (which proposes savings of around €112m, including a €30m reduction in social benefits for war invalids) that will allow Bosnia to obtain the first tranche of IMF support, doubts remain as to the entity's overall political capacity and willingness to see through such reforms in the face of rising unemployment, growing social unrest and increasingly vociferous interest groups.

With IMF estimates suggesting that Bosnia will experience an economic contraction of 3% in 2009, primarily in the Federation, with "a very mild recovery only beginning in the middle of next year," and with unemployment currently hovering around 40%, the ramifications of the global economic crisis will continue to magnify and exacerbate the shortcomings of the Federation.

By contrast, Republika Srpska quickly proposed a revised 2009 budget that meets the IMF's requirements by reducing spending by 4% to approximately €818m. Having already cut the salaries of government and public sector employees, and reduced public spending to below 40% of GDP as advised by the IMF, Republika Srpska, which continues to benefit from the proceeds of a string of successful privatisations, has found itself better placed to respond to the economic downturn.

As Aleksandar Dzombic, Republika Srpska's finance minister, emphasized, savings of some €36m were achieved through cuts in grants and internal debt, eliminating the need to reduce pensions and veterans' welfare payments. Despite the Federation's previous failure to fulfil their part of the agreement, Republika Srpska's request for immediate support from the IMF was immediately rejected.

Facing a stalemate over constitutional reform and other key measures for accession towards the EU, Bosnia 's continuing wobbles on the IMF tightrope have further exposed the country's economic, financial and structural fragility. Though a series of short-term measures have secured access to the first tranche of assistance, doubts remain over the Federation's capacity and willingness to contend with the political and socio-economic ramifications of implementing the stringent conditions on which future financial assistance depend. In order to mitigate Bosnia's growing crisis of legitimacy, therefore, urgent steps must be taken to ensure that the present and prospective dysfunctionality of the Federation does not undermine the entire country's efforts to secure vital IMF assistance.

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