Clare Nuttall in Almaty -

The stock markets of Bosnia-Herzegovina were making spectacular progress until 2007, when Kosovo's inexorable march toward independence triggered worries about regional instability. Experts are now predicting that regulatory changes and a fresh wave of privatisations will put the Sarajevo and Banja Luka exchanges back on track.

In a recent report on the Bosnian markets, Raiffeisen Group anticipates that financial reforms and pensions legislation will allow local capital markets not just to recover, but soar. "2008 is expected to be the turning point for the development of local asset management facilities and institutions... Completion of the new legal frame for the establishment of the pension reform and investment funds has opened the way for advanced development of the local capital market," Raiffeisen says. "We will be looking at a boom in this new financial sector."

At present, activity on both the Bosnian exchanges is less than half the levels seen in early 2007. "In Sarajevo and Banja Luka, there is now an average turnover of €1m a day - on a good day," says Ivona Kristić, an analyst with Raiffeisen. Last year, the Sarajevo Stock Exchange (SASE) typically saw around €2m-3m turnover a day, while trading volume on the Banja Luka Stock Exchange (BLSE) was between €1m-2m.

Raiffeisen describes both exchanges as "dawning markets," characterised by low liquidity, price volatility and takeover-driven turnover. Since 2002, their growth was at first slow due to a lack of interest and awareness on the part of local investors. However, with robust economic growth and rising corporate earnings, combined with high discounts on the most liquid shares, activity on both exchanges intensified from 2006 onwards. Regional investors from Croatia, Slovenia, Serbia, Italy and Austria were joined by a handful of the big institutional investors from Western Europe and the US.

The leading indexes for the SASE and the BLSE grew by 77% and 111%, respectively, during 2006, and doubled during the first quarter of 2007. Total turnover during 2007 exceeded that of the three preceding years combine. The BLSE in particular developed into a strong bull market due to the announcement of privatizations of some of the Bosnian Serb Republic's largest companies in the telecommunications, oil and electricity sectors. This expansion came to an abrupt halt in April 2007, and indexes on both exchanges plummeted. The downturn was chiefly due to local factors, and preceded the global liquidity crisis by several months.

On the SASE, the severe correction of prices that started in April of 2007 was attributed to unsustainable company fundamentals. The same factors were at work on the BLSE, but were exacerbated by the non-transparent Gacko power plant deal between the Bosnian Serb Republic's government and the Czech power company CEZ. This, Raiffeisen says, "led to an erosion of confidence of domestic and especially foreign investors in the Banja Luka Stock Exchange, and the combination with highly valued shares resulted in a sharp and violent market crash." The exchange's three main indicators each fell by 35-40% in under two months.

Bosnia's stock exchanges have been relatively insulated from the global liquidity crisis that hit international markets in August 2007 due to their small size, underdeveloped stage and un-globalized nature. However, the crunch has still had a damaging effect, causing regional mutual funds to withdraw. "The liquidity is not there," says Tim Umberger, analyst at East Capital. "There has been a fall in prices, and significant outflows of capital since many of the Slovenian and Croatian mutual funds, which used to be major players on the Bosnian market, are no longer investing."

Local and regional politics were other factors in keeping activity down on the exchanges. In the wider region, Kosovo's declaration of independence again increased tensions throughout the western Balkans, severely inhibiting investment. Police reform in Bosnia, the most important step on the road to signing a Stabilisation and Association Agreement (SAA) with the EU, led to the country's biggest political crisis since the Dayton Peace Accords that halted the wars in the 1990s.

Revival

Although some volatility in the Bosnian markets will remain, Raiffeisen forecasts that a revival is imminent on both stock exchanges. One highly important political step was the signing of the SAA on June 16. Financial market reforms, government and municipal bond issues and several large privatizations are set to follow. "The market is still quite volatile and will remain so until the end of this year, then resume growth," reckons Kristić. "There are already signs of recovery. For example, people have started asking us again about companies listed on these exchanges, and requesting financial statements."

The performance of local companies is also a promising sign for future investors. "Almost all Bosnian listed blue-chip companies reported quite good business results for 2007, which gives a totally new perspective for investment compared to the current market prices. Almost all blue-chip companies on SASE and especially on BLSE are traded with quite large discounts in the first quarter," says Raiffeisen.

A new law on investment funds and capital markets is due to be adopted in the Bosniak-Croat Federation - the other half of Bosnia-Herzegovina - by the end of this year. This will allow investment funds, both open and closed, to invest around 25% of their net asset value in foreign markets. Raiffeisen describes this as "a crucial change for their future returns and hedging of risks". The Securities Commission of the Federation has issued licenses for three open-ended mutual funds, which are currently managing assets worth approximately €5m, and is expected to approve two new licenses by the end of the year. A pension reform strategy is also due to replace the existing system with the three-pillar pension structure, which is set to enhance performance and deepen the equity market. "The new regulations are expected in late 2008 in the Republika Srpska. In the Federation, things are still a bit up in the air, but we still expect them by early 2009 at the latest," according to Kristić.

New financial instruments - state, entity and municipality bonds - are also due to be listed on the markets. The first corporate bonds were listed on the BLSE in 2007, followed by the first government bonds in January 2008. New government, municipal and corporate bonds are due to be listed on both the BLSE and the SASE later this year.

Finally, a new wave of privatizations are set to reactivate the markets, after the adoption of the new privatization law in the Bosniak-Croat Federation, which will give primary jurisdiction for the privatisation process back to the Agency for the Privatization of Bosniak-Croat Federation and establish a two-step administrative order. This will push forward the privatisations of major companies such as Aluminium, Bosnalijek, Krivaja, FDM and FDS. The privatization process of BH Telecom also set to go ahead in the second half of 2008, with Austria Telecom widely expected enter the market through a takeover of the Bosnian telecom operator.

With several large new companies coming onto the exchanges, prospects for increased activity on the exchanges are strong, and a return of international investors is expected in the longer-term. "Bosnia has interesting companies and is rich in natural resources, which are attractive to investors, but there is still risk - political risk, country risk, and company specific risk," says East Capital's Umberger. "The situation is already improving but it will take time."

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