BOSNIA AND HERZEGOVINA: 2009 INVESTMENT CLIMATE

By WW Staff

Reference ID:09SARAJEVO42

Created: 2009-01-13 10:20

Released: 2011-08-30 01:44

Classification: UNCLASSIFIED

Origin: Embassy Sarajevo


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RR RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN RUEHLZ RUEHNP RUEHPOD RUEHROV RUEHSK RUEHSR RUEHVK RUEHYG

DE RUEHVJ #0042/01 0131020

ZNR UUUUU ZZH

R 131020Z JAN 09

FM AMEMBASSY SARAJEVO

TO RUEHC/SECSTATE WASHDC 9503

RUCPDOC/USDOC WASHDC

RUCPCIM/CIMS NTDB WASHDC

INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE


UNCLAS SECTION 01 OF 07 SARAJEVO 000042


SIPDIS


STATE FOR EEB/IFD/OIA


E.O. 12958: N/A

TAGS: ECON EINV KTDB OPIC USTR BK

SUBJECT: BOSNIA AND HERZEGOVINA: 2009 INVESTMENT CLIMATE STATEMENT


REF: 08 SECSTATE 123907


Openness to Foreign Investment


1. Bosnia and Herzegovina (BiH) has made considerable efforts to open its economy to more foreign investment. Major initiatives include a liberal State Foreign Investment Policy Law, a value-added tax (VAT), and a uniform trade and customs policy. However, foreign investors continue to face a number of serious obstacles, including a complex legal and regulatory framework, non-transparent business procedures, and weak judicial structures. Privatization of state-owned enterprises has lagged behind the rest of the countries in the region (Croatia, Serbia, Montenegro and Macedonia). Government authorities at all levels have begun to address these obstacles as part of the larger effort to transition to a market economy. However, BiH is still in the early stages of this process. As a result, foreign investment (particularly greenfield investment) has shown only limited gains. Foreign investment in the banking sector is the exception, with Austrian banks taking a dominant position in the local banking market. Private Public Partnerships (PPP), particularly in the healthcare and transportation sectors, are gradually gaining wider acceptance with the local governments. In December 2008, the entity of the Republika Srpska approved a law authorizing PPPs in a large group of strategic sectors (transportation, energy, healthcare, etc.).


--From January-November 2008, foreign direct investment in BiH totaled EUR 598 million and originated from 26 countries (Slovenia, Austria, Croatia, Serbia, Switzerland, USA, Germany, Netherlands, Poland, Italy, Lithuania, Ireland, Norway, Bulgaria, Turkey, Hungary, Russia, Czech Republic, United Kingdom, Sweden, Denmark, UAE, Montenegro, Spain, Kuwait and Belgium) (Source: FIPA (Foreign Investment Promotion Agency of Bosnia and Herzegovina) This is down from a peak of USD 2.1 billion in 2007 ) a year that included a number of large state-owned enterprise privatizations in the Republika Srpska.


--In order to progress significantly beyond these limited gains, BiH will need to address three fundamental issues:


-- Complex legal and regulatory framework: Under the Dayton Constitution, the establishment of governmental structures at the State (national) and entity levels created a multi-tiered legal and regulatory framework that is often duplicative and contradictory; Bosnia and Herzegovina is divided into two sub-state &entities,8 one of which is known as the Federation of BiH and the other of which is called the Republika Srpska. For example, current employer contributions on net wages total 69 percent in the Federation of BiH (FBiH) and 52 percent in the Republika Srpska (RS). On a more positive note, corporate income taxes in both entities were recently harmonized to 10 percent. Nonetheless, the lack of a single economic space has a chilling effect on job creation in the formal economy and creates difficulties for companies trying to do business in the entire country. Entity business registration requirements are separate and different, especially in the Federation of BiH that is comprised of ten cantons where each canton has different business regulations and administrative procedures that affect companies. Simplifying and streamlining this framework is essential to improving the investment climate.


-- Business regulations and administrative procedures: Opportunities for corruption abound, thereby increasing the cost of doing business. In particular, public procurement tenders are not always transparent. Even though European Union-compliant public procurement legislation has been adopted, it has not been adequately enforced. The World Bank rates Bosnia and Herzegovina 119 out of 181 countries (2009 World Bank Doing Business Report) as a place to do business.


-- Weak judicial structures: BiH,s legal/judicial system provides no means for quick resolution of commercial disputes. Commercial courts do not exist and non-judicial dispute resolution mechanisms are few. Legal judgments in commercial disputes often appear to be less than objective. One positive note is the creation of the Competition Council, an independent public institution mandated to enforce anti-trust laws with a special attention directed towards preventing monopolies and enhancing private sector competition. The Council reviews and approves foreign investments in cases of mergers and acquisitions of local companies by foreign companies. It has created a refreshing level of transparency in the local legal system ) an organization yet to be tainted by the country,s political


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scene.


--Investment Law: The State-level "Law on Foreign Direct Investment" provides a broad framework for foreign investment. The law accords foreign investors the same rights as domestic investors. With the exception of the armament and media sectors, where foreign control is limited to 49 percent, there are no restrictions on investment. Investors are also protected from changes in laws regarding foreign investment. Should the government make changes, the investor may choose the most favorable set of rules to apply. The law prohibits expropriation and nationalization of assets, except under special circumstances and not without due compensation. Finally, because of the requirement for equal treatment, the law also treats foreign investors the same as domestic investors with respect to bidding on privatization tenders.


--BiH's Foreign Investment Promotion Agency (FIPA) provides some assistance to foreign investors, but is constrained by limited staff and budgetary resources.


Conversion and Transfer Policies


2. The Law on Foreign Direct Investment also guarantees the immediate right to transfer and repatriate profits/remittances and permits local and foreign companies to hold accounts in one or more banks authorized to initiate or receive payments in foreign currency. The implementing laws in both entities include transfer and repatriation rights. The Central Bank,s adoption of a currency board in 1997 guarantees that the local currency (the Convertible Mark or KM) is fully backed by hard currency (Euros) or gold. The currency board mechanism fixes the exchange rate at just under 2 KM to the Euro (1 EUR = 1.95583 KM). For investors, this ensures currency stability and convertibility. From January through October 2008, average inflation was 7.4 percent (source: Central Bank BiH). The cost of commodities such as food and gas (transport costs) contributed most to increased inflation partly in response to a global increase of prices, but recent declines in fuel prices have reversed this trend. Central Bank reserves have risen steadily, registering over 5.8 billion KM (USD 4.2 billion) in October 2008, a sign of the continued strength of the currency board, but are expected to decline in the current decline of external demand for exports.


Expropriation and Compensation


3. As noted above, the State investment law forbids expropriation of investments, except when it is in the public interest. According to Article 16, foreign investment shall not be subject to any act of nationalization, expropriation, requisition or measures that have similar effects, except where the public interest may require otherwise. In such cases, all procedures are executed in accordance with applicable laws and regulations, without any type of discrimination and with payment of appropriate compensation. Laws in both entities implement this guidance. Neither entity governments nor the State government has expropriated any foreign investments to date.


Dispute Settlement


4. BiH has recently implemented significant changes to court operations and staffing, as well as to substantive and procedural laws. These reforms are designed to streamline commercial and other proceedings, but it will take time before they are fully implemented and commercial (and other) court capacity matures. The U.S. Government is implementing a number of reform programs to court practice that should expedite case processing and further develop judicial capacity. The USG has also provided training and resource materials to judges, trustees, attorneys, and other stakeholders on BiH,s new bankruptcy, collateral and enforcement laws. BiH courts recently completed their first bankruptcy cases under new bankruptcy legislation, and early indications are that the system functions well.


--Over the past few years there has been only one case of a legal dispute involving a U.S. investor and the local government. Although this dispute remains unresolved, the claimant is currently pursuing negotiations with the local government and has not opted for international mediation. While the outlook for BiH,s commercial court system is positive, absorption capacity and practice inefficiencies still limit timely resolution of commercial disputes. The results of the above-mentioned reforms, as well as court-referred pilot mediation programs, are encouraging, but


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more needs to be done to standardize these reforms.


--Bosnia and Herzegovina has been a member of the International Centre for the Settlement of Investment Disputes (ICSID) since 1997. The country accepts international arbitration as a means for settling investment disputes between private parties if the parties agreed to do so in a contract.


Performance Requirements and Incentives


5. There are several foreign direct investment related incentives, including exemptions from payment of custom duties and customs fees for investment. Bosnia and Herzegovina is divided into three jurisdictions for tax purposes: the Federation of BiH, the Republika Srpska and the Brcko District. For example, the new Corporate Income Tax Law in the part of BiH known as the Federation (&FBiH8) allows tax relief to foreign investors who invest 20 million KM (USD 15 million) over a five year period (4 million KM per year). In the Republika Srpska, for investors in the machinery and production equipment sector, the tax base is reduced for the amount of the respective investment. In the Brcko District, the Corporate Income Tax Law allows offsetting profits with losses over a five-year period. Foreign investors can open bank accounts in all jurisdictions (the Federation, Republika Srpska, and Brcko District) and transfer abroad, without any restrictions, the funds acquired from their profits. The Law on the Policy of Foreign Direct Investments of Bosnia and Herzegovina ensures national treatment of foreign investors, i.e, foreign investors have the same rights and obligations as residents of BiH. They have the same rights as the citizens of Bosnia and Herzegovina to invest and reinvest profits in any economic sector.


Right to Private Ownership and Establishment


6. Under the State investment law, a foreign enterprise has the same rights as a Bosnian enterprise or citizen. Consequently, foreign entities can establish and own business enterprises with the same rights as domestic entities. Foreign investors may own real estate in BiH and they enjoy the same property rights in respect to real estate as BiH citizens and legal entities. Armaments and the media, where foreign control is limited to 49 percent, are the only exceptions. Foreign interests must follow the same regulatory procedures when establishing their enterprises.


Property Registers


7. Property registers are largely unreliable. According to laws in both entities, property transfers must be registered with municipal authorities. In practice, transactions are often not recorded due to high transfer taxes. This leads to inaccurate and unreliable property records that leave property transfers open to dispute. In 2004 BiH passed a State-level framework law to create a moveable pledge registry. The registry became operational as of January 2005. In 2007, Brcko District passed a real estate property law annulling previous conflicting laws and developing a new workable registry. This law is now being used as a potential model in the Republika Srpska for its property reform.


Protection of Property Rights


8. The BiH government is in the process of upgrading its intellectual property rights laws in preparation for eventual membership in the European Union and the World Trade Organization. Although the current laws are sufficient for basic property protections, enforcement falls far below what is necessary to maintain adequate standards. Much of the problem with enforcement lies with the newly-created state-level enforcement agency and the remaining agencies that all have an obligation to enforce property protections in their own respective jurisdictions. The primary BiH institution for IPR policy in the national-level Intellectual Property Rights Institute (IPRI), which is relatively new and lacks sufficient support from the Government to make serious inroads in IPR reform.


--In the Bosnian private sector, there is a low level of awareness of copyright issues and requirements. Curbing business software piracy could significantly improve the local economy, create new jobs and generate significant tax revenue. As a result, software producers and official distributors are less competitive in an environment that makes the establishment of a legitimate market difficult. According to the Business Software Alliance (BSA), the rate


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of illegal software installed on personal computers in Bosnia and Herzegovina last year has dropped by another one percent from the year before and currently stands at 68 percent, which is about average for the region. U.S. companies should plan to hire a local attorney to pursue infringement matters in local courts.


--Although BiH still does not have adequate IPR protection, the IPR environment is moving in a positive direction. For example, the recent decision of the entity Governments and the State-level Government to legalize and license its use of Microsoft software was a significant step forward in its commitment to IPR protection. In 2006, Microsoft and Oracle successfully reached a legalization agreement with one of BiH's electric utilities, which is one of the largest state-owned businesses in the country. These successes are a significant step forward in terms of the government serving as an example for copyright protection. Generally, certain government agencies are well-intentioned but hampered by a lack of capacity while others have the capacity to act but are not making a determined effort to enforce IPR. Several years ago, a notorious market in Sarajevo known as &CD Alley8 was dismantled by local authorities. Since then, pirate CD and DVD distribution has been more geographically dissipated, and appears to be on a smaller-scale but is still present in public markets. Last year, Customs officials seized over 170,000 counterfeit products that included logo emblems of NIKE, Adidas, Puma and Diesel apparel and footwear. However, these activities were sporadic, rather than part of a comprehensive anti-piracy strategy.


Transparency of the Regulatory System


9. Establishing a business in Bosnia can be an extremely burdensome and time-consuming process for investors. There are a total of twelve procedures to complete registration for a new business and on average it takes one month to complete all required steps (note: this varies widely among different areas). Registration can sometimes be expedited if a local lawyer is retained to follow up at each step of the process. The administrative costs are approximately USD 450 and optional attorney fees range from USD 200 to USD 1,000. Businesses must register in each entity in which they wish to conduct operations. However, investors in one entity may register their business as a branch in the other entity, significantly reducing the time and administrative hurdles to begin operations. Other administrative procedures can be even more time-consuming. For example, obtaining a construction permit can take as long as six months to one year.


--The myriad of state, entity and municipal administrations creates a heavily bureaucratic system that lacks transparency. All three levels of government (municipal, cantonal in the Federation, and entity) establish laws and regulations affecting businesses, creating redundant and inconsistent procedures that encourage corruption. Often it is impossible to know all of the laws or rules that might apply to certain business activities, given overlapping jurisdictions and the lack of any central source of information. It is therefore critical that foreign investors obtain local assistance and advice.


--Businesses are subject to inspections from a number of entity and cantonal/municipal agencies. They include: the financial police, labor inspectorate, market inspectorate, sanitary inspectorate, health inspectorate, fire-fighting inspectorate, environmental inspectorate, institution for the protection of cultural monuments, tourism and catering inspectorate, construction inspectorate, communal inspectorate, and veterinary inspectorate.


Efficient Capital Markets and Portfolio Investment


10. Capital markets remain underdeveloped in Bosnia. Both entities have created their own modern stock market infrastructure with separate bourses in Sarajevo (SASE) and Banja Luka (BLSE). The two exchanges have similar histories and represent good intentions to create capital markets in Bosnia and Herzegovina. SASE was founded by eight brokerage houses in 2001 and trading started in 2002 similarly to the BLSE which was established in 2001 and commenced trading in 2002. However, factors such as the small size of the market, lack of progress on privatization, and public mistrust of previous voucher privatization programs have impeded the development of a healthier market for shares. Nonetheless, both Bosnian stock exchanges experienced significant booms and downturns in late 2006 and throughout 2007. During first


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six months of 2007, the total turnover on both Sarajevo and Banja Luka Stock Exchanges experienced triple-digit growth over the same period the previous year: Sarajevo Stock Exchange (SASE) half-year turnover increased by 419 percent and Banja Luka Stock Exchange (BLSE) by 245 percent. As a result, both Bosnian stock exchanges were among the highest growth exchanges in the world during 2007. Growth was encouraged via a spillover effect from strong performances in neighboring stock markets (Belgrade, Zagreb, and Ljubljana). Some market observers credited greater awareness among small investors as a growth factor. In addition, a greater transparency of company ownership registrars available to the public starting in December 2006 inspired greater levels of investor confidence on both exchanges. However, during the second half of 2007 and throughout 2008 foreign investment has dwindled and many small investors have seen previous gains dissipate on both exchanges. While the bust after the boom has not had a significant impact on the broader Bosnian economy, it is a setback to the development of an important aspect of Bosnia,s capital market. For example, in 2008 the Banja Luka Stock Exchange (BLSE) had a turnover smaller than BAM 250 million ($180 million), compared to BAM 700 million ($500 million) during 2007. Trends in the local market were not only shaped by the global financial crisis but also political instability and the economic reform slowdown.


--Standard & Poor,s issued its first sovereign credit rating for Bosnia and Herzegovina in December 2008. S&P assigned a &B plus rating8 for Bosnia,s long-term foreign and local currency government bond, a slightly stronger grade than the B assigned by Moody,s. Both S&P and Moody,s maintain a &stable8 outlook for Bosnia and Herzegovina.


--Bosnia and Herzegovina, since the end of the war, has had a relatively stable banking and financial system, with the most significant investment coming from Austria. The banks, weathering of the recent global financial crisis is an indication of its stability, but also its lack of exposure to external markets and thereby its underdeveloped state. Bosnia,s Central Bank noted in December 2008 that citizens withdrew more than 800 million convertible marks (USD 571) from commercial banks since the start of the financial crisis, although the trend has certainly slowed from its peak in September/October 2008 and an increasing number of deposits have been made in the last month, indicating a return to confidence in the financial system.


--In 2004 BiH passed a State-level framework law mandating the use of International Accounting Standards, and in 2005 both entities passed legislation eliminating the previous differences between the entities and Brcko District. Accounting practices that are fully in line with international norms have been implemQd26qgRors.


Political Violence


11. The war in Bosnia and Herzegovina was halted by the Dayton Peace Accords in November 1995. Armed conflict has ceased and there have been no attacks targeting foreign investments. However, there are still risks from occasional, localized political and criminal violence.


Corruption


12. Corruption remains prevalent in many political and economic institutions. The overly-complex business registration and licensing process is particularly vulnerable to corruption. Businesses must navigate a burdensome and complicated web of regulatory procedures to obtain the necessary licenses to begin operations. With the large number of officials involved, there are multiple opportunities to demand "service fees." Domestic and international entrepreneurs often have been known to pay bribes to obtain necessary business licenses, or simply to expedite the approval process.


--For example, local authorities do not generally accept degrees from international universities, creating problems for some locals, but many foreign investors and other foreign businessmen. Due to an outdated law that has yet to be revised, employees of government, business and financial institutions that have foreign degrees are obliged to get these degrees &validated8 by the local authorities. The process for validation is rather obtuse, and opens the door


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for rent-seeking government officials.


--Transparency International (TI) operates a branch office in BiH. TI's 2008 Corruption Perception Index ranked BiH 87 (a decline over 2007, when it was ranked in 84th place) out of 179, on par with countries such as Algeria and Sri Lanka.


Bilateral Investment Protection Agreements


13. BiH has signed/ratified 36 agreements to promote and protect investments with the following countries: Austria, Belgium and Luxembourg, Belarus, Croatia, Czech Republic, China, Denmark, Egypt, Finland, France, Greece, Netherlands, Hungary, Indonesia, Iran, Italy, Serbia, Montenegro, Qatar, Kuwait, Libya, Macedonia, Malaysia, Moldova, Germany, OPEC Fund, Pakistan, Portugal, Romania, Slovenia, Spain, Sweden, Switzerland, Turkey, UAE, Ukraine, the United Kingdom, and the United States (OPIC).


--BiH does not have a bilateral investment treaty with the United States.


OPIC and Other Investment Insurance Programs


14. OPIC's activities in Bosnia include: insurance for investors against political risk, generally covering loss due to expropriation of assets, political violence, and currency inconvertibility; and insurance coverage for contracting, exporting, licensing and leasing transactions.


--Political risk insurance is also available from the EU Investment Guarantee Trust for Bosnia and Herzegovina, administered by the Multilateral Investment Guarantee Agency (MIGA), a World Bank affiliate. The International Development Association (IDA), a member of the World Bank Group, has a program to provide guarantees against a range of political risks, primarily for short-to-medium-term commercial transactions between BiH enterprises and foreign companies, suppliers and banks.


Labor


15. BiH has an educated workforce with relatively low labor wage costs. However, several industry sectors (construction, IT, healthcare) have experienced a significant loss of skills and staff over the past decade, due to a lack of educational opportunities and emigration. Tax rates on labor are high, discouraging hiring of new workers and increasing incentives for unregistered employment. In addition, a rigid wage determination system stands in the way of job creation and worker mobility. This is a result of a collective bargaining system that retains most of its socialist era characteristics. Employees and employers share the costs of health care, pension, and unemployment insurance in the Federation while in the Republika Srpska all of these costs are borne by employers. In the Republika Srpska, employers also bear child care contributions. Many employers underreport their labor force in order to avoid paying taxes and benefits. While official unemployment is approximately 40 percent, "unofficial" estimates of unemployment that include the large gray economy are approximately 18-22 percent.


Foreign Trade Zones/Free Ports


16. The BiH Law on Free Trade Zones allows the establishment of free trade zones (FTZs) as part of the customs territory of BiH. Customs goods are considered, for the purpose of import duties and commercial policy import measures, as not being on BIH customs territory, provided they are not released for free circulation or placed under another customs procedure or used or consumed under conditions other than those provided for in the implementation regulation to the Law on Customs Policy. Free Trade Zone founders may be one or more domestic or foreign legal entities registered in BiH. Kp2onQQ|Q!4Q8M6*XTQe value of goods exported from the FTZ zone will exceed at least 50 percent of the total value of manufactured goods leaving the zone within a period of 12 months, subject to approval by the Council of Ministers. The users of FTZs do not pay taxes and contributions, with the exception of those related to salaries and wages. Investors are free to invest capital in the FTZ, transfer their profit and retransfer capital. Customs and tariffs are not paid on imports into the FTZ. The import of equipment that will be used for manufacturing within the FTZs can be discontinued if the value of goods produced and exported abroad is less than 75 percent of the total value of goods produced in that zone. Currently there are five free trade zones in BiH: Vogosca, Visoko, Hercegovina-Mostar, Banja Luka and Slobomir


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(Bijeljina).


Foreign Direct Investment Statistics


17. According to a Foreign Investment Promotion Agency of BiH, FDI as of November 30, 2008, totaled EUR 598 million (USD 840 million). Investments from Slovenia, Austria, Croatia, Serbia, Switzerland and USA represented the largest country investors in 2008. The manufacturing sector had the highest percentage of FDI followed by the Banking and Trade sectors.


--BiH has signed free trade agreements with Albania, Croatia, Macedonia, Moldova, Montenegro, Serbia, UNMIK/Kosovo and Turkey. BiH has preferential export regimes with Australia, Canada, Japan, New Zealand, Norway, Russia, Switzerland and USA. According to the preferential export regime with the European Union, all goods of BiH origin that fulfill EU technical standards and conditions can be imported to all 27 European Union member states until the end of 2010 without any quantitative restrictions and without paying customs and other similar duties. In December 2006, Bosnia and Herzegovina signed the Central European Free Trade Agreement (CEFTA) which became fully operational in November 2007. The regional trade group includes Albania, Bosnia and Herzegovina, Croatia, Macedonia, Serbia, Montenegro, Kosovo and Moldova. In 2008, Bosnia and Herzegovina signed the Stabilization and Association Agreement (SAA) with the European Union which is an important step towards the EU membership. The most important part of the SAA is the establishment of a free trade zone between Bosnia and Herzegovina and the European Union, implying the mutual abolishment of all custom tariffs and quantity limitations in mutual exchange of goods from BiH and the EU. The SAA should encourage further development of competitiveness among the country,s exporters and increase investments and employment. With the start of 2009, import tariffs are eliminated for 11,000 products that BiH imports from the EU. For products such as cosmetics, tractors, motorcycles, furniture, major appliances, electronic equipment, computers and tools tariffs were cut by 50 percent immediately upon signing, and from January 1 they have been eliminated completely.


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