C O N F I D E N T I A L SECTION 01 OF 02 SARAJEVO 000082

SIPDIS

STATE FOR EUR/SCE AND EEB/IFD
TREASURY FOR OASIA - PETER MAIER

E.O. 12958: DECL: 01/27/2020
TAGS: EFIN ECON PGOV SOCI IMF IBRD BK
SUBJECT: BOSNIA: IMF SECOND TRANCHE ON HOLD

REF: 09 SARAJEVO 1419

Classified By: DCM Jonathan Moore for reasons 1.4 (b) and (d)

Summary
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1. (C) Bosnia and Herzegovina Federation entity has not yet
met conditions for disbursement of the second tranche of the
IMF stand-by arrangement, worth roughly USD 135 million. The
IMF's local representative stressed in a January 15 statement
that the IMF board will not approve disbursement -- either to
the Federation or to the Republika Srpska -- until both
entities meet all conditions as agreed last year in June and
reiterated in November. The Federation Minister of Finance
confirmed in a statement the following week that the
Federation has not yet met its commitments to pass necessary
reforms. Failure to do so puts at risk not only this
disbursement, but ten more scheduled over the next three
years, along with supporting loans from the World Bank and
European Commission. Loss of these funds would eventually
force both the Federation and the Republika Srpska to make
deep cuts affecting social programs, wages, and public
investments, and would further damage the precarious
political situation here in the run up to the 2010 elections.
End summary.

Reform of Federation Social Benefits Programs Stalled
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2. (U) In his January 15 statement, IMF Resident
Representative Milan Cuc focused on the Federation's failure
to amend past legislation that had created a complex and
overly-generous system of unemployment and pension benefits
for veterans, demobilized soldiers, war victims, and former
Ministry of Defense employees. In the Bosnian government's
June 2009 letter of intent to the IMF, the basis of the
stand-by arrangement, the Federation committed to pass such
amendments by the end of the year. For its part, the

Republika Srpska -- according to the IMF statement --
fulfilled its parallel obligation to adopt legislation
establishing a property census of veterans and other
beneficiary groups, its minimal legislative requirement for
the second disbursement of the IMF program. In both the
Federation and the RS, establishment of the property census
constitutes a first step in moving from a rights-based to a
means-based system of social benefits. Cuc's statement
acknowledged that another set of essential steps for
disbursement of the second tranche had been met by the end of
the year: adoption of 2010 budgets by both entities and the
BiH State government within agreed deficit parameters. In
the case of the State budget, trimmed to a deficit of 4.5
percent of GDP, reaching agreement within parliament before
January 1, the start of the new fiscal year, was an
unprecedented event.

A New Concern: Squandering the Special Drawing Rights Windfall
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3. (SBU) Privately, Cuc raised a separate concern, not
foreseen in the stand-by arrangement. The allocation of new
Special Drawing Rights to all IMF members in August 2009
boosted BiH's foreign exchange reserves by 140 million SDRs,
or approximately USD 220 million. Initially, BiH authorities
had indicated that the SDRs would be held in reserve as a
fiscal cushion. Soon thereafter, however, without consulting
the IMF, the BiH Central Bank exchanged the SDRs for euros
and distributed them to the finance ministries of the two
entities. Although not explicitly a violation of the
stand-by arrangement, this raised concern in the IMF that the
Bosnian government was not acting in the spirit of the
program. The IMF has now asked the entity governments to
clarify how they will use the windfall. The IMF board will
not meet, Cuc has said, until the Federation passes the
needed laws and until both entities satisfactorily explain
their plans on use of the SDRs.

Bevanda: Yes, We Are the Problem
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4. (U) Federation Finance Minister Vjekoslav Bevanda
acknowledged in a January 20 statement that "the majority of
open issues are related to the Federation" and that failure
to pass reform of its system of social benefits was the main
obstacle to disbursement of the second tranche. He noted
that the Federation's 2010 budget counted on regular
disbursements of the IMF program, including the Federation's
share of the second tranche, worth KM 128 million (USD 93
million). Highlighting the cost of continued failure to pass

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the necessary measures, Bevanda pointed out that in the
absence of funds from the IMF, the Federation would have to
make equivalent cuts across the board. Meanwhile, the World
Bank, whose separate USD 111 million budget support loan is
closely tied to the IMF program and is likewise conditioned
on reform of the social benefits system, has already been
sending signals that its money will be reprogrammed for other
uses if the Federation does not meet the conditions by the
end of February. Also at risk is a 100 million euro (USD 140
million) budget support program from the European Commission,
and -- further down the road -- the remaining ten
disbursements of the IMF program, worth a total of USD 1.35
billion.

Comment
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5. (C) We expect the IMF to maintain a strict line regarding
the Federation's requirement to enact reforms of the social
benefits system, as clearly laid out in the letter of intent.
What the Fund will require regarding the Central Bank's
disposition of SDRs is less clear, though it seems likely
that the entities will be able to talk their way out of that
issue. In the meantime, as the electoral year heats up,
enacting the needed reforms will be more critical for the
economy, but increasingly difficult politically. The
consequences of a delay or blockage in disbursement will flow
over into this year's pre-election tensions, and will almost
certainly be cited by officials in Republika Srpska as proof
of the incompetence of the Federation.
ENGLISH