SECOND BUSINESS ROUNDTABLE WITH THE GOVERNMENTS OF BOSNIA AND HERZEGOVINA Sarajevo, September PETER NICHOLL GOVERNOR CENTRAL BANK OF BOSNIA AND HERZEGOVINA

2 THE CENTRAL BANK OF BH (CBBH) Commenced its operations on 11 August, 1997 A state-level institution Operates under its own Law An independent institution Its strategic direction is set by a Governing Board It has five offices: Three Main Units – Banja Luka, Mostar and Sarajevo Two branch offices – Brčko and Pale

3 The most important function of CBBH The CBBH operates monetary policy through a Currency Board arrangement Choice of a Currency Board: Choice of a Currency Board: It Provides a firm nominal anchor in the form of a fixed exchange rate. It removed discretion in a situation where there was considerable difficulty in establishing institutions and making political decisions. Works well in some other Eastern European Countries MONETARY POLICY

4 The fixed exchange rate is specified in the CBBH Law Full foreign exchange backing for all the KM liabilities of the Central Bank Full convertibility of the CBBH’s KM liabilities into the anchor currency THE CURRENCY BOARD

5 The fixed exchange rate is 1KM = euro. Initial exchange rate was 1 KM = 1 DEM The KM exchange rate has been unchanged since the CBBH commenced its operations in 1997 Transition from the DEM to the euro as the anchor currency went smoothly THE FIXED EXCHANGE RATE

6 CBBH FOREIGN RESERVES (end of period – in KM millions)DATE NET FOREIGN RESERVES MONETARY LIABILITIES FREE RESERVES Dec ,1 160,3 - 16,2 Dec ,3253,929,4 Dec ,7836,729,0 Dec ,2973,248,0 Dec ,62591,675,0 Dec ,22345,1118,1 Aug ,0 2260,0 143,8

7 FULL CONVERTIBILITY KM ISSUED FROM AUGUST 11, 1997 UNTIL SEPTEMBER 18, 2003 (in KM billions) KM ISSUED TO BH BANKS KM PURCHASED FROM BH BANKS NET KM ISSUED 11,744 9,633 2,111 The table shows that the KM has been a convertible currency within BH

8 The Currency Board has been a very successful type of monetary policy for BH The KM has been a stable currency against the DEM and the euro since it was introduced. Inflation in BH is low and stable. KM use has risen steadily and the KM is the dominant transactions currency in all parts of the country. SUCCESS OF THE CURRENCY BOARD

9 INFLATION IN BH (Retail price index, Annual % growth) Year ended Federation of BH Republika Srpska BH average Dec ,016,18,0 Dec ,32,20,9 Dec ,7 2,40,3 July ,4 1,41,41,41,40,7

10 FOREIGN DIRECT INVESTMENT (in KM millions)PERIOD FOREIGN DIRECT INVESTMENT , , , , , Q1 140, Q1 181,7

11 Decision of the BH Presidency that the Currency Board will continue The Currency Board produced major economic and social benefits Long term goal – take BH economy closer and into Europe THE CURRENCY BOARD WILL CONTINUE

12 New CBBH Board appointed from 11 August, 2003 Governor Nicholl reappointed until 31 December, 2004 Vice Governor Kemal Kozarić will become Governor on 1 January, 2005 Decisions by the BH Presidency were: taken early, thus avoiding uncertainty provide a high degree of continuity look well ahead, thus assisting the smooth transition to a new Governor in 2005 NEW GOVERNING BOARD

13 REQUIRED RESERVES (RR) RR is the only instrument of monetary policy available to the Central Bank of BH, under the Currency Board Arrangement Goals: Efficiency and flexibility Harmonization Financial stability Features: Applied to all deposits (KM & foreign currencies) 5% (CBBH Law permits ratio to be set by the CBBH Governing Board between 0% and 20%) Reserve deposits at CBBH are remunerated

14 CHANGES IN THE BANKING SECTOR Reform of the payment system Significant increases in a banks’ minimum capital requirements Inter-entity banking Deposit insurance Arrival of foreign banks Privatization of government owned banks

15 CAPITAL STRUCTURE IN BH BANKING SECTOR (in %)DATE December 31, 2000 December 31, 2001 December 31, 2002 May 31, 2003 STATE CAPITAL PRIVATE CAPITAL DOMESTICNA FOREIGNNA* * The data is not available, but the % of ownership would have been low

16 An improving banking sector Return of confidence Return of depositors Lending on more reasonable terms Real competition High level of foreign investments Obstacles Obstacles High banking risks THE BANKING SECTOR

17 FUTURE INITIATIVES IN THE BH FINANCIAL SECTOR National Capital Markets Council (NCMC) Sovereign credit rating Securities market Stock exchanges Banking supervision Harmonization with the EU standards and regulations

18 Economic outlook hard to predict BH going through several transitions simultaneously Regulatory, tax and legal systems need to be changed Improving, but still too complicated, environment for private investment Stable macroeconomic situation 6% to 7% expected economic growth rate per annum For investment in BH, the balance between opportunity and risk now favors opportunity THE ECONOMIC OUTLOOK