BosniaBusiness and economic outlook

Quarterly update – July 2013Final analysis by Nenad Pacek

Contents

• Executive summary• Important facts• Economic fundamentals• Corporate sales and profit trends• Growth prospects• Currency and the current account• Inflation and interest rate • Other economic and business issues• Forecast table

Executive summary

• GDP contracted by 0.5% in 2012 (growth was 1.0% in 2011)• A new recession will be avoided this year, meaning that 2013 ought to be slightly

better for business, but only just • Corporate expectations are also a bit more optimistic compared to 2012• However, 2013 growth will be trivial (and below potential), hindered by the usual

suspects (weak external and domestic demand, political fragility) • In our base case scenario, growth will be flat this year (0.5%) and accelerate to 1.5% in

2014• Inflation will remain low, domestic demand will struggle, government spending will be

cut, political paralysis will continue, investments will be subdued, unemployment will remain high, and wages will remain stagnant (but the grey economy will work as usual)

• Some support could come from the external sector, but only if the EU and SEE countries recover more rapidly, which is not certain at this point in time

• Growth is set to improve in the mid-term, but this will require much better external (and internal) conditions and stronger capital inflows

Important facts I

• Population of 3.8m (declining by 0.1% annually)• GDP per capita (PPP) is $8,300• GDP: $16.6bn (but sizeable unofficial economy)• The country consists of two autonomous entities: the Muslim-Croat Federation and

the Serb Republic • Economically and politically highly fragile; politically paralysed and dependant on

foreign transfers • Registered unemployment exceeds 44% (27% using the ILO measurement),

although many people are registered as unemployed, but do work in the grey economy (and the ILO measurement captures this)

• More than 50% of the young are unemployed• The grey economy in Bosnia is one of the biggest in the world as a share of GDP• Mineral products, base metals, machinery and mechanical appliances account for

50% of the country’s exports

Important facts II

• The country’s main trading partners are Germany, Italy, Slovenia, Austria, Croatia and Serbia

• Services account for 67% of GDP, industry accounts for 25% of GDP, while agriculture accounts for 8% of GDP

• FDI is very limited• Progress on EU accession remains slow: a Stabilisation and Association Agreement

was signed in 2008, but full membership talks have not started and are dependent on domestic political reforms and stability

• Bosnia’s medium term growth prospects are harmed by a dysfunctional political system, reluctance of foreign investors to use the country as a cheap manufacturing base, and an on-going brain drain

• The Dayton agreement that ended the war is complicating the governance of the country and economic progress as the country’s three ethnic groups continue to oppose working with each other

Economic fundamentals

• Economic fundamentals are mixed • Public debt has risen to 39% of GDP• Foreign debt is moderately high at 59% of GDP• Foreign exchange reserves are €3.3bn and cover more than four months of imports

(sufficient)• The domestic currency is pegged to the euro• The current account deficit is too high, indicating that the pegged currency is

significantly overvalued (and has been for a long time)• Bosnia needs the IMF to help fund its large current account deficit as well as the

budget deficit • The latest IMF disbursement of €40m was in early May (part of a €405m financing

arrangement) after parliament passed a law cutting military pensions

Corporate sales and profit trends for 2012-2014

• Bosnia was a growth market for less than half of surveyed companies in 2012 – the majority of growing companies managed to increase their sales in single digits, 40% reported zero growth while 15% recorded a drop in revenues

• Profit movements were not significantly better than sales• Companies are more optimistic about business this year; close to 60% expect sales

growth, while 45% hope to increase profits, largely in single digits• Less than 5% expect a decline in sales and profits, while almost 40% expect zero

sales growth • Corporate expectations for 2014 are better; none of the surveyed firms expect

either sales or profits to decline • 75% expect sales growth, while 65% expect an increase in profits, largely in the

single digit zone • The remaining companies expect zero sales and profit growth

Corporate sales and profit trendsas expected in Dec 2012 and June 2013

Consumer goods sales and profit trendsJune 2013 survey

• In 2012, consumer goods firms struggled to find sales growth; almost 35% grew their sales, more than 15% declined in double digits, while 50% stagnated

• None of the surveyed consumer goods companies experienced a decline in profits; the majority had some profit growth, some of them growing even in double digits

• Expectations for this year have deteriorated; 15% expect a sales drop (it is the only sector expecting a sales drop in 2013), 15% expect flat sales, while the rest forecast to grow in the range of 1-15%

• Profit expectations have weakened as well, with almost 45% of consumer goods companies expecting flat sales in 2013

• Expectations for 2014 are much stronger; all companies expect an increase in revenues, largely in the single digit space

• The majority also expect to increase profits, with close to 35% of consumer goods companies expecting to grow their profits in double digits

Food and beverages sales and profit trendsJune 2013 survey

• 2012 was good for food and beverages firms; more than two-thirds grew sales and profits, solely in single digits, while the rest either stagnated or declined

• Food and beverages firms expect a better 2013• Close to 65% expect sales growth, while the rest expect flat sales (better than

in our Dec 2012 survey, when some 15% expected a decline in sales)• More than 70% are hoping to increase their profits in single digits this year• Food and beverages firms remain moderately optimistic about business in

2014• More than 65% forecast an increase in both sales and profits, largely in single

digits, while the rest forecast to stay flat

Industrial B2B sales and profit trendsJune 2013 survey

• In 2012, industrial B2B firms were the ones worst off, in terms of both revenues and profits; 25% recorded a decline in sales, close to 40% faced negative profit growth, while around 40% saw sales and profits stagnate

• Industrial B2B firms are not too optimistic about business this year; close to 60% expect flat sales, while the rest expect predominantly a single-digit sales growth

• Profit expectations are worse – around 75% expect their profits to remain flat, while around 5% expect negative profits

• 2014 ought to be just slightly better – half of industrial B2B firms forecast flat sales, while the other half forecast single digit sales growth

• Profit expectations are very similar, albeit slightly weaker than the top line figure

• No industrial B2B firm expects a sales or profit decline next year

Pharma/health care firmsJune 2013 survey

• In 2012, close to 60% of pharma/healthcare companies grew neither sales nor profits; 15% were negative, 40% stagnated, while 45% grew largely in single digits

• Pharma/healthcare companies are slightly more optimistic about business in 2013 than was the case in our Dec 2012 survey

• Around 60% expect to grow in both sales and profits (single digits)• None of the firms expect their sales and profits to decline • Corporate expectations for 2014 are much better• All pharma/healthcare companies forecast single-digit sales growth, while 80%

expect to grow their profits as well, but solely in single digits

IT sales and profit trendsJune 2013 survey

• The only sector that experienced neither a decline in sales nor a decline in profits in 2012 was the IT sector; around 65% of IT firms faced zero growth in sales and profits, while the rest grew in low single digits

• Corporate expectations for this year are very good; 80% expect to grow both sales and profits in single digits (much better than in the Dec 2012 survey)

• Expectations for 2014 remain positive• Around 65% expect sales growth, while 75% expect profit growth, both solely

in the single digit zone• None of the IT firms surveyed expect a sales/profit decline

Corporate sales and profit trends in 2013based on June 2013 survey

Corporate sales and profit expectations for 2014based on June 2013 survey

Growth prospects I

• GDP grew on average 5.6% per year between 2004 and 2008, then contracted 2.8% in 2009, grew 0.7% in 2010 and 1.0% in 2011

• Last year was disappointing -- the economy was in recession and contracted by 0.5% (subject to revision)

• Industrial output declined by 5.2%, construction fell by 2.5%, retail trade was up 4.4% (indicating a resilient grey economy), while tourist arrivals grew by 13.7%

• Exports and imports fell by 4.4% and 1.8% respectively; the spill-over of the Eurozone crisis was obvious and Bosnia was not able to cope with such external shocks

• Private consumption was subdued – the large grey economy and slightly better currency transfers prevented it from total collapse

• Partial data for the first several months of this year are mixed, but they indicate better economic activity in the Muslim-Croat Federation (compared to the Serb Republic)

Growth prospects II

• In the Muslim-Croat Federation, industrial output rose by 9% y-o-y in the first five months of the year, driven largely by good manufacturing sector (and utilities) performance, while construction output increased by some 17% y-o-y in the same period

• Both sectors recorded a much weaker performance in the Serb Republic• In the same period, the overall export sector rebounded (up by almost 11%), while

retail trade remained sluggish in both entities• We do not expect industry and exports to slip into negative territory, but to post

positive, albeit modest, growth throughout the rest of the year • However, we warn that both sectors are heavily dependent on the EU and SEE

outlook• Economic recovery throughout this year and next will remain very slow and fragile,

and highly dependent on the external environment• However, Bosnia will step out of last year’s recession and register a mild economic

revival - GDP will grow 0.5% in 2013 and could accelerate to 1.5% in 2014

Growth prospects III

• Downside risks to this base case (growth) scenario stem primarily from the external side (EU and SEE), which is very fragile and uncertain

• Furthermore, internal difficulties such as a dysfunctional political system, weak domestic demand, fiscal tightening (demanded by the IMF), rising unemployment and stagnant wages will continue to weigh on overall economic activity

• Political uncertainty will dampen investment, fiscal tightening will impact consumption, while the weak external environment could hurt remittances

• At least, the inflation rate will remain low • Growth will speed up over the medium term and should average 3% in the

period 2014-2018 -- good prospects exist in hydropower generation and the metal and food industries, but such a growth scenario will require better external conditions and stronger capital inflows as well as stronger domestic investments

Currency and the current account

• The current account deficit registered a modest widening last year, but shrank by almost 33% in the first quarter of this year on the back of a narrowing trade deficit

• In the period of Jan-May 2013, exports rose by almost 11% y-o-y (imports declined in the same period), while the trade gap narrowed by some 12.6% y-o-y

• Exports should remain positive for the reminder of the year, but the trade gap (and the current account deficit) will stay high for several more years to come

• The large gap shows that the pegged currency is overvalued (it has been for a long time), but we are unlikely to see the authorities abandoning the currency peg

• The currency board is likely to be maintained at the fixed rate of 1.96 Bosnian marka for one euro – letting the currency fall would be devastating since over 70% of all loans in the country are denominated in foreign currencies

• Very few countries in the world run a currency board and most sooner or later have to abandon it (in this system the domestic currency in circulation always has to be matched by foreign exchange reserves)

• The strong currency is hurting exporters

Inflation and interest rates

• Aggregate inflation for the country was 2.1% in 2012 (down from 3.7% in 2011)• The inflation rate decelerated to 0.1% in May 2013 (1.0% y-o-y in our last update)

in the Muslim-Croat Federation • The May inflation rate slowed to 0.3% y-o-y in the Serb Republic (it was 0.9% y-o-y

in our last update)• Subdued inflation is a result of weak household and government consumption• Inflationary pressures will remain small throughout this year and next• Inflation will average 0.7% this year and remain low in 2014 as well

Other economic and business issues

• The month of June was marked by protests in the capital city Sarajevo due to the failure of parliament to adopt an ID registration law

• A recent temporary fix has failed to satisfy protestors, which indicates that protests reflect more than just discontent about the ID law (e.g. poor economic and political condition of the country, corruption, etc.)

• Zivko Budimir, the president of the Muslim Croat Federation, was arrested on corruption charges in April and released on bail in May

• He refused to resign from his post (as the parliamentary commission demanded) • The country’s political system will remain dysfunctional, internal political disputes

will continue, more protests could occur sporadically• EU accession will be delayed• All these factors will have an impact on economic and business growth in the

future

Bosnia - forecast table

Bosnia: Macro indicators and forecasts 2010 2011 2012 2013 2014 2015

Real GDP (% change) 0.7 1.0 -0.5 0.5 1.5 3.0

Consumer prices, % (average) 2.1 3.7 2.1 0.7 1.3 2.2

Budget balance (% GDP) -4.5 -3.9 -3.6 -3.0 -2.5 2.0

Current account (% GDP) -5.4 -12.4 -13.5 -12.0 -11.0 -9.5

Marka/Euro (Average) 1.96 1.96 1.96 1.96 1.96 1.96

Disclaimer, copyright, sources

© 2013 CEEMEA Business Group*

CEEMEA Business Group currently works with senior leaders of over 340 large multinational companies operating in the Central Eastern Europe, Middle East and Africa regions, helping them understand economic and business outlooks globally, regionally and at country levels. Regional and global executives also receive regular advice and updates on best practices for expansion and success in emerging markets. Executive members of the CEEMEA Business Group can also attend regular peer group meetings held throughout Europe and in Dubai. Source: GSA Global Success Advisors GmbH and CEEMEA Business Group researchBasic data sources come from central banks, own intelligence network, CEEMEA Business Group corporate survey, governments and other public sources. Interpretation, views, forecasts, business quotes and business outlooks by GSA Global Success Advisors GmbH and CEEMEA Business Group.

This material is provided for information purposes only. It is not a recommendation or advice of any investment or commercial activity whatsoever. Global Success Advisors and CEEMEA Business Group accept no liability for any commercial losses incurred by any party acting on information in these materials.

Contact: Nenad Pacek, President and Founder, GSA Global Success Advisors GmbH; Co-founder, CEEMEA Business GroupM: +43 676 646 0607 E: nenad.pacek@globalsuccessadvisors.eu www.ceemeabusinessgroup.com

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DT-Global Business Consulting GmbH, Address: Keinergasse 8/33, 1030 Vienna, Austria,Company registration: FN 331137t and GSA Global Success Advisors GmbH, Hoffeldstraße 5, 2522 Oberwaltersdorf, AustriaCompany registration: FN 331082k