Openness to Foreign Investment

Bosnia and Herzegovina (BiH) has made significant efforts to open its economy to more foreign investment. Major initiatives include a liberal State Foreign Investment Policy Law, a new value-added tax (VAT), and a uniform trade and customs policy. Despite these efforts, 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 has lagged behind the rest of the region, providing fewer opportunities to investors interested in working in the region.

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. During  2007 foreign direct investment in BiH originated from 18 countries (Serbia, Switzerland, Russia, Austria, Croatia, USA, UAE, Hungary, Slovenia, Italy, Belgium, Germany, Turkey, Malaysia, UK, France, Lithuania, Netherlands) totaling USD 2.1 billion.

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,” 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 wages total 69 percent in the Federation of BiH (FBiH) and 52 percent in the Republic Srpska (RS).  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. Further 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 105 out of 178 countries (2008 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. While a legal framework for bankruptcy has been established, functioning commercial courts do not exist. Non-judicial dispute resolution mechanisms are few. Legal judgments in commercial disputes often appear to be less than objective.

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. (www.fipa.gov.ba )

Conversion and Transfer Policies

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. The currency board mechanism has also minimized inflation where the combination of the Central Bank of BiH’s Currency Board and fiscal discipline has kept the underlying inflation rate the lowest in the region. In the period January through June 2007, inflation was around 1 percent (source: Central Bank BiH).  Although exact figures are not yet available, inflation is known to have increased later in the year in response to a global increase in the cost of commodities such as food and petroleum products.  Central Bank reserves have risen steadily, registering over USD 4.5 billion in June 2007, a sign of the continued strength of the currency board.

Expropriation and Compensation

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

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. USAID is implementing additional reforms to court practice that will expedite case processing and further develop judicial capacity and will soon deploy case management software into the courts to promote greater efficiencies.  USAID has also provided training and resource materials to judges, trustees, attorneys, and other stakeholders on BiH’s new bankruptcy, collateral and enforcement laws, in order to shepherd bankruptcy cases through the system to demonstrate bankruptcy’s role in improving BiH’s economy by restoring assets to productive use.  BiH courts recently completed their first bankruptcy cases under new bankruptcy legislation, and early indications are that the system can function.

While the outlook for BiH’s court system is positive absorption capacity and 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 more needs to be done to standardize these reforms.

Performance Requirements and Incentives

There are several foreign direct investment related incentives. These include exemptions from the 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 Brčko District. For example, the new Corporate Income Tax Law in the part of BiH known as the Federation (“FBiH”) 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 Brčko 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 Brčko 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 the profits in any economic sector.

Right to Private Ownership and Establishment

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. 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.

Protection of Property Rights

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.

Protection of Intellectual Property Rights: The BiH government does not adequately enforce intellectual property rights (IPR) even though it is enacting and revising laws in preparation for eventual membership in the European Union and the WTO. BiH is not a signatory to the Trade-Related Aspects of IPR (TRIPS) agreement. BiH does not adequately protect intellectual property, patents, copyrights, trademarks, trade secrets or semiconductor chip layout design.  However, BiH is currently at the stage in IPR protection where it has a fairly complete legal framework and participation in international agreements, but has a policy institution that is in its infancy, and an almost non-existent enforcement structure.  BiH's institution for IPR policy is the national-level (known as "State"-level) Intellectual Property Rights Institute (IPRI).  Given that BiH recently initialed a Stabilization and Association Agreement with the European Union, the Government will have to make improvements in IPR protection over time to comply with EU standards.

In 2005, the International Intellectual Property Alliance made special mention of BiH because of its lack of effective legislation and enforcement.  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, 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.  Virtually all levels of government and most state-owned companies have used unlicensed software, although the recent decision of the entity Governments to legalize their use of Microsoft software was a significant step forward in their commitment to IPR protection.  These successes are a significant step forward in terms of the government serving as an example for copyright protection.

Transparency of Regulatory System

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 it takes at least one month to complete all required steps. 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 370. 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 second entity, significantly reducing the time and administrative hurdles to begin operations. The registration process should soon be simplified when new State-level business registration legislation is implemented. Under this new law, there will be one uniform business registry for the entire country.  Other administrative procedures are 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, 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. Inspection functions may be consolidated into one agency in the future but relevant legislation has not yet been passed.

Efficient Capital Markets and Portfolio Investment

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). 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 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.  Almost 70 percent of the total turnover in BiH was at the SASE.  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, the impact on the Bosnian economy appears limited as bank financing is still the chief source of capital for Bosnian companies. Overall credit continues to expand, with credit to both consumers and businesses showing healthy increases. However, long-term credit is hampered by the lack of an appropriate legal framework to secure transactions and enforce contractual obligations.  Enforcement of new bankruptcy legislation is expected to alleviate some of these problems. 

In 2004 BiH passed a State-level framework law mandating the use of International Accounting Standards, and in 2005 both entities passed enabling legislation eliminating the previous differences between the entities and Brčko District. Accounting practices that are fully in line with international norms have been implemented.  However, these standards have not yet been generally internalized throughout the country due to weak accounting capacity.  Financial statements of BiH companies should be scrutinized carefully by foreign investors.

Political Violence

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 landmines, and unexploded ordnance in Bosnia and Herzegovina. An estimated one million landmines are still scattered throughout the country and visitors are advised to stay on well-trafficked surfaces and roadways during their stay. 

Corruption

Corruption remains prevalent throughout political and economic institutions. The 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 are forced to pay bribes to obtain necessary business licenses, or simply to expedite the approval process.

Transparency International (TI) operates a branch office in BiH. TI's 2007 Corruption Perception Index ranked BiH 84 (an improvement over 2006, when it was ranked in 96^th place) out of 179, on par with countries such as Thailand and Panama.

Bilateral Investment Agreements

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

OPIC's activities include: (1) insurance for investors against political risks: (a) generally covering loss due to, (i) expropriation of assets, (ii) political violence, and (iii) currency inconvertibility; and (b) with specific programs for certain investment types, including insurance coverage for contracting, exporting, licensing and leasing transactions, (2) loans and loan guaranties, and (3) support of equity funds for investors.

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

BiH has a highly educated workforce with relatively low labor wage costs. However, tax rates on labor are high, discouraging hiring of new workers and increasing incentives for gray market 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. Therefore, such a large informal sector could increase official GDP by 30-40 percent and reduce the unemployment rate to fewer than 20 percent (World Bank 2007 estimate)

Foreign-Trade Zones/Free Ports

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.  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 four free trade zones in BiH: Vogosca, Visoko, Hercegovina-Mostar, and Slobomir (Bijeljina).

Foreign Direct Investment Statistics

According to a BiH Central Bank survey, FDI as of September 30, 2007 totaled USD 2.1 billion. The telecom  industry had the highest percentage of FDI (44 percent) primarily because of the privatization of Banja Luka-based Telekom Srpske (one of the three state-owned incumbent operators) which was sold to Belgrade-based Telekom Srbija (fixed-line and mobile telephone provider owned by the Serbian Government and the Greek operator OTE), followed by the manufacturing sector (34 percent).  Investments from Serbia, Switzerland, Russia, the USA, Austria, Croatia and Slovenia represented the largest percentages in 2007. BiH has signed CEFTA, which ensures free trade with Albania, Croatia, Macedonia, Moldova, Montenegro,  Serbia and, Kosovo. Free trade with Turkey is regulated by a separate FTA.  BiH has preferential export regimes with Australia, Canada, Japan, New Zealand, Norway, Russia, Switzerland and the USA.  According to the preferential export regime with the European Union, all goods of BiH origin that fulfill EU technical-technological standards and conditions can be imported to all 27 EU member states until the end of 2010 without any quantitative restriction and without paying customs and other similar duties.