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Bosnia and Hercegovina economy: Facing a gas cut-off?(EIU Viewswire Via Thomson Dialog NewsEdge) COUNTRY BRIEFING FROM THE ECONOMIST INTELLIGENCE UNIT Bosnia has been given just over a month to present a schedule for repayment of an old US$105m gas debt, or else it faces being cut off by Russias Gazprom, which supplies the countrys gas. The countrys ability to pay, absent of a sharp hike in prices for households and industry, is in doubt. Any cessation of Russian deliveries would leave the country without gas, plunging the population into hardship, bringing industry to a near-standstill and threatening a balance-of-payments crisis. Yet it is not clear that Gazprom would push the situation this far; and there is a chance that the gas debt could be offset against Russias sovereign debt to the Bosnian state. On August 22nd Almir Becarevic, the head of BH Gas, the state-owned gas utility in Bosnia and Hercegovina (BiH), announced that Russian officials had given Bosnia until the end of September to produce a plan for repayment of a debt of US$105m for gas supplied between 1991 and 1995. Mr Becarevic appears to have been negotiating with the Russians for some time. Local press reports added that Gazprom, the majority state-owned Russian gas giant, was prepared to take measuresup to and including a cessation of gas suppliesif this was not forthcoming. Gazprom would not be breaking any contracts if it halted supplies: the existing contract with BiH expires on October 1st. This happens to be the date of the countrys presidential and parliamentary elections. No bullying From the Russian side, the move is not particularly surprising. Gazprom, which this month became the largest company in the MSCI Emerging Markets Index and is now the worlds third-largest company by market capitalisation, has focused to an increasing extent on raising revenue in the last year. This is in the interest of its political masters as well as the huge Western portfolio investors that hold Gazprom stock. The clearest and most controversial demonstration of Gazproms revenue-maximising mindset was the doubling and trebling of gas prices for former Soviet states such as Georgia, Azerbaijan and Ukraine at the start of this year; in the case of Ukraine, this was enforced with a huge cut in gas supplies that had knock-on effects for all of Gazproms European customers, including BiH. At the same time, it is worth noting that Gazprom has issued no ultimatums to Bosnia. BiH is a small customer for Gazprom, one that buy Russian gas at roughly a market rate (meaning a price comparable to that paid by Germany, Italy and Gazproms other major European customers). It is not seeking to hike the price for future deliveries. Having damaged its reputation in Europe by insisting on raising prices for Ukraine to a market level overnight, rather than over a phased period, Gazprom has little interest in courting further negative publicity by playing hardball with BiH, particularly as the debt is relatively small. It is noteworthy that Gazprom is not insisting that the debt be paid immediately; merely that a repayment schedule be drawn up before October. BH bust? Although Gazprom has left some ambiguity over its response in the event of a failure to produce a debt-repayment schedule, BH Gas and the BiH authorities have grounds for concern. Principally this centres on the ability of BH Gas to repay the US$105m debt. BH Gas is already in a difficult position financially: as gas import prices rose sharply last year, it recorded a pre-tax loss of KM8.5m (US$5.6m), having made a profit of KM11.5m in 2004. The main cause of this was a 61% rise in sales costs year on year, most of which was caused by a sharply rising gas import bill. Moreover, BH Gas has debts of KM24.6m. Last year KM3.9m of principal and KM6.2m of interest was paid back, although this was done by the governmentpresumably because BH Gas itself could not afford to do so. It therefore seems that BH Gas would struggle to repay the debt, even if it was able to secure a lengthy repayment period (say, 10 years) and a low or zero interest-rate. Assuming that BH Gas is unable to pay under its current financial arrangements, either domestic tariffs would have to rise or the government would have to pay out of its own coffers. Neither is particularly attractive from the perspective of the government. On the surface, BiH seems quite able to repay the US$105m debt. The amount is equivalent to around 1% of estimated 2005 GDP, and spread over 10 or 20 years its impact on the consolidated fiscal position would probably not be destabilising. However, it is unclear which of the country's governmentsit has two sub-state level "entity" governments, the Muslim-Croat Federation and the Serb Republic, and a state-level governmentwill be required to stump up. The state government has very limited sources of financing; assuming a ten-year repayment plan, annual repayments to Gazprom would add around 6% to the state government's annual spending. More broadly, BiH's governments are currently faced with massive internal debts, consisting of frozen foreign-currency claims from BiH's 1992-95 war, war damage and restitution claims, and government spending arrears. With the resolution of these claims likely to amount to some 10-20% of GDP, the governments' room for fiscal manoeuvre in meeting Gazprom's demands looks limited. Economy on the line A sharp rise in tariffs, meanwhile, would cause widespread hardship in Sarajevo, Zvornik and Zenicathe towns and cities where most of the population relies on gas alone for heat during Bosnias long, cold winter. It would also apply the brakes to BiHs economic growth. In 2005, industrial output rose by 19.8% year on year, driven by strong output growth for mining and metallurgy enterprises. Already the countrys two big metallurgy enterprisesthe Birac Alumina Plant in Zvornik and the Mittal Steel foundry in Zenicahave suffered as a result of rising gas prices. Birac, which accounts for 40-50% of BiHs gas imports, recorded a pre-tax loss of KM33m last year (from just KM3.4m a year earlier). The loss is entirely accounted for by the Birac plants rising costs; its income was little changed in year-on-year terms. If gas prices were to rise much further, BiHs industrial recoverybased mainly on energy-intensive enterprisescould well be stopped in its tracks. Higher prices, or even worse a partial or full shutdown, at either Birac or Mittal Steel could also have a dramatic impact on macroeconomic stability. Both companies are leading exporters, and have been instrumental in driving the 40% export growth achieved in January-July 2006. This performance has in turn helped ease fears over the risk posed by BiH's huge official current-account deficit to the country's fixed exchange-rate regime. Should exports falter, these fears could re-emerge. The alternative to repayment is even less palatable. BiH relies on Russia for 100% of its gas consumption (forecast at around 400,000 cubic metres this year) and all of this is delivered via a single pipeline that runs from Hungary. There are plans for a second line, to enter the country from Croatia and serve the big industrial plants, but this is far from certain to be commissioned and would in any case be unlikely to open for another 2 years at least. Even then, BH Gas might struggle to source sufficient gas volumes. While Croatia is a gas producer, it is not self-sufficient and relies on Russia for 40% of its gas needs. So even if a second line were established, the most credible supplier to fill it would be Russia. Offset reprieve? The situation may not be quite as gloomy as this analysis suggests. The Russian Federation owes BiH around US$120m in sovereign debt. According to BH Gass Mr Becarevic, the Bosnian side has floated the idea of offsetting the US$105m gas debt against this, and Gazprom is not opposed to the proposalalthough other options remain on the table. The idea of offsetting the debt is certainly attractive for BH Gas, and perhaps the BiH government, but it may be less so for Gazprom. Although the company is very close to the Kremlin, receiving favourable treatment across a range of government decisions and in turn acting as a tool of the state, it cannot be certain that the government would reimburse it in full in the event of a sovereign debt/gas debt swap. This perhaps explains why, according to Mr Becarevic, Gazprom is interested in solutions other than the debt-offset arrangement. BH Gas and Gazprom officials give the impression that a solution will be found. Given the stakes for BiHs population and businesses, it must be hoped that this optimism is not misplaced. SOURCE: ViewsWire Eastern Europe Copyright 2006 Economist Intelligence Unit |