Monetary policy in Bosnia and Herzegovina

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1. Currency board is an arrangement with a fixed foreign exchange rate tied to the „peg“ currency, gold or even a basket of currencies, with all the currency in circulation freely convertible into the peg currency and with the basic activities of the central bank clearly defined by the central bank law. It is based on strict rules:

• The coverage of the national currency issue is a stable foreign currency, the so-called peg currency, minimum in 100% amount;

• At any moment, the national currency is on demand convertible into a stable foreign currency which it is pegged to, according to the previously defined ratio;

• Maintenance of the currency stability is the first and basic objective of the arrangement, which all the other objectives are subordinate to.

2. The Law on the Central Bank of Bosnia and Herzegovina regulates BH monetary policy. The Central Bank of Bosnia and Herzegovina is organised according to the currency board model, functioning by the passive monetary policy rules and has no discretionary rights as a typical central bank. This means that it cannot use the foreign exchange rate as an instrument to mitigate economic shocks, it cannot create money without coverage or lend to the government, it cannot act as a lender of last resort, i.e. lend money to banks and it cannot stimulate economic growth directly.

In practice, currency board is a very simple rule meaning that anyone who wants the local currency – convertible mark (KM) has to purchase it for foreign convertible currency. As KM is tied to the „peg“ currency, euro, purchase of KM is carried out by the fixed foreign exchange rate being KM 1.95583 to one euro. When KM is purchased for some other convertible currency, those transactions are carried out by the market exchange rate. So, for the purpose of the currency board functioning, foreign currency reserves have to be sufficient to enable all those having KM banknotes and coins, including banks' holdings in reserve accounts with the Central Bank of Bosnia and Herzegovina and Central Bank's depositors deposits, to convert them into the peg currency. In simpler terms, each issued KM has coverage in foreign currency or, in technical terms, monetary liabilities must never exceed the foreign exchange assets of the Central Bank of Bosnia and Herzegovina. See more details on: https://cbbh.ba/Content/Read/14

3. According to the Law on the Central Bank of Bosnia and Herzegovina, monetary policy has been entrusted to the Central Bank of BH, thus establishing the currency board, i.e. the strict relation of KM to EUR. Such model is justified by the features of our economy, having clearly contributed to the country' economy and thus having justified its existence.

A change to alternative monetary policy, either inflation targeting or floating or free exchange rate, is brought about by the features of the economy, among other things. Essentially, the choice depends on a number of factors, from historical context, public perception of earlier arrangements and possible crises and the current features.  

The currency board is not an obstacle for economic growth, as BH problems are not monetary but real. Whatever is done with the exchange rate, our exports do not have to increase necessarily, as we are less competitive in terms of production than countries producing similar or same products. Simply, the production costs, for many reasons, are too high and no monetary interventions can help much. On the other hand, the weakening of KM exchange rate would certainly have negative effects on debtors with loans indexed to or issued in foreign currencies. In case of devaluation, the debt value would grow. Regarding inflation targeting as monetary policy, such model has been proven in practice, in long-term perspective, to be more adequate for calmer periods on global markets of food and energy sources and in the countries with a significant impact on global prices of these goods. BH imports significant quantities of food and all the oil and natural gas, and the country has quite a limited capacity to absorb price shocks. In other words, whichever the inflation target level might be, we are quite likely to breach it rather frequently, thus damaging the credibility of both monetary policy and the central bank. This does not mean that the country's monetary policy cannot be changed, there is a legal procedure to do so. However, as a rule, it is not done during crises and if economy has not been through significant structural changes.