The main drivers for the confirmation of Bosnia & Herzegovina's (BiH) B3 ratings are the following:

1.) Legislation is being put in place to strengthen the external debt payments process and remove some of the key roadblocks that led to brief delays on debt service to several multilateral financial institutions and one commercial bank in January-February of this year.

2.) Negotiations over a new IMF stand-by agreement are beginning this week, which should revive a stalled program of structural economic reform and allow the country to regain access to external finance at concessional rates from the IMF, European Union, World Bank and other sources.

3.) Slow but positive progress is being made on critical components of Bosnia's EU agenda following the formation of new State-level institutions in February, although significant challenge lie ahead.

4.) Economic growth prospects have weakened, given the dependence on exports and foreign direct investment and foreign credit for growth, most of which comes from a crisis-struck Europe.

The B3 country ceilings for foreign and local currency debt and deposits were also confirmed.

RATINGS RATIONALE

RATIONALE FOR CONFIRMING RATINGS AT B3

One of the most important considerations behind Moody's confirmation of Bosnia & Herzegovina's sovereign ratings is that measures are being taken to strengthen the debt service procedures, in particular to assure that such payments would not be caught up in political infighting as occurred earlier this year. It was clear that those delays related only to the processes, not the capacity to pay. The money needed to make the payments was already on deposit with the Central Bank, which operates as the fiscal agent for the payment of Bosnia & Herzegovina's debt service. All that was lacking was the payments instruction from the State Ministry of Finance. Once that was resolved, all payments were made within the relevant grace periods.

In Moody's view, the necessary changes to debt payments procedures are being made with an appropriate degree of urgency. The indicated amendments to the relevant statutes regarding the payment of Bosnia & Herzegovina's debt were approved last week by the Council of Ministers of BiH and submitted to Parliament. These changes are meant to ensure that the external debt will be serviced even if there is no State budget in place nor a temporary decision on financing. Moreover, the Central Bank will be empowered to solicit payments orders from the entity-level governments if they still fail to receive payments instructions from the State. We would expect the approval of such amendments to be a prior action for a new IMF stand-by agreement.

The second driver for Moody's confirmation of the BiH government's B3 relates to the imminent start of negotiations over a new IMF stand-by agreement (SBA). Although there is no guarantee that these negotiations will actually lead to a new program within a few months, Moody's believes the motivation of the Bosnian sub-sovereign entities for a program is stronger than it has been since the last one lapsed in 2010. Wage and benefit cuts and pension reforms are already underway or planned at various levels of Bosnia's complex, multi-layered government, which indicates there could be a sound basis for negotiations. At the same time, the IMF would likely require additional fiscal consolidation at the entity level, which would go a long way towards mitigating Moody's concerns about the relatively large sub-national budget deficits in recent years as well as the cost and availability of financing.

A disbursing IMF program would permit the release of other multilateral funds, such as a tranche from the EU's €100 million financial assistance program, and potentially new credit from the World Bank following an agreement on additional structural reforms. These new funds would allow the refinancing of the roughly $500 million coming due over the next two years from the 2009 IMF SBA, and reduce reliance on more expensive domestic financing.

The third rating driver for confirming BiH's ratings is the recent progress being made on the country's agenda to eventually join the EU. Two of the major requirements from the EU -- the law on state aid and the national census -- were approved soon after the State-level government was formed in mid-February. The third, which involves changes in the constitution to comply with the judgment of the European Court on Human Rights, is in serious negotiations.

An EU Roadmap for Bosnia was presented at a high-level summit in Brussels recently. The Roadmap includes an August 2012 deadline for an agreement on the constitutional reform in order to finalize the country's EU Stabilization and Association Agreement. They also instructed Bosnian officials to devise a constructive system for dialogue with the EU once/if the country's EU candidacy is approved, with a November 2012 deadline. Moody's expects slippage on the latter target date, however, given continued resistance from some sub-national governments to relinquishing their sovereignty in this area.

Finally, Moody's has kept Bosnia & Herzegovina's rating at B3 because of continued uncertainty about the country's near- to medium-term economic growth prospects. The slowdown in the European economy, Bosnia's main trading partner and the source of most of its foreign investment and credit, is likely to constrain Bosnia's growth for several years given the deleveraging taking place in the domestic economy.

RATIONALE FOR THE STABLE OUTLOOK

In Moody's view, the main stumbling block to the 16-month impasse over formation of the State-level institutions -- and ultimately the dispute that led to the late debt payments -- concerned the size of the State budget. Moody's say the accord on a multi-year State budget between the State and the lower levels of government suggests that a similar stalemate is unlikely to occur in the near future.

WHAT COULD CHANGE THE RATING UP/DOWN?

The next rating action would be in a positive direction in the event that the country submits its candidacy application to the EU, since this would mean that additional reforms would have been taken and/or be underway in both the economic and political sphere. Continuous compliance with a new IMF stand-by agreement, especially if accompanied by World Bank lending related to fundamental structural reform, would also be credit positive.

The next rating action could be downward in the event that there are slippages in compliance with the IMF stand-by program that would lead to interruptions in program disbursements and put concessional external financing out of reach. Any such development would create uncertainty concerning the governments' ability to roll over the large repayments due to the IMF over the next two years.

The principal methodology used in this rating was Sovereign Bond Methodology published in September 2008. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

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Kristin Lindow Senior Vice President Sovereign Risk Group Moody'sInvestors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653Bart Oosterveld MD - Sovereign Risk Sovereign Risk Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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