Front Matter Page
IMF Country Report No. 14/178
BHUTAN
2014 ARTICLE IV CONSULTATION—STAFF REPORT; PRESS RELEASE; AND STATEMENT BY THE EXECUTIVE DIRECTOR FOR BHUTAN
July 2014
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2014 Article IV consultation with Bhutan, the following documents have been released and are included in this package:
The Staff Report prepared by a staff team of the IMF for the Executive Board’s consideration on June 20, 2014, following discussions that ended on March 7, 2014, with the officials of Bhutan on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on May 30, 2014.
An Informational Annex prepared by the IMF.
A Debt Sustainability Analysis prepared by the staffs of the IMF and the World Bank.
A supplement on Enhancing Financial Sector Surveillance prepared by the IMF and the World Bank.
A Staff Statement of June 20, 2014 updating information on recent developments.
A Press Release summarizing the views of the Executive Board as expressed during its June 20, 2014 consideration of the staff report that concluded the Article IV consultation with Bhutan.
A Statement by the Executive Director for Bhutan.
The following document has been or will be separately released.
Selected Issues Paper
The publication policy for staff reports and other documents allows for the deletion of market-sensitive information.
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Front Matter Page
BHUTAN
STAFF REPORT FOR THE 2014 ARTICLE IV CONSULTATION
May 30, 2014
Key Issues
Outlook and Risks: Growth in Bhutan was robust during the last Five-Year Plan (2008/09 to 2012/13), driven by the development of the hydropower sector. However, growth has slowed recently due to policy efforts to moderate aggregate demand to ameliorate overheating pressures. Downside risks remain due to high public debt, potential financial sector vulnerabilities, and the need to manage recurrent pressures on Indian rupee reserves. The main external vulnerability stems from a prolongation of the slowdown in India, Bhutan’s main trade and development partner.
Main Policy Recommendations: The main near-term policy challenge is to revive growth while ensuring that external pressures do not reemerge. The key policy recommendations are:
Fiscal policy should be tightened while preserving social and productive expenditure. Revenue reforms, including broadening the tax base by reducing the number of zero-sales tax-rated goods and taxing domestic value added more extensively, would help in the near term. Over the medium term, consideration should be given to introducing a value-added tax.
On monetary policy, external flows should be fully sterilized and liquidity should be tightened to prevent credit growth from rebounding too strongly. Interest rate spreads need to be narrowed and better reflect market conditions. Over the medium-term, there is a need to further improve the monetary transmission mechanism and deepen the financial system. In particular, it is essential to further develop the government bond market by greater and more regular issuance.
Reserves have to be managed carefully to contain recurrent pressures on rupee reserves, including by aligning the currency composition of reserves with that of the structure of external liabilities and trade.
Further financial deepening should be balanced with maintaining financial stability. Risks to stability necessitate continued vigilance, given past rapid private credit growth. Supervision and regulation need to be strengthened to monitor and safeguard banks’ asset quality and limit systemic risk, including by use of macroprudential measures.
Approved By
Paul Cashin and Ranil Salgado
Discussions took place in Thimpu during February 24–March 7, 2014. The staff team comprised S. Jain-Chandra (head), A. Mohommad, and M. Raissi (all APD). Mr. Mohan and Mr. Kapur (OED) participated in key policy meetings. The mission met with Finance Minister Dorji, Governor Tenzin, Finance Secretary Dorji and other senior officials and representatives of the business community. May Inoue and Qianqian Zhang (all APD) assisted in the preparation of this report.
Contents
INTRODUCTION
RECENT ECONOMIC DEVELOPMENTS
OUTLOOK AND RISKS
POLICY THEME #1—ENSURING MACRO-ECONOMIC STABILITY
A. Fiscal Policy
B. Monetary Policy
C. External Sector Issues
POLICY THEME #2—SAFEGUARDING FINANCIAL SECTOR STABILITY AND FOSTERING DEEPENING
POLICY THEME #3—DIVERSIFYING THE SOURCES OF GROWTH AND ENHANCING INCLUSIVENESS
STAFF APPRAISAL
BOXES
1. Gross National Happiness
2. Inflation in Bhutan
3. The Macroeconomic Effects of Hydropower Development in Bhutan
4. Spillover from India to Bhutan
5. Real Exchange Rate Assessment
FIGURES
1. Recent Macroeconomic Developments
2. External Developments
3. Fiscal and Monetary Developments
4. Business Environment and Governance
TABLES
1. Selected Economic Indicators, 2009/10–2014/15
2. Government Budget Summary, 2009/10–2013/14
3. Balance of Payments, 2009/10–2017/18
4. Medium-Term Macroeconomic Framework, 2009/10–2018/19
5. Monetary Survey, 2008/09–2012/13
6. Financial Soundness Indicators, 2006/07–2012/13
7. Millennium Development Goals
ANNEX
I. Key Recommendations on Enhancing Financial Sector Surveillance in Low-Income Countries
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BHUTAN
STAFF REPORT FOR THE 2014 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX
May 30, 2014
Prepared By
Asia and Pacific Department
Contents
FUND RELATIONS
RELATIONS WITH THE WORLD BANK GROUP
RELATIONS WITH THE ASIAN DEVELOPMENT BANK
STATISTICAL ISSUES
Front Matter Page
BHUTAN
STAFF REPORT FOR THE 2014 ARTICLE IV CONSULTATION—DEBT SUSTAINABILITY ANALYSIS
May 30, 2014
Approved By
Paul Cashin and Ranil Salgado (IMF) and Jeffrey Lewis and Ernesto May (IDA)
The Debt Sustainability Analysis (DSA) has been prepared jointly by IMF and World Bank staff, in consultation with the authorities, using the debt sustainability framework for low-income countries approved by the Boards of both institutions.
Based on the Joint Fund-Bank Debt Sustainability Framework for Low-Income Countries (LIC DSA), Bhutan’s risk of external debt distress is moderate. Bhutan’s rapid hydropower development is projected to lead to a substantial buildup of external debt in the medium-term, with debt ratios breaching most of the country-specific indicative thresholds for protracted periods of time. Also risks stem from volatile hydro-related debt service payments. Bhutan’s debt situation is only expected to improve over the long run, reflecting significantly higher electricity exports when more hydropower projects come on stream. The staff’s assessment is primarily based on unique mitigating factors, namely explicit guarantees from India that cover financial and construction risks for the hydropower projects, thus allowing for the exceptional treatment of hydropower loans from India as similar to FDI—i.e., non-debt creating. As well, India buys the surplus output (after domestic use) with the price based on a cost-plus basis (building in a net return of 15 percent). Other mitigating factors include Bhutan’s strong track record of project implementation, rapid growth in energy demand from India, committed donor support, and Bhutan’s high level of international reserves.1 Notwithstanding these mitigating factors, staff cautions against further new non-concessional borrowing as the level of debt has increased substantially compared to previous DSAs. Stress tests to public sector debt dynamics reveal the need for fiscal consolidation and the importance of sustaining rapid economic growth going forward.
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BHUTAN
STAFF REPORT FOR THE 2014 ARTICLE IV CONSULTATION—ENHANCING FINANCIAL SECTOR SURVEILLANCE
May 30, 2014
Key Issues
Bhutan’s financial sector has substantially deepened in recent years through high credit growth and entry by new banks. However, rapid credit expansion has had negative side effects by contributing to overheating and the buildup of financial sector risks. Financial institutions’ risk management has not kept pace, and sufficient assets are not available for liquidity management or investment diversification. Growing liquidity and interest rate mismatches need to be addressed by the regulatory framework.
Bhutan should aim to develop a comprehensive Financial Sector Development Strategy (now underway with World Bank assistance). This should entail a careful sequencing of reforms within a medium term plan while balancing any trade-offs between financial stability and deepening. The strategy might include measures such as floating minority shares in public enterprises; encouraging private bond issuance; and creating an enabling environment for private equity including by relaxing constraints on foreign involvement in venture capital funding. It should also encompass improved access to financing by individuals and by small- and medium-sized enterprises under the authorities’ Financial Inclusion Policy.
Improving banks’ ability to manage financial risks is essential for further sustained financial deepening. Development of financial instruments and markets, including through increased and regular Treasury bill issuance, will allow financial institutions to manage risk better themselves, while facilitating effective transmission of monetary policy. This would be supported by an improved liquidity management framework for the RMA.
Regulation and supervision should be further developed. There are immediate needs to fill gaps in regulation, including putting in place effective bank liquidity requirements; increasing use of stress testing to monitor risks associated for instance with large exposures and with rising funding costs; and implementing crisis management and deposit insurance arrangements. The RMA should continue with work on broadening the range of macroprudential tools.
Prepared by
This paper was prepared by the Monetary and Capital Markets Department and the World Bank. The authors are Hunter Monroe (MCM), Cecile Niang (World Bank), Ian Tower, and Bryn Vollan (MCM experts). The Enhancing Financial Sector Surveillance mission to Bhutan took place during August 26-September 12, 2013.
Contents
GLOSSARY
INTRODUCTION
BACKGROUND ON THE FINANCIAL SECTOR
A. Formal Financial Service Providers
B. Informal and Semi-formal Financial Service Providers
DEEPENING THE FINANCIAL SYSTEM
ENHANCING REGULATION AND SUPERVISION
A. Recent Developments in the Financial Sector
B. Developments in Financial Soundness
C. Policy Recommendations
STRENGTHENING MONETARY OPERATIONS
A. Overview
B. Government Securities Market
C. Enhancing Monetary Operations
D. Strengthening Monetary Transmission
CONCLUSION
BOXES
1. Stress Testing of the Banking Sector
FIGURES
1. Private Credit to GDP (in percent)
2. Financial Sector Assets
3. Share of Firms with a Checking or Savings Account
4. Share of Firms Using Banks to Finance Investments
5. Share of Firms Using Banks to to Finance Working Capital
7. Share of Firms with Financial Statements Reviewed by External Auditors
8. Average of Daily Reports Generated in Credit Information Bureau
9. Bank Lending, End-June 2013
10. Banks’ Current Accounts with RMA (Excess Reserves)
11. Government Financing, July 2011-July 2012
12. Banks’ Placements with Other Domestic Banks, January 2012-June 2013
13. Banks’ Deposit and Lending Rates (mid-rate), 2002-Aug 2013
14. Treasury Bill Activities, July 2011-July 2013
TABLES
1. Structure of the Financial System
2. Bank Outreach in Bhutan and Peer Countries, 2011
3. Detailed Recommendations
Glossary
| BDBL |
Bhutan Development Bank Limited |
| BDFC |
Bhutan Development Finance Corporation |
| BIL |
Bhutan Insurance Limited |
| BNB |
Bhutan National Bank Limited |
| BOBL |
Bank of Bhutan |
| BOP |
Balance of Payments |
| RSEBL |
Royal Securities Exchange of Bhutan Limited |
| CIB |
Credit Information Bureau |
| CRR |
Cash Reserve Ratio |
| DHI |
Druk Holdings and Investments |
| Druk PNB |
Druk Punjab National Bank Limited |
| FED |
Foreign Exchange Department |
| FIP |
Financial Inclusion Policy |
| IMF |
International Monetary Fund |
| LIC |
Low Income Country |
| LoLR |
Lender of Last Resort |
| MCM |
Monetary and Capital Markets Department |
| MOD |
Monetary Operations Department of the RMA |
| MoU |
Memorandum of Understanding |
| MoF |
Ministry of Finance |
| NBFI |
Nonbank financial institution |
| NPPF |
National Pension and Provident Fund |
| Nu |
Bhutanese Ngultrum |
| OD |
Overdraft Facility |
| RBI |
Reserve Bank of India |
| RICBL |
Royal Insurance Corporation of Bhutan Limited |
| RGOB |
Royal Government of Bhutan |
| RMA |
Royal Monetary Authority |
| RSTLAW |
RMA Short-Term Liquidity Adjustment Window |
| SLR |
Statutory Liquidity Ratio |
| TA |
Technical Assistance |
| W&M |
Ways and Means Account |
| WB |
World Bank |
Front Matter Page
Press Release No. 14/301
FOR IMMEDIATE RELEASE
June 24, 2014
International Monetary Fund
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Fax 202-623-6772
