1. Our authorities’ discussions with the 2016 Article IV mission were constructive and productive. The mission chief, Mr. Jiri Jonas and his team have an excellent understanding of the macro-economic situation in Bhutan, including the unique features of the country’s economy. The authorities wish to place on record their appreciation of the outstanding work done by the IMF mission team. They also broadly agree with the assessment made in the Article IV report, and hope to benefit from staff’s recommendations.

2. Our authorities are also thankful to IMF staff and management for the Fund’s engagement with Bhutan over the years. As the country endeavors to achieve rapid socioeconomic progress, it also needs to develop capacities in various areas of economic management. The authorities have, in this task, received from the Fund both encouragement and assistance, of which they are deeply appreciative. Indeed, Bhutan has been a major beneficiary of Fund technical assistance (TA). Eighteen TA missions were completed in FY2015; fifteen were completed in FY2016; and three have been completed and six are planned for completion in FY2017; These cover diverse areas, including budget planning, government finance statistics, balance of payment statistics, AML/CFT, currency management and national accounts.

3. Bhutan’s development record over the last three decades has been impressive, and particularly so in recent years. GDP per capita more than doubled during 2004-14. During 2000-2014, the percentage of population below poverty line reduced from 36.3 to 12, infant mortality fell from 68.4 to 29.7 and universal primary enrollment was achieved. There have been similar marked improvements in several other indicators also- maternal mortality ratio, immunization coverage, road connectivity in rural areas, rural electrification and so on. Bhutan scores very well on indicators of environment - more than 80 percent of the country’s land area is under forest cover, it is a net sink for Global Greenhouse Gas (GHG) emissions, the quality of water at the macro level is very high and air pollution is considerably lower than internationally acceptable levels.

4. Our authorities are committed to building on this strong track record and following policies that ensure both macroeconomic stability and strong and inclusive growth. They recognize that addressing the several challenges that lie ahead would require both sound macroeconomic management and structural reforms. These challenges include managing hydropower related inflows, managing the projected spike in hydropower revenues keeping in view the likely phasing out of external aid, and addressing youth and urban unemployment.

5. The authorities are in agreement with staff’s assessment that Bhutan’s medium-term outlook is favorable. They are confident that with the commissioning of new hydropower generation projects, growth will significantly accelerate from FY2017/18 and the current account will return a surplus. The financial sector has been assessed as generally healthy by staff. While the authorities note staff’s emphasis on containing the fiscal deficit in FY2016/17 and FY2017/18, they feel that staff’s concerns about fiscal outcomes are somewhat overstated.

6. The authorities are cognizant of the need for avoiding an excessively expansionary stance and large shifts in the fiscal balance. The fiscal deficit in FY2015/16 is projected to be significantly lower than what was budgeted for. Though it is correct that capital spending tends to pick up in the last two years of the five year plans, the authorities endeavor to ensure that the selected projects are not beyond the implementing capacity of the government agencies. They also recognize the need for increasing tax revenues and are hopeful of introducing a new goods and services tax (GST), with Parliament’s approval, by the end of 2018. On the expenditure side, they have taken several measures to contain current spending. Going forward, they also intend to strengthen the fiscal framework with a view to containing public debt and avoiding excessive volatility in the fiscal stance. However, any such framework will have to keep in view the fact that as hydropower exports and revenues increase and GDP growth accelerates, external support is likely to reduce. This is an area to which the authorities plan to give more attention in the coming months.

7. Staff’s advice on monetary policy is consistent with the authorities’ own views. The current monetary policy stance is viewed as suited to the prevailing monetary conditions. There is certainly a need to improve the monetary policy transmission mechanism which currently relies solely on the cash reserve ratio (CRR). The authorities will carefully consider staff’s suggestions in this regard and follow a graded approach in moving forward, mindful of the need for adequate institutional capacities and supporting legal frameworks. They also intend to review the base rate system keeping in view both the wide-spread dissatisfaction with it and staff’s suggestions, which include learning from the Indian experience.

8. As reported by staff, a comprehensive framework for macro-prudential policy was put in place by the RMA in 2014 and some macro-prudential regulations have already been implemented. The authorities intend to implement additional regulations in the coming months, in doing which the advice of the recent TA mission on banking supervision and regulation should prove useful.

9. In the external sector, the large current account deficit and the high external public debt should be seen in the background of the large external investment and imports relating to the hydropower projects that are under implementation. The authorities feel that there is no reason for concern on these counts. As already stated, the current account should move to a surplus once hydropower exports pick up. Also, staff rightly points out the unique circumstances that mitigate the external risks that appear high because of the current level of the ratio of public and public guaranteed (PPG) debt to GDP. Though the current level of international reserves is high, covering about 11 months of imports, this too needs to be seen in the context of the current hydropower centered development strategy. These reserves are built largely on external aid flows and borrowing for the hydropower related investments. The authorities note staff’s advice for further improvement in the composition of foreign reserves. They would not describe the Rupee shortage of 2012-13 as a crisis. They also do not consider the risk of another rupee shortage as likely, particularly because of RMA’s recent swap agreement with the RBI which would enable RMA to have access to short-term Indian Rupee liquidity support. Moreover, arrangements to sell or buy Indian Rupees against USD and gain access to Indian Government securities are being currently pursued.

10. The authorities consider it important that spillovers from development of hydropower are managed well. They are keen to separately keep track of developments in the hydropower and non-hydropower sectors. In particular, they would like to separate the impact of developments in the two sectors on the balance of payments. Fund technical assistance in this regard will be very welcome.

11. Our authorities also plan to give attention to the problem of high youth and urban unemployment. Development of the private sector and diversification of the economy would be critical to addressing this challenge. In the near term, they see the need for employment of a significantly greater number of Bhutanese citizens in the construction of hydropower projects. All necessary measures will be taken to substantially raise the percentage of Bhutanese citizens employed in construction of these projects from the current low level of 20 percent. Staff has rightly mentioned the need for addressing the existing lack of skills in this regard. However, the authorities do not agree with staff that a lack of willingness to take up jobs requiring manual work could also be a contributing factor to this state of affairs. A more plausible contributing factor would be lack of awareness about the job opportunities that are likely to be created resulting in lack of acquisition of the required skills. The authorities intend to address all such factors.