Bhutan: 2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Bhutan
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International Monetary Fund. Asia and Pacific Dept
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Publication Date:
24 May 2022
eISBN:
9798400210211
ISBN:
9798400210211
Language:
English
Keywords:
tourism sector; development goal; reserve coverage; debt stock; record-setting vaccination campaign; COVID-19; Tourism; Financial sector; Digitalization; Global
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1. Prior to the pandemic, Bhutan had made significant strides in improving per capita income and reducing poverty, qualifying for its graduation from the Least Developed Country (LDC) status in 2023. Looking ahead, Bhutan faces the challenges of diversifying the economy, while facing continued uncertainty about the future path of the pandemic and minimizing any persistent impact.

Abstract

1. Prior to the pandemic, Bhutan had made significant strides in improving per capita income and reducing poverty, qualifying for its graduation from the Least Developed Country (LDC) status in 2023. Looking ahead, Bhutan faces the challenges of diversifying the economy, while facing continued uncertainty about the future path of the pandemic and minimizing any persistent impact.

Context and Recent Developments

1. Prior to the pandemic, Bhutan had made significant strides in improving per capita income and reducing poverty, qualifying for its graduation from the Least Developed Country (LDC) status in 2023. Looking ahead, Bhutan faces the challenges of diversifying the economy, while facing continued uncertainty about the future path of the pandemic and minimizing any persistent impact.

2. The pandemic had a broad-based adverse impact on the economy.

  • GDP contracted by 2.4 percent in FY2019/20 and 3.7 percent in FY2020/21. Transportation, construction, and tourism suffered the most, but with some offsets from an increase in hydropower production, which accounts for around 17 percent of GDP. Overall and youth unemployment roughly doubled to around 5 and 22.6 percent at end-2020.

  • Inflation peaked in early 2021 from higher food prices and supply chain disruptions. Despite recent moderation, it remained elevated at 5.3 percent (year-over-year) in February 2022. Higher global commodities prices stemming from the war in Ukraine and continued supply disruptions are expected to keep inflation elevated throughout 2022 but will be partially offset by favorable base effects.

  • The fiscal deficit increased to 6.3 percent of GDP in FY2020/21, reflecting higher pandemic-related expenditure, with the Twelfth Five Year Plan (FYP) re-prioritized and front-loaded. The National Resilience Fund (NRF) provided income support to individuals directly affected by the pandemic and interest payment support to individuals and businesses.

  • While the pandemic impacted non-hydro exports, higher hydropower exports provided some offset, narrowing the current account deficit (CAD) marginally to 11.8 percent of GDP in FY2020/21.

  • Private sector credit growth slowed to 6.5 percent in June 2021, an 8-year low, reflecting weak demand. Financial sector vulnerabilities have increased amid elevated non-performing loans (14.1 percent in June 2021) and concentration risks (services and housing sectors, and large borrowers).

3. The wide-ranging policy responses helped contain the spread of the virus and cushion the impact of the pandemic (Appendix I). Bhutan’s vaccination campaign has been one of the fastest in the world, achieving full vaccination of the adult population by end-July 2021 and of children aged five and older by end-March 2022. Booster doses have also been administered to the population aged twelve and older, starting since December 2021. Decisive public health measures helped contain the health burden and the loss of lives. The wide-ranging policy responses have helped mitigate the socio-economic costs of the pandemic. The responses include the deployment of the National Resilience Fund (NRF), the Economic Contingency Plan (ECP), and a series of fiscal, monetary, financial, and labor market measures (including the “Desuung” Guardians of Peace program, a value-based skills development program providing community- and nation-building volunteer opportunities for the unemployed youth).

Outlook and Risks

4. The near-term outlook is weighed down by pandemic and geopolitical uncertainties. A gradual recovery is expected in FY2021/22, with growth projected at4.4 percent, supported by Bhutan’s record-setting vaccination campaign, higher electricity exports, ongoing fiscal support, and base effects. The lockdowns to contain the omicron variant and global ramifications of the war in Ukraine are expected to impact Bhutan’s economy through weaker demand (including a weaker rebound in tourism), higher oil and commodity prices (with implications for transportation, food and other inputs costs), and potential supply disruptions. Inflation is projected to remain elevated at 7.9 percent in FY2021/22 (average), given Bhutan’s dependence on imports of both oil and food, whose prices are rising, as well as continued supply disruptions. The overall fiscal deficit is expected to widen to 10.2 percent in FY2021/22 on account of continued fiscal stimulus, including higher capital expenditure. The current account deficit is projected to moderate to 10.6 percent of GDP in FY2021/22, with reserve coverage reaching about 19 months of imports.

5. Over the medium term, growth is expected to be driven by a recovery in services and manufacturing and hydropower, with generation capacity expected to more than double by FY26/27. Inflation is projected to remain in line with that in India, Bhutan’s key trading partner, given the ngultrum’s peg to the rupee. The fiscal deficit is expected to moderate as pandemic-related measures are gradually phased out and revenue reforms deepen. The CAD and reserve coverage are expected to improve from declining hydropower-related imports and rising hydropower exports.

6. Bhutan’s long-term growth strategy has benefitted from its unique developmental approach, prioritizing overall well-being and environmental sustainability. Bhutan’s Gross National Happiness (GNH) is a multi-dimensional development approach that seeks to achieve a balance between material well-being and the spiritual, emotional, and cultural needs of the citizens, with emphasis on access to education, health, and finance (see CR/18/300). One of the three carbon negative countries in the world, Bhutan is exposed to risks of natural disasters stemming from climate change, particularly in water-dependent sectors (hydropower, agriculture, and forestry).

7. Uncertainty around the economic outlook is elevated, with the balance of risks tilted to the downside (Appendix II). External risks include a sharper-than-expected global slowdown and/or a slowdown in India, including from future pandemic waves, an intensification of geopolitical tensions, and a prolonged decline in tourism. Domestic risks stem from pandemic-related uncertainties. Other domestic risks include prolonged financial sector strains amid limited fiscal space, including from any contingent liabilities in the financial sector masked by the broad-based pandemic support measures—and delays in hydro projects, which would affect growth, external buffers, and debt dynamics. That said, recent increases in hydropower production and remittances have supported reserves.

8. The authorities broadly agreed with staff’s assessment of the near- and medium-term outlook and risks. The authorities’ growth projections are broadly in line with staff’s. Agreeing with staff, the authorities highlighted inflation as an important concern and expected it to remain elevated in the near term. Potential future pandemic waves and a continued stringent COVID policy, while the latter has been critical for savings lives, have increased risks to growth and fiscal space. Beyond the near term, the authorities conveyed guarded optimism about the recovery as pandemic-related restrictions on labor and goods movement across borders ease, and tourism slowly re-opens. They also emphasized the role that government capital spending and new hydropower projects have played in supporting growth.

Text Table. Bhutan: Selected Economic and Financial Indicators, 2017–26

article image
Sources: Bhutanese authorities; and Fund staff projections.

The expenditure for FY2021/22 includes an estimated amount for income support provided to individuals and loan interest payment support to borrowers financed by the National Resilience Fund.

Public and publicly guaranteed debt, including loans for hydropower projects.

Policies to Secure the Recovery and Strengthen the Outlook

A. Fiscal Policy

9. The FY2021/22 fiscal response has appropriately prioritized measures to support the recovery. The budget focused on health, education, and infrastructure. About 33 percent of the capital outlay in the Twelfth FYP (19 percent of GDP) has been allocated to FY2021/22, although the recent pandemic wave and labor constraints increased implementation challenges. The public infrastructure projects are primarily geared towards generating employment and exports and developing ICT and innovation. As a result, the fiscal deficit is projected to rise to 10.2 percent of GDP. The phasing out of support measures is expected to be gradual, given pandemic and geopolitical uncertainties. Going forward, fiscal policy should balance the need to support the livelihood of the most vulnerable and sustainability considerations, by focusing on more targeted measures1, to mitigate the longer-term impact of the pandemic and the potential spillover effects of the war in Ukraine on vulnerable households. The gradual phasing out of support measures should be well-communicated and predictable to ensure that individuals, businesses, and the financial sector can adequately prepare for the post-pandemic development phase.

10. The Goods and Services Tax (GST) is scheduled to be implemented in July 2022, following some IT-system and pandemic-related delay. Its steadfast implementation would broaden the tax base, reduce compliance costs, and support revenue mobilization. The GST rate would be set at 7 percent. Preliminary analysis suggests the revenue boost from the GST could amount to about 0.4 percent of GDP initially, and to about 2 percent of GDP in the medium term.

11. Bhutan’s risk of overall and external debt distress is assessed to be moderate, but with limited space for additional shocks. The stock of public and publicly guaranteed (PPG) debt increased to 135 percent of GDP in FY2020/21. While the mechanical results point to a high risk of overall and external debt distress, with breaches in the indicators under the baseline scenario, judgment was applied to the risk ratings given unique mitigating factors supporting the sustainability of Bhutan’s debt stock. First, almost three quarters of Bhutan’s PPG external debt is linked to hydropower project loans from India, which covers both financial and construction risks of the projects and buys surplus electricity at a price reflecting cost plus profits. Second, while the pandemic increased the debt stock, the debt dynamics are expected to improve over the medium term, driven by a significant increase in electricity exports and the completion of hydropower construction. Stress tests suggest that Bhutan’s external debt trajectory could be vulnerable to exchange rate and export shocks, while the overall debt sustainability could be susceptible to contingent liability shocks. Within the moderate rating, Bhutan is assessed to have limited space to absorb additional shocks without changing its risk rating.

uA001fig01

Outstanding PPG Debt by Source

(June 2021)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Source: Royal Monetary Authority.

12. A gradual medium-term fiscal consolidation, underpinned by revenue mobilization and greater expenditure efficiency, is critical to increase policy space and support Bhutan’s development goals. A gradual consolidation will bolster macroeconomic stability by reducing debt vulnerabilities and external imbalances, while balancing Bhutan’s developmental needs. Revenue mobilization, including through a smooth implementation of the GST, could help offset a projected decline in grants. Furthermore, updating the base of land/property taxes and gradually rationalizing tax exemptions would boost revenue. On the expenditure side, pandemic-related fiscal expenditures should become more targeted from FY2022/23, following the expiration of current measures. Some of the broad-based measures, particularly regarding financial sector support, could be re-oriented to support the most vulnerable and to other priority items including education, health, and infrastructure. In this context, it would be important to continue improving access to quality health care, strengthening the quality of education including through vocational training and digitalization, and providing access to subsidized childcare to raise female labor force participation in urban centers.

13. Fiscal policy could integrate a transparent, rolling, multi-year budget framework within the FYP cycle. Bhutan’s system of FYPs, guided by the GNH Commission, provides important anchors for budgetary planning and development goals. At the same time, a rolling and multi-year budget framework integrated within the FYP could make capital spending and growth less volatile and improve the efficiency of expenditure over the medium term. One possible approach would be to provide indicative fiscal targets for the next five years during the mid-term review. Such an approach could also help facilitate the implementation of large capital projects across multiple FYPs, increase the operational focus on long-term growth issues, such as the strategic priorities including health, education, and infrastructure developments, informed by the GNH principles (Box 1). Furthermore, enhanced fiscal transparency—including by reflecting pandemic support measures on-budget (e.g., the NRF) and timely evaluation of project implementation—should aid an effective re-prioritization of fiscal resources post-pandemic. The authorities should also ensure governance safeguards and accountability of crisis-related spending, including transparency in procurement (e.g., publication of contracts and beneficial ownership information of awarded companies).

14. Staff supports the authorities’ plan to further develop the domestic debt market, based on a medium-term debt management strategy. At present, domestic debt financing remains limited (7 percent of total PPG debt), primarily through short-term T-bills and recent bond issuances. Developing domestic sources of stable and longer-term funding will be important, especially as the share of concessional external debt is expected to decline with Bhutan’s graduation from the LDC status. Domestic debt issuances would increase supply of risk-free assets and help improve liquidity management. Going forward, the RMA should focus on developing monetary policy tools, including by implementing the liquidity management framework to establish an active interbank market and reference rate, and the Ministry of Finance should introduce a more regular issuance calendar.

15. The authorities broadly agreed with staff’s call for revenue mobilization and medium-term fiscal consolidation. Besides the introduction of the GST in July 2022, the authorities are planning on direct tax and property tax reforms to further broaden the tax base and increase revenue. The authorities concurred that pandemic support measures should be more targeted going forward given sustainability and financial stability considerations. They noted that although the public debt ratio has increased significantly, the risk of debt distress remained moderate due to the unique mitigating factors supporting the sustainability of Bhutan’s debt stock. Furthermore, the authorities expect a moderation in the debt-to-GDP ratio over the medium term, aided by a gradual fiscal consolidation, a significant increase in electricity exports, and the completion of hydropower construction. On the budgetary framework, the authorities emphasized the importance of the FYPs in providing a blueprint for long-term planning and in attracting financing from development partners and expressed interest in integrating a rolling budget framework within the FYP to reduce volatility and to facilitate longer-term projects. Finally, the authorities reiterated the importance of further developing the domestic bond market as an alternative source of funding and strengthening fiscal-monetary coordination.

B. Monetary Policy

16. Monetary policy has been appropriately accommodative but should be gradually normalized as the recovery strengthens and considering inflationary pressures from supply-side shocks. The Cash Reserve Ratio (CRR) was reduced by 300 basis points to 7 percent in 2020, the first easing since 2015, to support liquidity and credit, accompanied by various financial sector measures.2 Money supply witnessed strong growth in FY2020/21, driven by deposits amid broad-based pandemic-relief measures and limited investment opportunities. While accommodative monetary policy has been appropriate amid elevated uncertainties, the RMA needs to plan for a phased withdrawal of support as the recovery takes hold, unemployment declines, and credit growth picks up amid inflationary pressure. This includes a gradual increase in the CRR, aided by forward-looking communication and close monitoring of excess liquidity and prices.

17. Staff continues to support modernization of the monetary policy framework. The Domestic Liquidity Management Framework (DLMF) benefitted from Fund CD and was announced in December 2020 for liquidity forecasting and management and carried out through overnight, weekly, and long-term (90-day) operations. While excess liquidity has stalled its operationalization, the overnight marginal lending facility should help establish an interest rate corridor, deepen the interbank market, and facilitate policy transmission. Debt market development will increase the supply of risk-free assets, build a benchmark yield curve, and help with monetary policy implementation.

18. Further reforms, including in the liquidity management framework and digitalization, would support market development. A phased reduction in excess liquidity stemming from pandemic-related policies would create two-way demand and foster interbank market development. The authorities’ recent advances in financial market digitalization, including payment systems, can also deliver significant benefits for a country with Bhutan’s topography (Box 2). The recently announced central bank digital currency (CBDC) pilot should initially focus on capacity building and be tailored to development needs.

19. The authorities concurred that the pandemic warranted accommodative monetary policy, but excess liquidity has strained modernization of the monetary policy framework. The authorities highlighted that the monetary measures, including the reduction in CRR, helped banks extend short-term concessional bridge loans for businesses’ working capital. They noted that excess liquidity is mainly driven by a mismatch between strong growth in (short-term) deposits and tepid (long-term) credit demand, including from a saturated housing market and construction-related demand. Finally, the authorities expressed a willingness to continue making progress on the DLMF and digitalization of the financial system, including exploring a CBDC through a pilot program focused on capacity building.

C. Financial Sector Policy

20. Bhutan’s financial sector faced pre-pandemic vulnerabilities from high NPLs and low profitability. In 2019, the return on assets, return on equity, and system-wide non-performing loan (NPL) ratios weakened relative to their recent historical averages.

uA001fig02

Weakening Financial Stability Indicators Pre-Pandemic

(In percent)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Sources: Royal Monetary Authority of Bhutan; and IMF staff estimates.

21. Credit quality indicators are expected to worsen when policy support expires. The RMA introduced a loan repayment moratorium, an interest waiver on loans supported by the NRF, and a comprehensive NPL resolution framework to provide relief to both borrowers and financial institutions and facilitate credit supply. Despite an incentive scheme to repay loans, less than half of borrowers have taken advantage, straining bank profitability. NPLs remain elevated, amid increasing substandard classification and decreasing provisioning. Liquidity in the banking system remained elevated, with the statutory liquidity ratio rising to over 30 percent and deposits increasing 26 percent in June 2021. Despite the RMA’s support and various initiatives, credit provision remained subdued reflecting weak demand, with private sector credit growth at 6.5 percent in June 2021.

uA001fig03

Change in NPL Classification, Dec-19 to Dec-20

(Nu. million, unless otherwise noted)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Sources: Royal Monetary Authority of Bhutan Annual Supervision Report; and IMF staff estimates.

22. Policies should urgently address the NPLs in the banking sector, while balancing the need for continued near-term targeted support. A significant deterioration in NPLs would weaken banks’ capital position.3 Going forward, a well-communicated plan for withdrawing broad-based policy support should be accompanied by banks’ focus on monitoring cash flows, assessing corporate viability and targeting resources to viable but illiquid firms. In addition, a moratorium on dividend payments can support bank capitalization. Any extension of broad-based moratoria could further mask financial sector risks, weaken medium-term growth potential, increase inequality, and create contingent liabilities for the government. While the new NPL resolution framework is an important step, its steadfast implementation would require improved asset valuation.

23. Some progress has been made in implementing a risk-based supervisory (RBS) framework. In 2019 the RMA adopted an RBS framework and issued risk management guidelines, bringing its supervisory practices closer in line with recommendations of the Basel Framework (the set of international standards for prudential bank regulations). In 2020, the RMA conducted an RBS pilot for two financial institutions and published the results of basic stress tests in the first risk-based Annual Supervision Report. Going forward, the RMA plans to gradually implement the RBS across all financial institutions, requiring institutions to put in place an efficient risk management architecture, adopt risk-focused internal audit procedures, strengthen management information systems, and set up risk functions. The risk management framework would be proportionate to institutions’ size, activities, and complexity. A new regulatory framework for developing a resilient and credible insurance sector is also under development.

24. Staff supports the authorities’ plan to further strengthen financial supervision, building on recent progresses. Future priorities include i) closely monitoring loan performance, including by analyzing cash-collection rate and the migration of NPLs; ii) requiring banks to assess the viability of large borrower exposures and submit a detailed large-loan exposure report; iii) ensuring that the loan origination and provisioning standards and loan loss classifications are strictly enforced; iv) ensuring that financial institutions are carefully monitoring all prudential and integrity risks, including by conducting stress tests; v) rolling out the prudential and AML/CFT RBS to all financial institutions and strengthening internal risk management. Furthermore, modernizing the insolvency and bankruptcy process, including for cottage and small industries, would help timely and efficient resolution of stressed assets.

25. The authorities acknowledged the risks to the financial sector stemming from pre-pandemic vulnerabilities, masked by the generous pandemic support. They emphasized that the broad-based financial sector support reflected their core values of ensuring social cohesion during the crisis. They acknowledged, however, that such broad-based support is beginning to reach its fiscal limits and any future support better target the sectors, individuals, and businesses most affected by the pandemic. Moreover, the authorities concurred that close collaboration with the banks will be key to monitor risks from higher NPLs and better target future policy support programs. Separately, the authorities are committed to continuing implementation of the NPL resolution framework and the RBS framework, which should boost longer-term financial stability.

D. External Sector and Exchange Rate Policy

26. Bhutan’s exchange rate peg has been an adequate nominal anchor and remains appropriate. The peg has important implications for debt and reserve management. Seventy percent of public external debt is denominated in Indian rupees, and over 90 percent of trade is with India. Rupee reserve constituted about 26 percent of total reserves in FY2020/21, up from around 16 percent two years ago. In line with past advice, staff recommends further increasing the share of rupee reserves, consistent with trade and financial flows. Staff supports the authorities’ plan to keep the recent SDR allocation as part of Bhutan’s international reserves, given a lack of near-term financing pressures. In addition, staff supports the authorities’ recent relaxation on foreign exchange restrictions, including on the access to foreign currency by industries.4

27. Staff assesses Bhutan’s external position to be broadly in line with the level implied by fundamentals and desirable policies (Appendix III). Both the EBA-lite current account and the IREER methodologies support this assessment. The CAD has narrowed in recent years, as hydropower exports picked up, coupled with a decline in construction-related imports. The overall balance remains positive supported in part by grant financing. The net international investment position (NIIP) is projected to narrow gradually in the medium term under current policies. Given the concessional nature of grant financing and the long-term FDI-like loan liability structure, the risks of imminent external financing stress are low. Bhutan’s reserve coverage remains adequate. Going forward, higher electricity exports, accompanied by medium-term fiscal consolidation, should further support an improvement in the CAD and N IIP.

uA001fig04

Balance of Payments

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Sources: Royal Monetary Authority of Bhutan; and IMF staff estimates.

28. The authorities concurred with the staff’s external sector assessment and agreed with the appropriateness of the peg as a nominal anchor. They emphasized the importance of the hydropower sector in supporting external stability and agreed that the CAD would improve over the medium term, with the onboarding of new hydropower plants and a pickup in electricity exports. Furthermore, the authorities reiterated the importance of rupee reserves as an external buffer and highlighted that convertible currency reserves can be exchanged into rupee reserves, if needed.

E. Structural Reforms

29. The post-pandemic recovery offers an opportunity to lay the groundwork for greater diversification, including through higher value-added activities. The Digital Drukyul Flagship Program appropriately aims to leverage digitalization to promote inclusion and transform the economy (Box 2). The authorities’ efforts in improving tourism infrastructure, skills training, and dissemination of digital content can help upgrade the industry. Prioritizing ‘High Value, Low Volume’ tourism would help address both revenue and sustainability concerns (Box 3). Improving export market access through digital platforms can increase agribusiness demand and output.

30. Further progress with improving access to finance remains crucial. Despite important progress on financial inclusion, focus needs to be on bridging gaps across gender, age, and regions as well as types of financial products.5 Efforts towards further digitalization, which include expanding digital payments and digital IDs, will help deepen access (Box 2).

31. Policies and programs to address skill mismatches, exacerbated by the pandemic, are welcome and should continue. To address the joint problem of pandemic-related labor shortages in critical industries (e.g., construction) and high youth unemployment stemming from closures in the tourism and hospitality sector, several skilling and re-skilling programs were initiated. These increased the availability of courses, provided graduate-employer-matching, and subsidized temporaryjob placement. Going forward, fiscal allocation for vocational education, teachers’training and remedial education for lost schooling should be maintained. To meet short-term labor needs, continued training, job-matching assistance, as well as lower barriers for skilled immigration would be warranted. Better access to subsidized childcare could also help increase female labor force participation in urban areas.

32. Further improvements in infrastructure development should help support Bhutan’s development goals and economic transformation. Bhutan is ranked 149th among 160 economies in the World Bank’s 2018 Logistics Performance Index (latest publication). Further developing the digital infrastructure could help support Bhutan’s transition to a knowledge-based economy.

33. Bhutan faces a pressing need for climate change adaptation.6 With most of the population living in river valleys and economic activity heavily reliant on water sources, lives and livelihoods are at heightened risk from climate vulnerabilities. Furthermore, rapid urbanization and the use of fuel wood are adding pressures on the ecosystem. Staff supports the authorities’ plans for climate change adaptation, disaster risk management and further greening of energy sources, including through climate-resilient budgeting and with a focus on infrastructure.

34. The authorities concurred that progress on structural reforms is critical to diversifying the economy and boosting long-term growth. They noted the pandemic offers an opportunity to boost diversification through digitalization and improved skill-matching. They highlighted their extensive programs to address skill mismatches and unemployment during the pandemic, and the intention to continue with many of these programs post-pandemic. They also agreed with staff’s assessment on the need to improve infrastructure—both physical and digital—to help support domestic economic activity. Such measures, with a focus on improving productivity, will be prioritized in the upcoming Thirteenth FYP (2023–2028).

F. Other Issues

35. The IMF stands ready to provide further capacity development (CD), including through the South Asia Technical Assistance and Training Center (SARTTAC). Since the pandemic, the CD engagement has been recalibrated towards online delivery but remained focused on major policy reforms (Appendix IV). Ongoing CD workplans include medium-term budget frameworks, rebasing of national accounts, development of high frequency indicators, GST implementation, risk-based supervisory framework, and liquidity management.

36. The authorities conveyed their appreciation for ongoing CD support and expressed interest in deepening collaboration with staff, including in areas of bond market development and digital currency. They highlighted that improving data coverage remains a priority.

Staff Appraisal

37. The pandemic has had a substantial impact on Bhutan’s economy. Real GDP contracted for two fiscal years, with contact-intensive and externally oriented sectors most affected, including transportation, construction, and tourism. The wide-ranging policy response helped mitigate adverse impact on lives and livelihoods. Nonetheless, the socio-economic impact has been sizable.

38. While pandemic and geopolitical uncertainties are weighing on the near-term outlook, medium-term growth is expected to be driven by a recovery in services, manufacturing, and hydropower. Growth is projected at 4.4 percent in FY2021/22, with the negative impacts from the omicron outbreak and rising commodity prices stemming from the war in Ukraine, partially offset by Bhutan’s record-setting vaccination campaign, higher electricity exports, ongoing fiscal support, and base effects. Inflation is projected to remain elevated in FY2021/22, owing also to higher oil, food, and commodity prices and supply disruptions. Over the medium term, hydropower generation capacity is expected to double, supporting growth, the current account balance, and the fiscal position. Inflation is projected to remain in line with that in India, Bhutan’s key trading partner, given the ngultrum’s peg to the rupee.

39. While fiscal policy has appropriately supported the pandemic response and recovery efforts, a gradual medium-term consolidation, underpinned by revenue mobilization, is critical. Staff welcomes the budget’s focus on health, education, and infrastructure. Going forward, fiscal policy should balance the need to support the most vulnerable and sustainability considerations, by focusing on more targeted measures. Fiscal policy should be anchored within a transparent, rolling, and multi-year budget framework, integrated within the FYP cycle. Amid higher debt levels and limited fiscal space, revenue mobilization, including through a smooth implementation of the GST, is needed to finance Bhutan’s development goals, while ensuring fiscal sustainability. Further developing the domestic debt market would help public financing and provide risk-free instruments for domestic investors.

40. Monetary policy has been appropriately accommodative but should be gradually normalized as the recovery strengthens and in light of inflationary pressures. Amid heightened uncertainties and a nascent recovery, accommodative monetary policy remains appropriate in the near term. The RMA nonetheless needs to plan for a phased withdrawal of support as the recovery takes hold, unemployment declines, and credit growth picks up amid elevated inflationary pressures. A gradual increase in the CRR, aided by forward-looking communication and close monitoring of excess liquidity and inflation will be necessary. As liquidity conditions normalize, progress on operationalizing the DLMF and overnight marginal lending facility should be prioritized, which will help with interbank market development and monetary policy transmission. Digitalization of the financial system has proceeded at a rapid pace throughout the pandemic and should continue to support productivity and diversification.

41. Financial sector policy should address risks in the banking sector while supporting the recovery. As pandemic-related restrictions are withdrawn and activity normalizes, a well-communicated plan for withdrawing broad-based policy support is needed. This should be accompanied by banks’ focus on monitoring cash flows, assessing corporate viability and targeting resources to viable but illiquid firms. In addition, if further support for bank capitalization is needed, a renewed moratorium on dividend payments could be implemented. A steadfast implementation of the new NPL resolution framework would benefit from improved asset valuation. Building on the recent progress, steadfast implementation of risk-based supervisory framework remains important.

42. Bhutan’s external position is assessed to be broadly in line with the level implied by fundamentals and desirable policies in FY2020/21. Bhutan’s peg has been an adequate nominal anchor and remains appropriate, given its trade patterns. The reserve coverage remains adequate. In line with past advice and consistent with Bhutan’s trade and financial flows, staff recommends further increasing the share of rupee reserves. Going forward, higher electricity exports, accompanied by medium-term fiscal consolidation, should further support the current account balance and NIIP. The authorities’ recent relaxation of foreign exchange restrictions would facilitate Bhutan’s financial integration.

43. The post-pandemic recovery offers an opportunity to lay the groundwork for a shift towards greater diversification and a knowledge-based economy. Prioritizing High Value, Low Volume’ tourism would help address both revenue and sustainability concerns. Further increasing digitalization, including by expanding digital payments and digital IDs, will help improve efficiency and expand access to finance of greater segments of the population, particularly those in rural areas. Improving market access through digital platforms can increase external demand for agricultural products. More broadly, continued improvements in physical and digital infrastructure should help support Bhutan’s development goals and economic transformation. Labor market policies and programs to address skill mismatches, exacerbated by the pandemic, are welcome and should continue. Finally, staff supports the authorities’ plans for climate change adaptation, disaster risk management and further greening of energy sources, including through climate-resilient budgeting and with a focus on resilient infrastructure.

44. Staff recommends that the Article IV consultation with Bhutan remain on a 24-month cycle.

Multi-Year Rolling Budget Framework Integrated in FYP

Fiscal policy in Bhutan reflects coordination across multiple agencies and with the planning process. The Ministry of Finance drafts the fiscal framework, while the Gross National Happiness Commission (GNHQ—which plays a central role in Bhutan’s national planning—is guided by this framework in developing the national plan. The finance ministry also coordinates macroeconomic interventions and is responsible for financing the fiscal framework through revenue, while the GNHC prepares projections for grants.

Bhutan has in the past experienced large fluctuations in expenditure and deficits. The fluctuations were related to the electoral cycle and its link with the five-year planning horizon. More recently, the COVID-19 shock has created disruption and volatility in fiscal policy, prompted by the need to frontload much of the capital and current expenditures to mitigate the immediate impact of the pandemic.

To help reduce the volatility in fiscal policy, there is scope to integrate a rolling, multi year budget framework within the FYP. This will also allow the authorities to identify a pragmatic and strategic fiscal objective to anchor the FYP, while allowing for flexibility to accommodate unexpected shocks. For example, one possible approach would be to provide indicative fiscal targets for the next five years during the mid-term review (covering the first half of the upcoming FYP, see gray in the figure below), which could make capital spending less volatile and more efficient, supporting sustained investment and economic growth. Such an approach would also increase the operational focus on long-term growth agenda and the strategic priorities including health, education, and infrastructure developments, and facilitate the implementation of large capital projects across multiple FYPs.

Digitalization for Economic Transformation

Bhutan has witnessed a rapid rise in digital adoption, but still faces some constraints in achieving widespread digital access. Access to the internet has risen and the cost of access, particularly through mobile-cellular devices, has been steadily declining. Nonetheless, internet access is highly concentrated in urban areas. Given the country’s topography and population distribution, improving connectivity infrastructure remains difficult and costly. The legal and regulatory framework relating to the digital economy remains incomplete and improving digital literacy is a key constraint.

uA001fig06

ICT Access

(Period inhabitants)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Source: International Telecommunication Union.

Digital adoption is expected to increase amid various government-led initiatives. As part of the Twelfth FYP, the Digital Drukyul Flagship Program was introduced with the aim of using information and communication technology (ICT) to transform Bhutan into a digital and inclusive society. The program focuses on seven areas: i) digitalization of health care; ii) provision of broadband connection to 1,000 schools, hospitals, and offices; iii) One Digital Identity (biometric ID); iv) integration of digital business licensing and single customs-trade systems; v) digitalization of key public services; vi) professional ICT certification and digital literacy for non-ICT workers; and vii) digitalization schools through e-learning platforms and education management information systems.

uA001fig07

Share of Population with Internet Access 1/

(In percent)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Source: National Statistics Bulletin Bhutan.1/ Darker green shade represents higher internet penetration (max 34 percent): lighter green represents lower internet penetration (min 18.7 percent)

Efforts by the RMA to digitalize the payment systems have advanced. Bhutan made important progress in the digitalization of the financial system from 2017–20, including the Bhutan Intermediate Payment Service (interbank transfers via internet, mobile, and ATMs instantaneously24/7),the Global Interchange for Financial Transactions (large value fund transfer between banks on a real-time gross settlement basis), RuPay (Indian banks cards to be used a local ATMs), and the QR-code payment system. Since the onset of the pandemic, Bhutan has witnessed a sharp rise in both value and volume of transaction through electronic means and in major cities all vendors now accept some form of digital payment.

uA001fig08

Payment Transaction Volume, by Type 1/

(In percent share of payment method)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Sources: Royal Monetary Authority of Bhutan; and IMF staff estimates.1/ Data for 2020 is available for Q1-Q3, data for 2021 is available for QI and Q2. Data for Payment Gateway, available only in 2021, is not shown and accounts for less than 0.6 percent of total transaction volume and ess than 0.05 percent of total transaction value.

Efforts to expand digitalization should continue. Major initiatives under the Digital Drukyul program, including the digital ID, which have been delayed during pandemic lockdowns should be advanced. Continued fiscal support for investment in physical infrastructure needed for digitalization should also be prioritized. Digitalization of the payment systems, particularly elements connecting Bhutan with international payments systems, should continueto be explored in line with Bhutan’s export diversification strategy and the return of international tourism.

On Transforming Bhutan’s Tourism Sector

Tourist arrivals reached a peak of 316 thousand visitors in 2019.There was significant variation in the nationality and expenditure of visitors. Those from outside the region provide significantly higher value per visitor, consistent with the Minimum Daily Package Rate (MDPR) program, which requires international visitors except those from India, Bangladesh, and the Maldives, to pay a minimum daily rate (USD 250) and book their visit through authorized travel agencies. In 2020, in an effort to reduce the footprint on the ecology, the Tourism Levy and Exemption Bill was introduced which requires regional visitors previously exempt from the MDRP to pay a small levy for entry to Bhutan.

uA001fig09

Inbound Tourism, by Nationality

(In thousands, unless otherwise noted)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Sources: World Tourism Organization; Bhutan Tourism Council; and IMT staff estimates1/ Includes all countries except those listed individually

Bhutan’s governing tourism philosophy of “High Value, Low Volume “to ensure sustainability offers an opportunity post-pandemic. The philosophy would support an acceleration of the planned pivot towards wellness tourism, while remaining an exclusive travel destination based on the GNH values. The introduction of the regional levy is a step towards this goal. Bhutan can also explore other niche tourism segments, like ecotourism and virtual tourism that could support quality growth and job creation.

Wellness tourism is growing in popularity globally, and Bhutan is well-placed to take advantage of the trend. Wellness tourism can include traditional and preventative medicines, personal care, beauty, spa, thermal and mineral springs. In 2018 the global industry was worth US$ 639 billion, of which US$ 137 billion was spent in the Asia-pacific region. The Bhutanese market is currently small, and the expected rise in demand for wellness tourism post-pandemic could be harnessed.

Eco-tourism and virtual tourism. Ecotourism is one of the highest value-added tourism activities and has significant existing demand from high-income tourists. In this respect, Bhutan could learn from other small eco-tourist countries like Costa Rica and Botswana. Virtual tourism—web-based video tours conducted by a local guide on the ground and watched by individuals located elsewhere—also gained popularity during pandemic lockdowns, allowing foreigners to experience a country for a nominal fee at little environmental cost. Given Bhutan’s digitalization strategy, virtual tourism could be an important source for future tourism, particularly amid continued pandemic uncertainty and boost demand for future in-person visits.

uA001fig10

Wellness Tourism

(In percent of total exports)

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Sources: IMF WEO: Global Wellness Institute; and IMF staff estimates.

During the post-pandemic phase, it will be important to be mindful of tradeoffs among different forms of tourism. Bhutan will need to identify and calibrate a well-sequenced and comprehensive set of policies to promote the tourism sector that coordinates the public and private sector, complies with health and safety needs, and builds trust and confidence with travelers.

Figure 1.
Figure 1.

Bhutan: COVID-19 Developments

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Figure 2.
Figure 2.

Bhutan: Real Sector Developments

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Figure 3.
Figure 3.

Bhutan: Fiscal Developments

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Figure 4.
Figure 4.

Bhutan: Financial and Monetary Developments

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Figure 5.
Figure 5.

Bhutan: External Developments

Citation: IMF Staff Country Reports 2022, 146; 10.5089/9798400210211.002.A001

Table 1.

Bhutan: Medium-Term Macroeconomic Framework, 2017–27

article image
Sources; Bhutanese authorities; and Fund staff projections,

The expenditure for FY2020/21 and FY2021/22 includes an estimated amount for income support provided to individuals and loan interest payment support to borrowers financed by the National Resilience Fund,

Public and publicly guaranteed debt, including loans for hydropower projects.

Table 2.

Bhutan: Government Budget Summary, 2017–27

article image
Sources: Data provided by the Royal Government of Bhutan; and IMF staff estimates and projections.

Pandemic-related spending (the National Resilience Fund) accounted for 1.4 percent and 6.6 percent of GDP in FY2019/20 and FY2020/21, respectively. Pay and allowances is the most important category of current expenditure, accounting for 9.5 percent of GDP in FY20/21.

Infrastructure spending (expenditure on structure) is the most important category of capital expenditure, accounting for 9.8 percent of GDP in FY20/21.

Table 3.

Bhutan: Balance of Payments, 2017–27

article image
Sources; Data provided by the Royal Government of Bhutan; and IMF staff estimates and projections,

Including grants for hydropower projects (Tala. Puna I, Puna II, Mangdechhu, Kholongchhu, Bunakha, Chamkarchhu, and

Table 4.

Bhutan: Monetary Survey, 2013–21

article image
Source: Royal Monetary Authority of Bhutan; and IMF staff estimates

Includes deposits of some public enterprises and off-budgetary entities; as such, data differ from bank financing data reported in the fiscal accounts

From 2011/12 onward, public enterprises include government corporations and other public corporations as in the previous definition.

From 2011/12 onward, private sector credit includes join corporations, NBFIs and private sector as in the previous definition.

Includes foreign exchange valuation adjustments and capital accounts.

Includes time and foreign currency deposits.

Table 5.

Bhutan: Selected Economic and Financial Stability Indicators, 2013–21

article image
Sources: Data provided by the Royal Government of Bhutan; and IMF staff estimates and projections.

Appendix I. COVID-19 Policy Response

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Appendix II. Risk Assessment Matrix1

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Appendix III. External Sector Assessment

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1n the external sector assessment, 2021 refers to fiscal year 2020/21, which runsfrom July 2020 to June2021. End-2021 therefore refers to June 2021.

Appendix IV. Recent and Planned Capacity Development

1. The Fund’s capacity development (CD) activities in Bhutan have continued through the pandemic. Since the pandemic, the CD engagement has been recalibrated towards online delivery but remained focused on major policy reforms. The online delivery (e.g., implementation of GST, compilation and data dissemination, improving the quality and coverage of fiscal reporting, risk-based supervisory framework, liquidity management, and macro forecasting) allowed high-level participation with the authorities, aided by the participation of local resident advisor.

2. SARTTAC is the main deliverer of CD in Bhutan (and the region). SARTTAC continued to play an important role during the pandemic. As highlighted in its FY2020 Annual Report, SARTTAC provided extensive training and TA in the Fund’s core areas of expertise such as training on macro-fiscal forecasting, financial programming, national accounts, and public financial management. Ongoing workplans have included medium-term budget frameworks, rebasing, updating PPI, development of high frequency indicators, finalizing the GST implementation, risk-based supervisory framework, liquidity management. CD from functional departments (MCM) is also planned (e.g., development of local debt markets).

3. In line with the Fund’s strategy, CD activities in Bhutan are tailored to the country’s needs and are integrated with surveillance:

  • Recent activities and collaboration with the Bhutanese authorities has helped with customization for country needs. The online delivery since the pandemic allowed CD in critical areas like GST implementation to continue and facilitated broad-based participation.

  • CD activities have been further integrated with surveillance and IMF policy advice. In addition to the regular CD delivery, APD and functional departments (e.g., FAD, MCM, STA) have worked with the authorities on specific queries that can aid policy formulation amid pandemic related uncertainties and other developments (e.g., domestic debt markets).

Appendix V. Uptake of Previous IMF Advice

1. The pandemic shock presented new challenges for Bhutan, but policies have been broadly consistent with previous advice. Fiscal, monetary, and financial sector policies since the last Article AIV have been broadly consistent with IMF advice, against the backdrop of the COVID-19 shock. Challenges remain related to financial sector reforms, however, and some of the structural reforms have been delayed.

2. Fiscal policy has appropriately focused on supporting the vulnerable and the economy amid the unprecedented COVID-19 shock. The accommodative fiscal stance, with emphasis on health and social support, reflected general Fund advice on pandemic management. As pandemic-related restrictions ease, fiscal spending should be targeted with a medium-term rolling framework to help reduce volatilities. Additionally, the shift towards capital expenditure projects will help address Bhutan’s significant infrastructure needs, as past Fund advice noted.

3. The implementation of the GST has continued despite pandemic-related delay, consistent with boosting the domestic revenue base. The implementation of the GST in June 2022 continues to be supported by Fund technical assistance (TA). Following past staff advice, it will be relatively broad-based and would have a simple rate structure.

4. With regards to monetary policy, a new liquidity management framework has been developed with support from the Fund, but its operation is delayed. With support from SARTTAC the RMAs liquidity management and forecasting capabilities have been enhanced, along with the structure in place to establish an interest rate corridor. However, given the ample liquidity during the pandemic stemming from fiscal and financial sector policy support, demand for overnight lending facilities has yet to materialize. It is expected to become operational as policy support is withdrawn and liquidity declines.

5. Loan moratoria and other borrower relief measures have taken pressure off the financial sector during the pandemic but must be wound down. Staff past advice on financial sector reforms, including strengthening resilience and modernizing the regulatory regime (e.g., tighten loan classification requirements for banks, mandate risk-based provisioning) remains relevant. The RMAis making progress towards risk-based supervision, consistent with Fund advice and with TA support.
1

For example, the income support under Kidu targets individuals most affected by the COVID-19 pandemic, including those who have been laid off, or placed on unpaid leave or faced reduced salary from businesses in tourism and tourism-dependent sectors, and who do not have any other means of sustaining their livelihoods.

2

The CRR remains the RMA’s main monetary policy instrument until the new liquidity framework is fully operationalized.

3

RMA results suggests a doubling of NPL ratio (to 30 percent) would reduce the system-wide capital adequacy ratio to 9.2 percent, below the minimum requirement (10 percent).

4

See Informational Annex for more details.

5

As of 2020, 76 percent of the adult population had a bank account, but only 21 percent had accessed credit facilities and 25 percent had an insurance policy.

6

Forrest coverage (about 71 percent of the country, above the government’s mandated target of 60 percent) and renewable energy offset carbon emissions.

1

“L”=Low; “M”=Medium; “H”=High. “ST” = short term; “MT= medium term; “LT”=long-term. The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The RAM reflects staff views on the source of risks and the overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

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Cover IMF Staff Country Reports
Bhutan: 2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Bhutan
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2022: Issue 146
Publisher:
International Monetary Fund
ISBN:
9798400210211
ISSN:
1934-7685
Pages:
70
DOI:
https://doi.org/10.5089/9798400210211.002

Outstanding PPG Debt by Source

(June 2021)

Weakening Financial Stability Indicators Pre-Pandemic

(In percent)

Change in NPL Classification, Dec-19 to Dec-20

(Nu. million, unless otherwise noted)

Balance of Payments

(In percent of GDP)

ICT Access

(Period inhabitants)

Share of Population with Internet Access 1/

(In percent)

Payment Transaction Volume, by Type 1/

(In percent share of payment method)

Inbound Tourism, by Nationality

(In thousands, unless otherwise noted)

Wellness Tourism

(In percent of total exports)
Figure 1.

Bhutan: COVID-19 Developments
Figure 2.

Bhutan: Real Sector Developments
Figure 3.

Bhutan: Fiscal Developments
Figure 4.

Bhutan: Financial and Monetary Developments
Figure 5.

Bhutan: External Developments