At A Glance
A small, landlocked country nestled deep in the Himalayas between India and China, Bhutan is characterized by steep mountains and deep valleys, which led to scattered population settlement patterns. Since Bhutan shifted to a democratic constitutional monarchy in 2008, the country has embarked on a development strategy founded on the principle of Gross National Happiness.
The country is known for its unique philosophy – Gross National Happiness (GNH) – which guides its development strategy. Abundant water resources in the valleys create ideal conditions to tap renewal energy sources with hydropower development which has spurred economic growth with quasi universal access to low-cost electricity. Fiscal revenues from selling surplus hydropower to India and tourism have helped the country invest substantially in human capital development. This has led to significant improvements in service delivery, education and health outcomes. Bhutan has made tremendous progress in reducing extreme poverty and promoting gender equality, with continuing efforts to address social inequality issues and regional disparities.
The COVID-19 pandemic and spillovers from the war in Ukraine have resulted in a significant deterioration in the macroeconomic situation. After the economy contracted for two consecutive years in FY19/20 and FY20/21, non-hydro industry and services sector activity have picked up. Tourism has been slow to recover, in part due to the new tourism levy act which tripled the sustainable development fee for international tourists from US$65 to US$200 per night. The youth unemployment rate increased from 20.9 percent in 2021 to 29 percent in 2022, which contributed to an increase in outward migration.
COVID-19 relief measures and subdued revenue performance have resulted in high fiscal deficits and public debt since FY20/21, with limited fiscal space to absorb additional shocks. International reserves have declined rapidly due to an increase in imports. Vulnerabilities in the financial sector with high non-performing loan (NPL) levels have increased fiscal risks, given that about 60 percent of assets of the sector are controlled by the public sector. Labor shortages during the pandemic resulted in significant delays in hydro projects and hence expected delays in additional hydro revenue flows, constraining the country’s ability to strengthen fiscal and external balances in the medium term.
The macroeconomic situation is fragile. In addition to continued global uncertainties and additional delays in hydro projects, downside risks to the growth outlook include delays in fiscal consolidation and financial sector vulnerabilities, which constrain the government’s ability to support a robust recovery.
Country Context
Bhutan is a lower-middle income country. Rapid economic growth in Bhutan has contributed to substantial poverty reduction over the last two decades. Annual real GDP growth averaged 7.5 percent since the 1980s, driven by the public sector-led hydropower sector and strong performance in services, including tourism. It was estimated that nearly 9 percent of the population lived below the $3.65/day poverty line in 2017, with poverty being more prevalent in rural areas and significant disparities across districts. More recent data (2022) is being analyzed to establish a comparable poverty trend for Bhutan.
Bhutan maintains strong economic and strategic relations with India, particularly as its major trading partner, source of foreign aid and as a financier and buyer of surplus hydropower. While hydropower has provided a reliable source of growth, non-hydro sectors, facing constraints related to the country’s challenging investment climate including high trade costs and a small domestic market, remain less competitive. As a result, job creation outside of the public sector and agriculture has been limited.
Recent Economic Developments
The economy grew by 4.3 percent in FY21/22 (July 2021 to June 2022), supported by the easing of social and mobility restrictions in the second half of FY21/22 and continued fiscal support to boost activity. The industry sector grew by 3.0 percent, supported by a recovery in the construction, manufacturing and mining sectors. The electricity sector contracted due to maintenance of the Tala hydropower plant, resulting in lower hydro exports and revenues. Services output increased by 5.7 percent, driven by transport and trade activities. The tourism industry remained subdued in FY21/22 due to COVID related travel restrictions. On the demand side, public investment and consumption supported growth, reflecting continued fiscal support, while private investment and consumption have not yet recovered.
Average inflation moderated from 8.2 percent in FY20/21 to 5.9 percent in FY21/22, driven by a moderation in food inflation. However, non-food inflation accelerated to 7.0 percent in FY21/22, reflecting higher fuel and transport prices. The moderation in prices contributed to a slight decrease in poverty to 8.8 percent in 2021 based on $3.65/day (from 9.6 percent in 2020).
The current account deficit (CAD) more than doubled to 33.1 percent of GDP in FY21/22. Exports remained subdued (as a share of GDP) due to lower hydro exports and near-zero tourism-related services exports. Imports surged due to a significant increase in the import of Information and Communication Technology (ICT) equipment and higher prices, particularly of fuel and food. As a result, gross international reserves declined rapidly in FY21/22, reaching US$833 million in June 2022 (a 37 percent decline, y-o-y), equivalent to 6.6 months of FY21/22 imports.
The fiscal deficit widened to 7.8 percent of GDP in FY21/22 from 6.2 percent in FY20/21. Total expenditures declined (as a share of GDP) but capital expenditures increased, reflecting continued fiscal support through accelerated implementation of the Twelfth Five Year Plan (FYP). Total revenues declined because of lower hydro revenues and external grants. Public debt increased to 133.3 percent of GDP in FY21/22 due to an increase in non-hydropower debt.
Economic Outlook
The economy is expected to grow by 4.5 percent in FY22/23. The further reopening of borders in September 2022 is expected to support growth in the industry and services sectors. Tourist arrivals are expected to remain subdued because of slow global growth and the introduction of the new tourism levy act. Growth is expected to remain subdued in FY23/24 due to lower public investments, typical for the first year of a new FYP and the transition to a new Cabinet following national elections. Medium term growth will be supported by a recovery in non-hydro industry and services sectors, and by the commissioning of a new hydropower plant.
Inflation is projected to remain elevated in the short term, owing to higher import prices, before moderating in the medium term. While the incidence of poverty is expected to decline further from 2022, a full recovery to poverty headcount rates estimated before the COVID-19 pandemic is not likely to be achieved until 2023 given elevated consumer prices.
The CAD is expected to remain elevated in FY22/23 at 28.6 percent of GDP due to lumpy imports of ICT equipment and a slow recovery of tourism. The CAD is expected to improve from FY23/24 due to lower ICT imports, and to moderate further in the medium term due to the doubling of hydropower capacity and a decline in imports following the completion of the hydropower projects. International reserves are expected to decline to 4 months of imports until FY24/25, before improving to 5 months import coverage in FY25/26.
The fiscal deficit is projected to decline to 5.8 percent of GDP in FY22/23, driven by lower capital spending. The deficit is expected to further decline to 4.5 percent of GDP in FY23/24 due to lower public investments in the first year of the new FYP, and measures to rationalize current expenditure and increase domestic revenues.
Despite a decline in hydropower debt, public debt is projected to remain elevated as a share of GDP in the short to medium term due to high fiscal deficits. Risks to debt sustainability are expected to remain moderate as the bulk of the debt is linked to hydro project loans from India (to be repaid from future hydro revenues) with low refinancing and exchange rate risks.
Last Updated: Apr 09, 2023
