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. The country is famous for its unique philosophy – Gross National Happiness (GNH) – which guides its development. Abundant water resources create ideal conditions for hydropower development which has spurred economic growth. Fiscal revenues from hydropower have helped finance large investments in human capital which led to significant improvements in service delivery and educational and health outcomes. Access to electricity is almost universal while access to functional piped water was 95 percent in 2015.
Bhutan maintains solid growth and macroeconomic stability. Hydropower construction and supportive fiscal and monetary policy have contributed to solid growth. Single-digit inflation, a stable exchange rate, and accumulating international reserves attest to the stability. Nevertheless, structural challenges remain, including large current account deficits, high public debt, an underdeveloped private sector, and a high youth unemployment rate. A delay in hydropower construction could cloud macroeconomic prospects in the coming years.
Bhutan has a stable political and economic environment. It has made a tremendous progress in reducing extreme poverty and promoting gender equality, while attention is needed to address inequality issues.
World Bank Group (WBG) support is guided by the Country Partnership Strategy (CPS) FY2015-2019 and the 2017 Performance and Learning Review (PLR). It focuses on improving fiscal and spending efficiency, increasing private-sector growth and competitiveness and supporting green development. The WBG has also almost completed the Systematic Country Diagnostics (SCD) as a basis for the formulation of its next County Partnership Framework (CPF) in alignment with the 12th Five-Year Plan (FYP) of the Royal Government of Bhutan.
Bhutan’s political environment has been stable and economic conditions have improved in recent years. Since Bhutan shifted to a democratic constitutional monarchy in 2008, the country has developed a solid development management system founded on the principle of GNH. The country successfully completed its third parliamentary elections in 2018 and the new government has endorsed the 12th FYP for 2018-2023. Bhutan maintains strong economic and strategic relationships with India, particularly as the major trading partner, as a source of foreign aid and as a financier and buyer of hydropower. Bhutan is vulnerable to natural disasters and climate-related risks.
Bhutan has become a lower-middle income country and poverty has been cut by two-thirds in the last decade. Average annual growth of Gross Domestic Product (GDP) has been 7.5 percent since the early 1980s, making Bhutan one of the fastest growing economies in the world. Gross National Income (GNI) per capita, at $3,080 in 2018, is now three times the threshold for lower middle-income countries and only 10 percent below the threshold for upper-middle income countries. Poverty measured using the $3.20 poverty line (in 2011 PPP terms) has declined from 36 percent in 2007 to 12 percent in 2017. There was good progress in shared prosperity, though the pace of progress slowed down in recent years.
RECENT ECONOMIC DEVELOPMENTS
Bhutan’s economy continues to be dominated by hydropower and its economic relationship with India. Growth is estimated to have rebounded to 5 percent in FY2019 after a deceleration to 4.6 percent in FY2018 due to maintenance and on-boarding delays on two major power plants (Tala and Mangdechhu). On the demand side, growth was underpinned by exports and consumption, reflecting the progress in hydropower maintenance and a procyclical public demand response to the associated income inflows. Services remain the main driver of growth on the supply side, where wholesale and retail trade has emerged as the key contributing sub-sector.
Approximately 80 percent of Bhutan’s imports are from India, and the Bhutanese Ngultrum is pegged to the Indian Rupee. Thus, inflation between the countries is closely linked. FY2019 began with a slowdown in inflation, hitting a low of just above 2 percent in July 2018 before gradually increasing to 3.1 percent in April 2019 due to food and oil price dynamics. The exchange rate has followed the appreciation of the Indian Rupee in recent months, decreasing from 70.78 BTN per USD to about 69 BTN per USD in August 2019.
Developments in the hydropower sector also contributed to a narrowing of the current account deficit to 16.3 percent of GDP in FY2019, as exports from the Tala plant expanded after the conclusion of maintenance work. At the same time, tourist arrivals increased by 8 percent in FY2019, contributing to the growth of service exports. The current account deficit was primarily financed through capital inflows from India. Foreign exchange reserves cover nearly 10.1 months of imports.
Bhutan has maintained its course of sustainable public finances, with the fiscal deficit estimated to have reduced to 2.1 percent of GDP in FY2019, from 4.6 percent two years prior. This reflects revenue growth from reforms that increased the corporate income tax base and changed the valuation rules for sales tax on vehicles in FY2018, and a slowdown in the initiation of new capital projects which limited spending growth. Government debt is estimated at 109.3 percent of GDP and is considered sustainable due to a special financing arrangement with India, which covers construction risks of hydropower plants and guarantees a return on surplus power purchases.
Little progress was observed in the labor market as labor force participation fell from 65.7 percent in 2017 to 62.6 percent in 2018. Agriculture contributes only 10 percent to GDP but accounts for 54 percent of employment. Working in agriculture is highly correlated with being poor: about 66 percent of poor household heads work in agriculture. Increases in agricultural exports and productivity helped reduce poverty in recent years. Extreme poverty at USD 1.90 per day is almost eliminated, a laudable achievement. The USD 3.20 poverty rate (in 2011 PPP) is estimated to have declined from 12 percent in 2017 to 11.2 percent in 2018. Hydropower is capital intensive and contributes little to job creation. Overall unemployment is low, but high youth unemployment represents Bhutan’s challenge to create more and better jobs.
Growth is expected to edge up to 7.4 percent in FY2020 on the back of increased hydropower exports from the newly on-boarded Mangdechhu plant. In the medium term, growth is expected to stabilize between 5 and 6 percent, supported by the initiation of new public investment projects under the 12th Five Year Plan and the construction of the Punatsangchhu I and II hydro plants.
Inflation is expected to increase moderately in the near term, following a strong growth outlook in India and firming food and fuel prices. Increased hydropower exports are expected to narrow the current account deficit further, to 10 and 7 percent of GDP in FY2020 and FY2021, respectively.
The fiscal outlook for Bhutan foresees a joint expansion of revenue and expenditure that will temporarily widen the fiscal deficit to 4.9 percent of GDP by FY2021. Revenue growth is expected due to increased hydro revenue from the Mangdechhu power plant and the introduction of a green tax on fuel and a goods and services tax (GST). Expenditure growth in the short-term is expected to outpace revenue growth due to increased investments in non-hydro projects as part of the 12th Five-Year-Plan and public sector wage increases.
Poverty reduction will continue at a modest pace in the near term. The USD 3.20 poverty rate is expected to decline to 9.9 percent in 2019 and 8.7 percent in 2020. Diversification into non-hydropower sectors remains the key challenge to accelerating job creation in non-farm sectors. Maximizing the growth potential of the tourism sector could significantly contribute to jobs and income growth, especially among the rural poor and low-skilled. As poverty is almost exclusively rural, efforts to develop agribusinesses and increase agricultural productivity will need to continue, by investing in the downstream value chain.
Last Updated: Oct 17, 2019