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Overview

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 strategy.

Abundant water resources create ideal conditions for hydropower development which has spurred economic growth with quasi universal access to electricity. Fiscal revenues from hydropower and tourism have helped finance large investments in human capital which led to significant improvements in service delivery, education and health outcomes.

Bhutan’s macroeconomic fundamentals have remained sound. The economy is largely driven by hydropower and tourism, which contributed to rapid economic growth through investments, export earnings, and contributions to the budget. Government commitment to maintaining a stable macroeconomic policy environment is evidenced in the economy’s single-digit inflation rates, continuation of the exchange rate peg, low fiscal deficits and a comfortable level of international reserves. Nevertheless, structural challenges remain, including large current account deficits, high public debt, an underdeveloped private sector, and a high youth unemployment rate. 

Bhutan has a stable political and economic environment.  It has made a tremendous progress in reducing extreme poverty and promoting gender equality, while efforts are still ongoing to address social inequality issues.

World Bank Group (WBG) support is guided by the Country Partnership Strategy (CPS) FY2015-2019 (extended) and the 2017 Performance and Learning Review (PLR).  It focuses on improving Public Financial Management, increasing private sector development and competitiveness to spur green growth.  The WBG completed the Systematic Country Diagnostics (SCD) that uderpins the forthcoming County Partnership Framework (CPF) FY21-25. The CPF is fully aligned with the 12th Five-Year Plan (FYP) of the Royal Government of Bhutan (RGoB).  

COUNTRY CONTEXT

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 strategy 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 the number of extremely poor 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 has been affected significantly by the COVID-19 crisis, with real GDP growth decelerating to 1.5 percent in FY20 (from 3.8 percent in FY19). Even though Bhutan managed to contain the number of domestic COVID-19 cases, the economy was affected through two main channels: a decline in the services sector as tourist arrivals dried-up, and disruptions in industrial activities, reflecting reduced foreign demand, shortages in critical inputs (including foreign labor), and temporary export restrictions.

However, hydropower production and exports increased in FY20 due to the on-streaming of the Mangdechhu project. On the demand side, consumption, public investment, and net exports declined due to domestic containment measures, disruptions in public sector infrastructure projects, and the lockdown in India -Bhutan’s largest trading partner-, which affected supply chains. 

In spite of relatively low growth, headline inflation accelerated to 7.6 percent in July 2020, driven by food prices and reflective of similar trends in India. Asset quality in the financial sector deteriorated further. The Non-Performing Loan (NPL) ratio rose to 17.7 percent in March 2020, up from 10.9 per-cent in December 2019. While this partly reflects seasonal fluctuations in NPL cycles, the sector has been adversely impacted by weak underwriting standards and supervision, and the effect of COVID-19 on businesses and households.   

The growth deceleration drove a reduction in trade activity and a narrowing of the current account deficit. Both exports and imports decreased, in line with weak foreign and domestic demand, and disruptions to trade. Given that imports declined significantly more than exports the current account deficit narrowed to 14 percent of GDP in FY20 (down from 22.5 in FY19). 

The fiscal balance, however, deteriorated, with salary increases and additional COVID-19 related expenditures driving the deficit to 3.1 percent of GDP in FY20. Total spending is estimated to have in-creased by 27.4 percent in FY20. Total revenues also increased, but to a lesser extent, and were driven by a one-off profit transfer from the commissioning of the Mangdechhu hydropower plant. Non-hydro revenues declined with the discontinuation of excise duty refunds from India and lower tourism receipts. With a higher deficit, public debt is projected to have increased, albeit modestly (to 109.1 per-cent of GDP from 104.4 at end FY19).

The poverty headcount, measured at $3.20 per day per person (in 2011 PPP terms), is estimated to have decreased slightly, from 11.5 percent in 2018 to 11 percent in 2019. Services sector workers in urban areas, including many that directly or indirectly depend on tourism, experienced jobs and earnings losses since the COVID-19 outbreak. However, tourism is highly concentrated in just a few districts with very low poverty while almost all of the poor live in rural areas, primarily engaged in subsistence agriculture, and are thus relatively shielded from the economic fallout of the pandemic.

ECONOMIC OUTLOOK

Economic growth is projected to slow markedly, averaging 2.5 percent a year over the medium term, well below the pre-COVID-19 five-year average of 5.5 percent. Tourism is expected to recover only gradually, given that travel restrictions in Bhutan will likely continue until at least early 2021, delaying a rebound in overall services sector growth. The slowdown in India is expected to depress manufacturing and exporting industries, and the construction sector is also likely to experience a protracted slow-down due to a limited pipeline of public sector infrastructure projects. Finally, hydropower production is expected to pick up marginally in FY21, providing limited support to industry sector growth. Inflation will likely remain elevated in the short term because of localized food shortages resulting in higher prices, but a moderation in prices is expected in the medium term. 

Relative to previous years, the current account deficit is expected to remain lower in the medium term mostly on account of subdued imports for public investment and hydropower projects. However, the fiscal deficit is projected to increase to 6.7 percent of GDP in FY21 before gradually decreasing over the medium term. This trend reflects upward pressure on expenditures to implement the COVID-19 recovery package and downward pressures on non-hydro revenues from weak economic activity. 

The pandemic is expected to significantly slow down the pace of poverty reduction. The poverty head-count rate (at $3.20 per day) is projected to remain unchanged at 11 percent in 2020. Unemployment will likely remain high, particularly in tourism related activities, though temporary cash support through the Druk Gyalpo’s Relief Kidu should help mitigate the impact of earnings losses. Reduced de-mand for agricultural products could lower exports and hurt agribusinesses. Elevated food prices could disproportionately impact poor households since not all of their food requirements are met by own production. This could exacerbate high levels of pre-existing malnutrition and should be closely monitored.

Last Updated: Oct 21, 2020

LENDING

Bhutan: Commitments by Fiscal Year (in millions of dollars)*

*Amounts include IBRD and IDA commitments
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Contacts

Tenzin Lhaden
Economist and Operations Officer
Bhutan Development Bank Limited Bldg.
Norzam Lam Chubachu
P.O. Box 244
Thimphu, Bhutan
+975-77-182-111