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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 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 a stable political and economic environment.  It has made tremendous progress in reducing extreme poverty and promoting gender equality, with continuing efforts to address social inequality issues and regional disparities.

Bhutan’s macro-fiscal stability has remained sound over the past decades. Like other countries around the world, Bhutan’s economy also faced challenges from the protracted COVID-19 pandemic.

Bhutan has been successful in fighting the COVID-19 pandemic, thanks to stringent containment measures and speedy vaccinations with over 90 percent of the eligible population fully vaccinated by August 2021. Cases have remained low; as of September 23, 2021, there have been 2599 confirmed cases, and the number of fatalities has remained at three.

Yet, it came with high economic costs. The border remained closed in FY20/21 (July 2020 to June 2021). Tourism activities did not resume since March 2020, and non-hydro industrial activities were adversely impacted by foreign labor shortages and trade disruptions with India, Bhutan’s largest trading partner. As a result, the unemployment rate rose to 5 percent in 2020, from 2.7 percent in 2019, with the rate of job losses highest in urban areas and among youth.

The Government launched a significant social program (Relief Kidu), the equivalent of a stimulus package, for struggling businesses and individual citizens who lost their job.

COUNTRY CONTEXT

Bhutan’s political environment has been stable and economic conditions had been improving until the advent of the pandemic. 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 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 relations with India, particularly as its major trading partner, source of foreign aid and as a financier and buyer of surplus hydropower. Bhutan is vulnerable to natural disasters and climate-related risks.

Bhutan has become a lower-middle income country. Over the last decade, the government has been able to reduce the number of extremely poor by two-thirds. From 2007 through 2017, the poverty rate dropped from 36 percent to 12 percent, based on the $3.20/day poverty line. Annual real GDP growth has averaged 7.5 percent since the 1980s, fueled by a rapid expansion of the public sector-led hydropower production. Significant hydro rents have helped the country to substantially reduce poverty. 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 contracted by 1.2 percent in FY20/21. Services sector output fell by 3.6 percent, as the tourism industry remained closed. While the hydro sector supported industry sector growth, construction and manufacturing were adversely affected by labor shortages and high input prices. On the demand side, private consumption contracted due to domestic COVID-19 containment measures and lower incomes.

Average inflation increased from 3.0 percent in FY19/20 to 8.2 percent in FY20/21. While food inflation eased to 10.1 percent in June 2021, from a peak of 17.0 percent in February 2021, non-food inflation accelerated in FY20/21, in line with price development in India and higher fuel prices. High food inflation likely eroded the real incomes of many rural poor. This is expected to have led to a slight increase in the $3.20 poverty rate, from 10.3 in FY18/19 to 11.0 percent in FY19/20.

As borders remained closed, the current account deficit has further narrowed to 11.5 percent of GDP in FY20/21, resulting in a smaller trade deficit than in FY19/20. Goods exports (as a share of GDP) remained resilient, supported by an increase in hydro exports from Mangdechhu and trade facilitation measures for non-hydro goods, mainly minerals and metals. Goods imports declined further compared to FY19/20. Gross international reserves increased by 16 percent (y-o-y) to US$1.6 billion in May 2021, equivalent to 15.8 months of goods and services imports.  

The fiscal deficit widened to 8.1 percent of GDP in FY20/21. Total revenues declined sharply because of weak economic activity, despite a one-off increase in hydro profit transfers from the on-streaming of Mangdechhu. Total expenditures increased, driven by an increase in capital expenditures (largely covered by external grants) and COVID-19 relief measures (projections include expenses from the Druk Gyalpo’s Relief Kidu program, which includes temporary income support and a partial interest rate waiver). Public debt stood at 124.7 percent of GDP as of June 2021 (up from 119.9 percent in FY19/20). However, debt sustainability risks are moderate as the bulk of the debt is linked to hydropower project loans from India (to be paid off from future hydro revenues) with low refinancing and exchange rate risks.

ECONOMIC OUTLOOK

The growth rebound in the short to medium term will be constrained by continued COVID-19 related restrictions as well as lower hydro outputs due to maintenance works and further delays in the Puna II hydro project, which will affect hydro exports and government revenues. The economy is expected to gradually recover in FY21/22, with output returning to pre-pandemic levels in real terms. Construction activity is expected to normalize, with improved availability of migrant labor from India and an expansion of public infrastructure projects. Non-hydro exporting industries will be supported by improved external demand from India. With tourism likely to recover gradually, services sector growth is expected to pick up in FY22/23.

Inflation is projected to remain elevated in the short term, in line with price increases in India and higher fuel prices. The current account deficit is expected to remain low relative to pre-COVID levels. Non-hydro exports, which include tourism services, are projected to recover gradually, offsetting the temporary reduction in hydro exports due to maintenance works. Imports are expected to increase from FY21/22 on the back of higher capital imports related to infrastructure and hydro construction.

The fiscal deficit is expected to remain elevated at 6.6 percent in FY21/22. The increase in tax revenues, reflecting the recovery in the non-hydro sectors, will be more than offset by a decline in hydro profit transfers from Mangdechhu. Spending pressures also remain high, as the government plans to frontload capital expenditure during the second half of the 12th Five-Year Plan to support a robust economic recovery. The deficit is expected to narrow from FY22/23 onwards as revenues from the tourism sector recover. Public debt is projected to remain elevated as a share of GDP in FY21/22 due to low economic growth and high fiscal deficits, and to increase further in FY22/23 with an expansion of investments in the power sector.

The $3.20 poverty rate is projected to rise further to 11.6 percent in FY20/21, given continued disruptions in economic activities.

Last Updated: Oct 06, 2021

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