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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 made tremendous progress in reducing extreme poverty and promoting gender equality, with continuing efforts to address social inequality issues and regional disparities.

Like many other countries, Bhutan is still recovering from the Covid-19 pandemic. The economy contracted for two consecutive fiscal years with the non-hydro industry and services sectors being adversely affected by supply chain disruptions, shortages of foreign labor, and the sharp fall in tourism-related activity as the country relaxed its quarantine restrictions only since September 23, 2022. This has had a direct impact on production, livelihoods and worker earnings, all of which contributed to the rise of estimated poverty rate from 8.8 percent in 2020 to 9.4 percent in 2021 based on $3.65/day. The youth unemployment rate, which was already high before the pandemic, doubled from 11.9 percent in 2019 to 20.9 percent in 2021.

Macroeconomic vulnerabilities have increased amid the pandemic and global ramifications of the war in Ukraine. COVID-19 relief measures for individuals and businesses and subdued revenue performance have resulted in high fiscal deficits from FY20/21. Higher global energy and commodity prices are weighing on the balance of payments, with declining international reserves. Labor shortages during the pandemic resulted in delays of 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 government started easing COVID-19 restrictions in the fourth quarter of FY21/22 after successfully managing the health impact of the pandemic and timely vaccinating its population. Bhutan has achieved high vaccination rates (as of mid-September 2022; 87 percent of the population has received two vaccine doses, and 72 percent of its adult total population has received a booster dose); and only 21 COVID-related deaths were recorded as of mid-September 2022 despite a surge in cases due to the Omicron variant in early 2022. The government has reopened tourism activity to international and regional visitors since September 23, 2022.

Country Context

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. Bhutan geographical location makes it vulnerable to natural disasters and climate-related risks.

Bhutan has become 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 the services sector, including tourism. The poverty rate dropped from 27 percent to 9 percent between from 2007 to 2017, based on the $3.65/day poverty threshold. 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 has grown by 4.6 percent in FY21/22 (July 2021 to June 2022), supported by the easing of social distancing and quarantine restrictions in the second half of FY21/22 and high vaccination rates. The industry sector grew by 5.0 percent, supported by a recovery in the construction, manufacturing and mining sectors. The electricity sector contracted due to maintenance at the Tala hydropower plant, resulting in lower hydro exports and revenues. Services sector output increased by 4.6 percent, driven by transport and trade activities. The tourism industry remained largely inactive since the beginning of the Covid-19 Pandemic. On the demand side, public and private investment and private consumption supported growth.

Average inflation moderated from 8.2 percent in FY20/21 to 5.9 percent in FY21/22, driven by a slowdown in food inflation due to favorable base effects and government interventions. However, non-food inflation has accelerated to 7.0 percent, reflecting higher fuel and transport prices. The moderation in prices has led to an increase in consumption and a slight decrease in poverty to 8.7 percent in 2022 based on $3.65/day.

The current account deficit (CAD) has more than doubled to 27.4 percent of GDP in FY21/22. Exports remained subdued (as a share of GDP) due to near-zero tourism-related services exports. Higher non-hydro goods exports, mainly base metals, were offset by a decline in hydro exports. Imports surged with an increase in ICT equipment and capital goods for hydropower projects, as well as higher fuel and food prices. As a result, gross international reserves declined rapidly in FY21/22, reaching US$840 million in June 2022 (a 37 percent decline, y-o-y), equivalent to 7.1 months of imports.  

The fiscal deficit widened further to 8.9 percent of GDP in FY21/22. Total expenditures declined (as a share of GDP) as COVID-19 relief measures (6.5 percent of GDP in FY20/21) have been financed by the King’s Relief Kidu program in FY21/22 outside of the budget. Capital expenditures increased, reflecting continued fiscal support to boost economic activity through accelerated implementation of the Twelfth Five Year Plan (FYP). Total revenues declined even more because of lower hydro revenues and external grants. Public debt declined to 130.9 percent of GDP in FY21/22 due to a decline in hydropower debt.

Economic Outlook

The economy is expected to grow by 4.1 percent in FY22/23. The relaxation of quarantine restrictions in September 2022 is expected to support growth in the industry and services sector. While output is gradually returning to pre-pandemic levels, slower domestic demand recovery due to high inflation and lower hydro investments are expected to decelerate growth in FY22/23. Growth is expected to remain subdued in FY23/24 due to lower public investments in the first year of the Thirteen FYP and delays in several hydropower projects.

Inflation is projected to remain elevated in the short and medium term, owing to continued supply disruptions and higher commodity prices. Poverty rate is expected to decline from 2022 onwards.

The fiscal deficit is expected to decrease slightly owing to fiscal consolidation related to the ongoing civil service reform and the rationalization of recurrent expenditures, although it will remain elevated at 8.2 percent of GDP in FY22/23 due to continued fiscal support through capital expenditures and subdued revenue performance. The deficit would decline to 5.5 percent of GDP in FY23/24 due to lower public investments in the first year of the Thirteen FYP and measures to improve spending efficiency.

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 hydropower project loans from India (to be paid off from future hydro revenues) with low refinancing and exchange rate risks.

Last Updated: Oct 09, 2022

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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