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p. 29 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Central Asia The Pacific III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia : South Asia

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Bhutan

Prudent macroeconomic management over many years has resulted in rapid economic growth and low inflation. Given the potential for growth in power generation, and continued donor support, the medium-term prospects are favorable, though efforts are needed to foster private sector growth and competition, and to broaden the economy to generate much-needed employment opportunities.

Macroeconomic Assessment

Consistent with the trend of recent years, economic activity remained buoyant with an estimated GDP growth of about 7.7% in 2002, higher than the 6.6% recorded in 2001. Strong expansion in the construction and power generation subsectors remained the main drivers of growth. Construction output has grown rapidly since 1996 and now accounts for some 15% of GDP, reflecting the activities related to the phased construction of major hydroelectric projects including Tala (1,040 megawatts), Kurichhu (60 megawatts), and Basochu (62.2 megawatts), as well as other construction works of the private and public sectors. Growth in the agriculture sector, which accounts for about one third of GDP, continued to be moderate at 2.5% in 2002, as the opportunities for expansion were limited by natural circumstances.

The Government maintained a prudent macroeconomic management stance during FY2002 (ended 30 June 2002), and at 3.4% of GDP posted a higher current fiscal surplus than the prior year's 2.6%. The estimated overall fiscal deficit narrowed to 6.8% of GDP in FY2002 from 11.8% in the previous year, and is attributed to lower capital expenditures associated with the phasing in of construction of hydropower stations and other public infrastructure works. The revenue ratio (excluding grants) remained strong at 22.9% of GDP in FY2002, slightly lower than the 23.5% recorded a year earlier, as a decline in nontax revenues (mainly public corporation dividends) limited the impact of a strong increase in tax revenues.

Monetary conditions remained moderate with broad money supply (M2) accelerating to 17.6% growth in FY2002 from 5.5% in the previous year. As in the past, the surplus on the balance of payments and the consequent rise in banking system net foreign assets were the dominant factors of the expansion of M2. However, in a welcome development, lending to the private sector has picked up substantially in the last 2 years after a couple of years of slow growth.

As measured by the CPI, annual inflation moderated to 2.7% in June 2002 from 3.6% a year earlier. Almost all the major components in the CPI basket are goods imported from India, and given the parity link between the ngultrum and the rupee, the low inflation rate prevailing over the border has contributed to price stability at home.

The trade deficit narrowed to 18.3% of GDP from 21.2% in FY2001, reflecting an increase in power exports to India as several major hydropower projects neared completion, and a decline in imports from that country. However, the current account turned from a surplus of 0.2% of GDP in FY2001 to a deficit of 1.7% in FY2002, due in rough equal measure to a fall in current transfers and a substantial decrease in interest income on financial sector assets held abroad. Capital inflows in the form of loans and grants, as in previous years, substantially exceeded the current account deficit in 2002. As a result, Bhutan's foreign exchange reserves, as of end-June 2002, stood at $317 million, equivalent to 20.2 months of merchandise imports, compared with $294 million a year earlier, when they were equivalent to 18 months of merchandise imports. Total external debt amounted to $291.8 million in June 2002, comprising 45% in convertible currencies and 55% in rupee loans. The debt, mostly in the form of official concessional loans, rose to 58.4% of GDP from 52.1% a year earlier. The debt service ratio increased slightly from 4.6% in FY2001 to 5.0% in FY2002.

Policy Developments

With the completion of the Eighth Five-Year Plan (1 July 1997 to 30 June 2002), the Ninth Plan was launched on 1 July 2002 with an emphasis on strengthening infrastructure, improving the quality of social services, and preserving and promoting culture and the environment. A feature of the Ninth Plan distinguishing it from earlier plans is the decentralization program, under which all development plans are to be framed at the local level with local communities determining the plans' priorities and strategies.

As a step toward strengthening institutional capacity, planning, and legal infrastructure, in July 2002 the Government separated the Department of Power into three entities, namely, the Bhutan Power Corporation, the Department of Energy, and the Bhutan Power Authority. The Bhutan Power Corporation, with about 1,200 employees, is now the largest company in Bhutan. The Government has also approved the establishment of industrial estates, and an FDI policy has been adopted. It allows foreigners to own up to 70% of joint-venture companies and specifies a minimum investment of $1 million in manufacturing sector projects and $0.5 million for services sector investments.

The 2003 budget announced various tax incentives aimed at boosting exports and employment. A personal income tax system was implemented in January 2002 as a basis for increasing revenues over the longer term. To strengthen the financial system, new prudential regulations have been introduced, including risk-weighted capital-adequacy requirements, rules specifying the qualifications of directors of financial institutions, and regulations preventing interlocking membership of boards of directors. The trade regime has been strengthened by a rationalization of import tariffs and export duties. Greater emphasis on rural infrastructure and wider coverage of social services form essential elements of the Government's strategy for reducing rural poverty.

Given the low employment elasticity of power, construction, and transport, the labor market's task of absorbing an estimated 70,000 educated young people over the next 5 years is quite challenging and adds urgency to the promotion of private sector activity.

The failure to date of excess liquidity to translate into new lending stems from conservative practices prevalent in the banking sector, coupled with a dearth of investment opportunities. Implementation of planned financial sector reforms would likely increase competition and enhance corporate governance, while externally, expanded existing and planned subregional economic cooperation activities are expected to lead to export diversification and a widening of the economic base.

Outlook for 2003-2004

The Government has maintained a prudent macroeconomic stance resulting in high, noninflationary GDP growth, and the outlook over the medium term appears quite favorable. The Ninth Plan aims to achieve average annual GDP growth of 8.2%, higher than the Eighth Plan's achieved 6.7%. Continued current fiscal surpluses, boosted by higher tax and nontax revenues, would facilitate progressive reduction in the existing heavy reliance on external resources to finance the capital budget.

The country's major power project, Tala, has crossed its halfway mark and is expected to be operational in mid-June 2005, and the Kurichhu and Basochu projects are largely complete. Significant additional power generation will not only boost revenues and exports, but is also expected to create new business opportunities in the country, and benefit rural communities through expansion of rural electrification. Over the medium term, power, construction, and transport are likely to maintain their lead role as the primary drivers of continued high growth.

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