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Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : South Asia
Bhutan Prudent policies, strong support from development partners, and rising export earnings from exploitation of the country’s vast hydropower resources have steadily raised incomes and social indicators. The outlook for continued development is bright, though reducing heavy dependence on grants and concessional loans at the same time as creating employment opportunities for new school graduates by promotion of greater private sector activity remain important challenges. Economic Assessment In 2003, Bhutan registered estimated GDP growth of 6.5%, slightly lower than the 6.7% achieved in 2002. All sectors of the economy recorded faster expansion than in the previous year except electricity production and construction, which together account for about one quarter of the economy. No new electricity production capacity was added during the year, and construction growth slowed to 9.8% from 25.0% in 2002. Nevertheless, projects under way indicate that these two sectors will continue, as in previous years, to be the main drivers of the economy. Major ongoing investments include the country’s main hydropower project in Tala, a low-income housing project in Thimphu, and the Thimphu expressway. The 2001 National Labor Force Survey estimated labor force participation at 56.5% and open unemployment at only 1.9%. The unemployment rate is estimated at 4.1% in urban areas (5.3% for females and 3.0% for males) and 0.6% in rural areas. About 50,000 school graduates and 19,000 migrants from rural to urban areas are expected to enter the labor market in the Ninth Five-Year Plan (NFYP) period (1 July 2002 to 30 June 2007). To absorb this relatively large inflow, the Government is pursuing measures to expand private sector employment opportunities. In FY2003 (ended 30 June 2003), the Government continued to exercise prudent fiscal management by maintaining the policy of covering all current expenditures by domestic revenues. However, larger than budgeted expenditures and lower than planned grant receipts led to a doubling of the fiscal deficit to 10.0% of GDP (Figure 2.15). The larger deficit was financed by external borrowings from development partners, advances from commercial banks, and issuance of securities. Inflation fell to 1.8% in the year to June 2003, from 2.7% the previous year, due to continued price declines in nonfood items. However, the CPI, which is under revision, may not be fully representative of price changes as it is based on an outdated basket and excludes services. Broad money supply (M2) grew by 29.7% in FY2003, mainly reflecting a rise in net foreign assets. Despite an increase in credit to the private sector, excess liquidity persisted with banks still holding some 48% of their deposits as reserves with the Royal Monetary Authority. Provisional balance-of-payments estimates for FY2003 show a marked improvement in the current account balance to a $61.3 million surplus (10.6% of GDP) from a $6.2 million deficit (1.2%) a year earlier. While the traditionally large trade deficit posted a small reduction, the current account turnaround resulted mainly from an increase in net transfers, in turn generated by large inflows of nonbudgetary grants from India for major power projects and greater official convertible currency grants. The financial account surplus widened as FDI in the tourism and hotel industry picked up, though larger concessional aid was the main factor. As of end-June 2003, total foreign reserves amounted to $374 million (nearly 80% in convertible currency and the balance in Indian rupees), providing import cover of almost 24 months. Also at that time, total external debt stood at $405.5 million, equivalent to 71.0% of GDP (44% in convertible currency loans and the balance in Indian rupee loans). Since all outstanding debt is on concessional terms, the debt service ratio in FY2003 was only 4.9%. Policy Developments Bilateral negotiations with India, which were concluded in 2003, confirmed that substantial grant resources would continue in the first 3 years of the NFYP. The FY2004 budget targets a reduced deficit of 4.2% of GDP to be financed primarily by grants. Domestic revenues are expected to strengthen marginally by about 2%. No new tax measures were taken so as not to stifle private sector development. Moreover, revenues from personal income tax (introduced in 2002 to enhance the domestic revenue base) are expected to decline because of likely tax rate cuts. On the expenditure side, a modest increase of around 3% is projected for both current and capital expenditures. Managing excess liquidity to promote growth remains a key financial challenge because of conservative bank lending practices and a dearth of investment opportunities. Implementation of planned financial sector reforms will likely result in increased competition and enhanced corporate governance. In July 2003, the National Pension and Provident Fund reduced housing loan rates from 13% to 10% in order to foster construction of new housing, which is in short supply in urban areas. In view of the strong external position, the one-to-one peg of the ngultrum to the Indian rupee has worked well and has not constrained private credit expansion. NFYP anticipates average annual GDP growth of 8.2%. NFYP emphasizes infrastructure expansion, sound macroeconomic policy, good governance, devolution of authority to localities, and improvement of access to social services. Outlook for 2004-2005 The outlook for the economy over the medium term is favorable. The scheduled delivery to Druk Air of two Airbus A319 aircraft in late 2004 and ventures by foreign investors to build luxury resorts will buoy tourism, though the electricity and construction sectors are expected to maintain their lead role as the primary engines of high growth. GDP is forecast to strengthen to 7.0% in 2004 and to 8.0% in 2005. The major Tala hydropower project, with 1,020 megawatts capacity, is expected to be commissioned by the end of September 2005. Larger power exports to India will eventually narrow the trade deficit and lift government revenues, facilitating a progressive reduction in the present total reliance on external resources to finance capital expenditures. Expansion of existing and planned subregional economic cooperation activities is expected to lead to export diversification and an expansion of Bhutan’s economic base.
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