Regions and Countries

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p. 6 of 13 BACK | NEXT Map Executive Summary I. Overall Performance During Eighth Plan Period A. Growth, Employment, Savings, and Investment B. Fiscal Developments C. Monetary Developments and Prices D. Balance of Payments and External Debt E. Human and Social Development II. Improving Quality of Life for All: The Ninth Plan Appendix

Country Economic Review - Bhutan : I. Overall Performance During Eighth Plan Period

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C. Monetary Developments and Prices

18. Given the existence of the exchange rate peg with the Indian rupee, there is limited scope for the exercise of monetary policy in Bhutan. The rate of growth in broad money supply (M2), which accelerated during the Seventh Plan period as a result of the net inflow of foreign assets derived mainly from external assistance, has slowed during the Eighth Plan period due to the deceleration that has occurred in net foreign asset inflows (Table 3).

19. However, in terms of monetary policy, the key issue continues to be the high level of excess reserves (liquidity) of the banking system, a situation that has persisted for many years. The Royal Monetary Authority (RMA) maintains that this is essentially the result of a lack of domestic investment opportunities stemming largely from the inherent weaknesses of the private sector. These reduce the potential private sector demand for bank loans (credit) that could otherwise be expected to absorb the high levels of liquidity emanating from large balance of payments surpluses. While these weaknesses are the result of the many mutually reinforcing impediments that continue to stifle private investment initiatives, as noted earlier, these tend to be exacerbated by the limitations of the banking system itself. Even though interest rates have been liberalized in recent years, there is still a lack of competition for business between banks and little evidence of their pursuing proactive policies to encourage bank lending for private investment purposes. Much of what bank lending there is tends to finance the import of cars and the construction or refurbishment of private houses, while the banks' general lending attitude tends to be conservative and based largely on the provision of physical collateral. Moreover, it is also partly colored by nonperforming loans that have been inherited.

20. The overall situation with respect to strengthening the domestic banking system is being addressed, and it has received assistance from both the Asian Development Bank (ADB) and the International Monetary Fund (IMF). In the meantime, some part of the excess liquidity of the banks will have been absorbed by the recent flotation of Treasury Bills to finance part of the capital expenditure of the Government, and will be further absorbed by the purchase of one of two new airplanes planned by Druk Air. Notwithstanding these actions, which are likely to be only temporary, a longer term solution to excess liquidity has to be found because, as noted above, it does aggravate the difficulties of private sector growth even if it is not the sole cause of those difficulties. RMA sees these financial issues to be as much an effect of limited private development as a cause, but it is still a contributory cause.

21. Inflation in Bhutan has traditionally run in parallel with inflationary trends in India, as a result of the overwhelming importance of India as a trading partner, the porous nature of the border with India, and the existence of the ngultrum-rupee peg. For many years, inflation in Bhutan has been in the range of 7-10 percent annually, albeit slightly higher during 1990-1995, but this annual rate fell substantially in FY2000 and FY2001 to 3.6 percent, largely as a result of reductions in some critical food prices and the importance of food in the price index.

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