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Country Economic Review - Bhutan : II. Improving Quality of Life for All: The Ninth Plan
C. Medium-Term Prospects, Challenges, and Risks52. Barring major unforeseen disturbances, Bhutan's medium-term prospects are good. For many years, the Government's commitment to economic growth, social equity, environmental preservation, open government, and prudent macroeconomic management has shown its capacity to balance the many potentially disturbing trade-offs associated with development; and its social and economic achievements have demonstrated its ability to deliver sustainable progress in difficult physical circumstances. Other than its tourism sector, its economy is relatively well insulated from the direct effects of global economic disorder, although it would be vulnerable to the effects of major developments in India. In general terms, therefore, there is no reason at the present time to expect Bhutan's socioeconomic trends to falter, and there is no reason to suggest that a real GDP growth rate of 6-7 percent per year over the medium term is not achievable, perhaps comfortably so if hydropower generation and export plans materialize on schedule. 53. The prospects for agriculture at least maintaining recent rates of growth are good, but, with most executing and implementing responsibilities for Ninth Plan initiatives being transferred to the districts and blocks as part of the Government's decentralization drive, much will depend on how this works out in practice. If it works out well, and if headway can be made in the development of domestic and external markets for farm produce, sector performance could well exceed recent growth rates and raise income opportunities for the rural population. For the industry sector as a whole, the prospects for surpassing Eighth Plan performance are relatively good as well, given the likely prospects for electricity and construction growth, although prospects for mining and manufacturing are more uncertain and will depend largely on how well the private sector reacts to growth stimuli. For the services sector, the medium-term prospects are also good, although much will depend on how tourism recovers from its recent downturn. 54. Fiscal policy will almost certainly continue to be managed prudently and conservatively, and the overall budget deficit is planned to be confined to about 3 percent of GDP during the Ninth Plan period. This is attainable, although, for reasons outlined in paras. 56-60, the deficit could come under strain and would come under strain if plans to mobilize domestic revenues were delayed or not fully successful. Monetary conditions seem likely to remain more or less unchanged, although excess liquidity could fall if private sector growth accelerates to surpass its recent sluggish performance. Inflation will continue to reflect Indian more closely than domestic conditions and seems likely to remain moderate. 55. Despite generally good prospects, however, the Government cannot be complacent, because there are several risks that could stem from either external or internal forces. 1. External Risks56. Bhutan has been, and remains, heavily reliant on foreign sources for financial resources. While there is nothing at present to indicate that there will be a decline in these inflows, the Ninth Plan's execution and Bhutan's wider medium-term prospects are to a greater or lesser degree dependent on whether there will be any decline in foreign financing or any hardening of its terms, and on whether Bhutanese exports of electricity to India continue to increase. 57. India is by far Bhutan's largest source of external funds and its only electricity export market. In the Ninth Plan, assistance from the Government of India is projected to remain a substantial portion of the total external resources. Should this level of assistance not materialize due to various reasons, implementation of the Ninth Plan may be seriously affected, although the Government of Bhutan could also mobilize additional resources from other sources and/or from its own internal resources to make up any resource gap. Depending on the timing, nature, and extent of any shortfall, it could potentially disturb proposed sector investments, lead to slower growth, and delay poverty reduction programs. 58. No particular problems are foreseen with respect to electricity exports to India. Bhutan supplies less than 0.5 percent of India's electricity demand which, when also considered in terms of India's own power supply shortages, augurs well for a continuation in Indian demand for Bhutanese electricity. Pricing issues have been resolved amicably in the past, and there is no reason to expect anything but a continuation of the same. However, Bhutan's power exports earn nonconvertible currency and, as the grace periods on convertible currency debt expire, loan repayments could begin to exert increasing pressure on convertible currency inflows. 59. In the case of the assistance programs of other external funding sources, whether bilateral or multilateral, the political and/or fiscal implications of the current war on terror may lead to fewer resources being available for foreign assistance and, in particular, for grant or concessional assistance. Already difficulties are being faced by multilateral organizations in their own access to grant resources and concessional loan resources, which has often led to reduced loan and TA programs for their member countries. These difficulties could well become aggravated if heightened global security concerns begin to utilize resources that would otherwise have flowed to multilateral organizations and/or increased support to directly affected countries. If so, this would also likely affect the bilateral agencies' own programs in the respective countries. Moreover, given the high level of Bhutan's exchange reserves, it could conceivably cause some agencies to reallocate a part of their resources to other countries. In Bhutan's case, therefore, in spite of its reputation for using foreign aid resources effectively, and despite aid commitments to future assistance programs, it could find itself in the position of having to accept lower inflows of foreign assistance, or inflows on harder terms - possibly through the blending of grants (or concessional loans) with nonconcessional loans. This could either have a harmful effect on the outcome of the Ninth Plan or could raise external debt. 60. Bhutan's present debt situation is quite manageable and well within its means to sustain. But the level of external public debt is already scheduled to rise over the medium term with a greater recourse to loans than before to finance its hydropower development, and with commercial debt likely to be incurred to finance a new airplane for Druk Air. While these higher levels of debt in no way raise alarm signals, the situation could be exacerbated by falling grant and/or concessional inflows and the unforeseen need to replace these with other foreign or domestic financing sources that would be available only on harder terms. Moreover, it should also be recalled that the domestic financing of capital expenditure has risen over the past 3-4 years and has led to a withdrawal in government deposits and to the reemergence of domestic debt in Bhutan. Again, this is manageable if it is not allowed to rise, and it could well be relatively short-lived anyway, but it might serve to limit financial maneuverability in the event of any abrupt and/or unexpected shortfall in the traditional sources of external financing. 61. However, it should be stressed that, with Bhutan's reputation for fiscal prudence, these risks should be seen as speculative possibilities rather than as likely eventualities. But they are risks nevertheless. Moreover, were they to occur in some form, they could have an impact on domestic sector developments even if they were prevented from becoming major fiscal issues by sound fiscal management. To provide an added cushion against this possibility, therefore, it would seem prudent for the Government to hasten rather than delay its plans for domestic revenue mobilization and user fee collection. 2. Domestic Risks62. The Ninth Plan is well conceived in terms of its strategic objectives, and it contains some perceptive proposals to tackle the pervasive structural and human impediments to Bhutanese development. However, for whatever reason, there is always the chance that its objectives will not be met in full and that its sector strategies will not generate the results expected. Moreover, the risks of failure or of underperformance - growing unemployment and discontent - are more real than those potentially stemming from external forces. 63. Thus far, the Government has been successful in securing GDP growth and in raising the living standards of its people, but, as a price of this success, it has raised expectations and aspirations and it has generated a conviction that continued progress is assured. But progress is beginning to assume an additional dimension for an increasing proportion of the population, namely that income and job opportunities will rise commensurately with GDP growth and that they will match the progress achieved in health and education. For the Ninth Plan period, whether this transpires will in large measure depend on the performance of the private sector and on how it responds to the stimuli being proposed by the Government for the medium term. Results are inevitably more uncertain. 64. In the past, the Government has transferred to the private sector the management and majority ownership of seven public sector enterprises, it has privatized bus companies, it has corporatized the postal services and telecommunications, and it has abolished the monopoly of the state over petroleum distribution. However, as noted earlier, further advances during the Eighth Plan have largely been limited to divestment and the outsourcing of public works contracts. There has also been the diversification of agricultural production towards the cultivation and export of cash crops, and a growth in private domestic trade and transportation, and it is to be hoped that similar forms of small-scale private initiatives will be encouraged by the attention being given in the Ninth Plan to extending rural infrastructure. The prospects for this do seem to be reasonably good, as do prospects for rising employment in the tourism sector, but the prospects for job creation in what might be called the nontourism formal sector seem more uncertain, especially in terms of job creation in the urban areas. This would require growth in manufacturing, processing, artisan trades, and the service industry, but it is in precisely these areas that growth has been sluggish over recent years. In turn, it would require an increase in private investment, especially among small and medium enterprises, but it is also in these areas that a reluctance to establish new businesses continues to be evident. 65. To complement the initiatives being taken by the Government to address the structural impediments to private sector development (power, communications, roads, industrial estates, etc.) as a means of reducing costs and improving competitiveness, and in parallel to the efforts being made to upgrade technical, business, and commercial skills, it would now seem essential for RMA to further accelerate its attempts to strengthen the banking system and credit appraisal skills in particular. A more aggressive, proactive attitude with respect to fostering growth in bank lending for business rather than consumption purposes needs to be encouraged because, without it, the potential offered by planned government initiatives elsewhere may not be realized. A study of private sector needs is currently being undertaken with the assistance of the World Bank/Foreign Investment Advisory Service, which should help to place the various financial and institutional requirements in context. Job creation and, by implication, private sector development, are the Government's most pressing medium-term challenges.
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