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Executive SummaryBhutan's Eighth Five-Year Plan is scheduled to end on 30 June 2002 and the Ninth Plan to begin on 1 July 2002. Real gross domestic product (GDP) is estimated to have grown at 6.7 percent per year during the Eighth Plan period, equal to the target and representing an impressive performance. Sector performance, however, has been mixed. Agriculture has grown at 4.3 percent per year, led mainly by forestry and livestock, with cash crop production relatively slow moving. The industry sector has grown at 7.1 percent a year, below the Plan target, especially the mining and manufacturing subsectors; but it has been buoyed by the performance of construction and, to a lesser extent, by electricity generation. With the Kurichu (60 megawatts [MW]) and Basochu (22 MW) hydropower plants coming on stream in the next few months, and the Tala plant (1,021 MW) scheduled possibly for 2006, hydropower development (with related electricity exports to India) has become the main engine of Bhutanese growth. The contribution of the services sector, which has grown at about 8 percent a year during the Eighth Plan, has been erratic, but has been underpinned by growth in transport and communications on the one hand, and in tourism on the other, although the latter has been somewhat depressed in recent months by the slowdown in the world economy. The Government has traditionally pursued a prudent fiscal policy, one that is guided by conservative financing principles, notably that domestic revenues should at least cover current expenditures, and that capital expenditure should be preferably financed from grants and, only after these, by concessional loans. The first of these principles prevailed during the first four years of the Eighth Plan, although during the current fiscal year it is possible that a small deficit could arise. However, if current expenditures fall short of those budgeted, which they might, this need not arise. A more significant trend has been the recourse to the domestic financing of capital expenditure. This has been the result of accelerated capital investment. It has been financed by the rundown of government deposits with the banking system and by the open market sale of Nu500 million of Treasury Bills. The existence of the exchange rate peg with the Indian rupee means that there is limited scope for monetary policy in Bhutan. However, the key monetary policy issue continues to be the high level of excess liquidity in the banking system. This is essentially the result of a lack of domestic investment opportunities stemming from the inherent weaknesses of the private sector, which reduce the private sector demand for bank credit that could otherwise be expected to absorb the high levels of liquidity emanating from large balance of payments surpluses. Nevertheless, these factors are also exacerbated by the limitations of the banking system. Even though interest rates have been liberalized, there is still a lack of competition between the banks for business, and little evidence of their pursuing proactive policies to encourage bank lending for private investment purposes. During the Eighth Plan period, Bhutan's merchandise exports have declined somewhat in proportion to GDP, although they have increased in dollar terms, and imports have increased slightly in proportionate terms and significantly in nominal terms. The trade and current account deficits have each increased in both proportionate and nominal terms, as have the deficits with India, considered separately, but capital inflows, mostly in the form of grants, have continued to exceed by some margin the deficits in trade and current account. The net effect of these trends has boosted Bhutan's foreign exchange reserves significantly over time. By the end of FY2001, they were sufficient to finance over 16 months of merchandise imports at the FY2001 level. Total public external debt has risen significantly during the Eighth Plan period and currently represents slightly more than 50 percent of GDP. However, convertible currency debt - all of it concessional - has declined as a proportion of GDP but has risen nominally (especially to the Asian Development Bank), but nonconvertible currency debt has risen sharply both nominally and proportionately, largely in response to the loans from India in connection with the new hydropower projects. There is no commercial debt at present, although this is likely to change when Druk Air renews its fleet. The debt service ratio, which has always been manageable, has actually declined during the Eighth Plan period; it stood at 5.6-5.7 percent of merchandise exports in FY2000 and FY 2001. Perhaps the most impressive achievements of the Government over the past 15-20 years have been the improvements in social indicators, albeit starting from the very poor levels of the 1980s. The long-standing commitment of the Government to improve the human condition is an important feature of Bhutan's development process. In the case of health indicators, for example, life expectancy rose from 35 years in 1961 to about 66 years in 1998. Similarly, between the mid-1980s and 2000, the infant mortality rate was reduced from 142 to 61 per 1,000 live births and the maternal mortality rate from 7.7 to 2.6 per 1,000 live births, while the under-5 mortality rate fell from 162 to 84 per 1,000 live births. Considerable progress has also been made in the field of education over the past 20 or more years. Considering that fewer than 450 children in the whole country attended secular primary schools in the late 1950s, and that the country then had no secondary schools, educational achievements have been impressive. The primary school enrollment ratio had reached 72 percent by 2000 - up from 25 percent as recently as 1990 - which suggests that a 95 percent ratio could be reached in 2002 and universal primary enrollment soon after that. Girls now comprise 46 percent of primary school children. Despite the many improvements and the rise in adult literacy to 54 percent in 1996, the adult literacy rate is only 28 percent for women, and particularly low - even down to 10 percent - in the more remote rural areas. Unfortunately, however, impressive GDP growth has not led to a commensurate growth in jobs. Private sector performance has been mixed. On the one hand, companies in the tourism business have performed well; several examples of outsourcing (especially public works) and corporatization have taken place; and many farmers, traders, tour operators, and transport firms have reacted positively to the improved marketing opportunities afforded by improved road access and, in many areas, by electrification. On the other hand, many of the key growth subsectors remain capital intensive, and none of the state-owned companies set for possible privatization during the Eighth Plan period have been privatized, although significant divestment of ownership among certain state enterprises has occurred in these years. As such, therefore, promoting private sector growth to absorb the growing number of young people whose better access to education has raised their social aspirations is, perhaps, the Government's major medium-term challenge. Although it is not yet finalized or published, indications are that the Ninth Plan is well conceived in terms of its strategic objectives, and that it contains some perceptive proposals to tackle the pervasive structural and human impediments to Bhutanese development. Its main objective is to raise living standards, particularly among the rural population, who have often been left behind in the process of development. It has two strategic foci. The first focus is to expand the rural road network and rural electrification. By expanding the rural road network, the Government hopes to reduce isolation, expand access to essential services, develop markets, moderate the fragmentation of the domestic market, widen personal choice and opportunities, promote the transfer of technology, and lessen vulnerability. Second, by expanding rural electrification, the Government hopes to raise rural productivity and stimulate the expansion of processing and off-farm employment opportunities in general. Importantly, it also hopes to reduce the use of fuelwood and kerosene for domestic heating and lighting, thereby lessening the incidence of associated respiratory infections, relieving some of the burden of housework and wood-gathering for women and girls, and facilitating home study for school pupils and others. The second focus is the strengthened emphasis to be placed on upgrading the quality of health and education facilities. This does not mean that efforts to extend the network of schools, clinics, etc. into currently deprived areas will be overlooked, but simply that a greater effort will be made to improve the quality and relevance of health care and teaching. Implicitly if not explicitly, moreover, government efforts to stimulate private sector activity appear more closely integrated into the overall thrust of the Ninth Plan than with previous plans. This is suggested, first, by the strategy to improve rural infrastructure and to stimulate the small-scale private initiatives of rural people. Given that such a high proportion of the country's population is self-employed and rural, these could collectively become a potent force in private sector development generally. Second, it is also suggested by the Government's intention to improve the quality of public services, notably to strengthen technical and vocational education at the district level; to expand agricultural extension activities; to raise labor productivity; and to continue to address the shortage of business, commercial, and technical skills at higher levels. Bhutan's medium-term prospects are good, 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. Similarly, the prospects for agriculture at least maintaining recent rates of growth are also good, but, with most implementing responsibilities for Ninth Plan initiatives being transferred to the districts and blocks as part of the decentralization drive, much will depend on how this works out in practice. For the industry sector, the prospects for surpassing Eighth Plan performance are relatively good, 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 they will depend on how much a revival in the global economy improves tourism. Fiscal policy will almost certainly continue to be managed prudently, and the overall budget deficit is planned to be confined to about 3 percent of GDP during the Ninth Plan period. This is attainable, but, if external financing falters, the deficit could come under strain. Monetary conditions are likely to remain unchanged, although excess liquidity could fall if private credit demand rises and private sector growth surpasses its recent sluggish performance. Despite generally good medium-term prospects, however, the Government cannot be complacent, because there are risks that could arise from both external and internal forces. First, it is possible that India's own fiscal situation may not permit it to be as generous with its grant aid as expected, and it may not be able to provide the level of loans for hydropower that is currently being contemplated. Similarly, if the current war on terror begins to use funds that would otherwise have flowed to multilateral organizations and to bilateral aid programs, funds from these sources may fall. Given the importance of external finance, a decline could reduce both Ninth Plan performance and the Government's financial maneuverability. Of more significance, perhaps, are the risks of not achieving rising living standards and adequate job creation. These could lead to growing open unemployment and dissatisfaction, with all the uncertainties to which these might lead.
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