Regions and Countries

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p. 3 of 4 BACK | NEXT Executive Summary I. Recent Economic Developments II. Development Challenges III. Risks and Vulnerabilities

Country Economic Review: Bhutan

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II. Development Challenges

25. Poverty Reduction. Using the findings of a pilot survey under the ADB-assisted Household Income and Expenditure Survey (HIES) and the benchmark of a minimum caloric intake of 2,124 calories per person per day, a computed absolute poverty line shows 29% of the population of rural areas and 2.4% of the urban population as poor. Although the Government has not adopted an explicit poverty reduction strategy, it is committed to achieving the Millennium Development Goals (MDGs) by signing a Poverty Partnership Agreement with ADB on 23 October 2001 and by adopting an integrated rural development program comprising, among others, agriculture support services, improved rural access, and targeted food aid programs. During implementation of the NFYP, the Government plans to maintain the pro-poor focus of its development objectives. Toward this end, it plans to further improve the coverage and quality of social services in the rural areas. Decentralization and devolution of development programs are expected to result in improved governance and delivery of social services. To measure progress toward achieving the MDGs, the Government with ADB assistance is strengthening research and diagnostic work and is undertaking the 2003 integrated living standards survey. The survey will provide the first “official” poverty lines for Bhutan. The Planning Commission Secretariat is establishing a poverty monitoring system and is analyzing, on a pilot basis, the impact of rural roads on poverty.

26. Progress Toward MDGs. Available data suggest that Bhutan remains on track in its efforts to achieve the MDGs. Bhutan intends to achieve universal primary education MDG by 2007, about 8 years before the target date. The gross enrollment rate for primary school increased from 67% in 1990 to 72% in 2000. Significant improvements have been achieved for such MDGs as decreased infant and maternal mortality rates, lower child malnutrition, and better access to clean drinking water. While health care coverage is high—90%—the Government plans to improve delivery of health services.

27. External Assistance. Inflows of external assistance in the form of grants and concessional loans are the primary source of financing for capital expenditures. Given growing pressures on global official development assistance, it is possible that the quantum of external assistance available to Bhutan may decline in the future. In the case of any possible shortfall in external assistance, the Government, which regularly reviews the progress in implementing the NFYP, may opt for domestic borrowing to fill the financing gap, or may phase the implementation of some of the development programs to the first 2 years of the Tenth Five-Year Plan.

28. Fiscal Decentralization. Compared with previous plans, decentralization of development expenditures to the districts (dzonkhags) and village clusters (gewogs) is an important hallmark of the NFYP. The DYTS and GYTS have been granted autonomy to make development plans, allocate resources, and make rules and regulations applicable within their jurisdiction. About 25% of the proposed NFYP outlay is earmarked for programs executed by districts and village clusters. It is noteworthy that administrative decentralization has been accompanied by financial decentralization, and detailed financial procedures with appropriate checks and balances have been put in place. These financial procedures form an integral part of the districts and village clusters Development Acts. These Development Acts also specify the level and kind of development activities to be undertaken at those levels, with the balance of activities falling under the realm of federal authorities.

29. Domestic Resource Mobilization. While domestic revenues (tax and nontax) have consistently exceeded current expenditures over the past 5 years, their residual contribution to meeting capital (development) expenditures has varied from a high of 26% in FY1998 to a low of 8% in FY2003, with an overall annual average of 15%. Because domestic resources are inadequate to support the development process, Bhutan relies to a very large extent on external assistance for funding its development programs and initiatives.

30. Finance Sector. The cost of financial intermediation in Bhutan appears high, given the prevailing 4-6% spread between the lending and deposit rates.¹¹ At the same time, the financial system has excess liquidity and the banking system continues to hold some 40% of its assets in noninterest earning deposits with RMA. The high intermediation costs and continued excess liquidity reflect inefficiencies of the banking system,¹² which are further exacerbated by the absence of competition. The high lending rates and collateral requirements, generally around three times the amount of financing being sought, act as effective barriers that deny the private sector access to credit from financial institutions. Fortuitously, the exchange rate policy––which pegs the ngultrum at par with the Indian rupee––and capital controls ensures that excess liquidity does not act as a destabilizing factor for balance of payments, price stability, and monetary policy. RMA has reduced some excess liquidity by issuing RMA bills, but this carries a 3% per annum cost to RMA. To dampen the growth of excess liquidity in the banking system and to encourage the banking system to employ its excess liquidity domestically, RMA recently issued a directive prohibiting the opening of fresh deposits across the border. To reduce additional excess liquidity from the banking system, RMA has raised the cash reserve ratio to 20%. The Government is considering granting greater autonomy to RMA and also strengthen its supervision of financial institutions.

31. Private Sector Development. The NFYP explicitly acknowledges that the private sector will be the engine of growth and the prime source of employment. To facilitate private sector development, some incentives were announced as part of the national budget for FY2002/03. They include tax holidays for (i) 3 years for manufacturing industries; (ii) 3 years for information technology and vocational institutes; (iii) 5 years for hotels, schools, and auto mechanical workshops established in rural areas; and (iv) 7 years for manufacturing industries established in rural areas. To encourage companies to plow back a portion of retained earnings, a reinvestment allowance of 20% will be allowed to incorporated companies. Income earned in convertible currency by manufacturing industries, information technology industry/services, and agricultural produce has been exempted from the corporate income tax and business income tax. The existing export tax on oranges, apples and cardamom exports will be abolished. Private sector representatives have resubmitted to the Government recommendations for boosting private sector activity in the country. They pertain to lowering and rationalizing of the domestic interest rate structure, lowering the existing 300% collateral requirement by commercial banks, enhancing the capacity of the banking system for project appraisal and monitoring, achieving greater coordination among Government ministries and departments, and limited lowering of environmental standards to facilitate the mining of exportable mineral resources such as marble. The Government is cognizant of the concerns of the private sector and has taken a number of steps to improve the enabling environment for private sector development and promotion. At the same time, the private sector also needs to come forward and demonstrate more fully its entrepreneurial abilities.

32. Employment Generation. One of the emerging challenges facing Bhutan is the economy’s ability to provide employment for the expanding labor force. Given the high capital intensity and low employment elasticity of the hydropower sector, the current mainstay of the economy, there is a need to find alternative ways for generating employment. The presence of a large number of skilled foreign workers suggests opportunities in vocational education and training, which can provide skilled employment to part of the emerging labor force. Moreover, innovative solutions, including support for self-employment and public-private partnerships, need to be explored to provide employment. To minimize the pull/push factors of migration toward the two main cities, the Government is giving high priority to an integrated approach comprising public infrastructure development and private sector employment generation in secondary towns.

33. Expansion of the Economic Base. The Bhutanese economy is overly dependent on hydropower,¹³ whose exports account for some 45% of Government revenues. In the near term, the hydropower sector will continue to be the mainstay of the economy. However, given the high capital intensity and low employment elasticity of this sector, the Government is providing incentives for development of other industries and services such as the information technology industry and controlled expansion of tourism and tourism-related services.