Countries and Regions

	Table of Contents
p. 1 of 4 BACK | NEXT I. Current Development Trends and Issues II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Assistance Levels

Country Strategy and Program Update 2004-2006: Bhutan

---

I. Current Development Trends and Issues

A. Recent Political and Social Developments

1. Bhutan launched its Ninth Five Year Plan (NFYP) on 1 July 2002. The plan emphasizes the strengthening of infrastructure, improving the quality of social services, ensuring good governance, promoting growth of the private sector, generation of employment, and preservation and promotion of culture and the environment. Compared to the previous plans, decentralization of development expenditures to the dzongkhags (districts) and gewogs (cluster of villages) is an important hallmark of the NFYP. The District Development Committees (DYT) and Block Development Committees (GYT) have been granted autonomy to make development plans, allocate resources, and make rules and regulations applicable within their jurisdictions. About 25% of the proposed NFYP outlay is earmarked for programs executed by the dzongkhags and gewogs.

2. During 2002, effective measures were undertaken to deepen the decentralization process with special emphasis on devolving local development planning, implementation and monitoring. To improve the quality and experience of the GYT leadership, a nation-wide re-election of Gups (leaders of respective GYTs) was held on the basis of universal suffrage, from September to December 2002. Another significant change was the replacement of the leadership of DYT: from a civil servant to an elected representative. Thus, district administrative and development functions were effectively bifurcated to better respond to the development needs of the respective Districts. Through a participatory and consultative process, involving discussions in all 20 DYTs and 201 GYTs, the National assembly revised and enacted the DYT and GYT Acts in 2002, vesting dzongkhags and gewogs with greater administrative and financial powers including the authority to retain and spend rural taxes for local development. The first draft of the written national constitution was completed in December 2002 and submitted to his majesty, the King. The constitution will be presented to DYTs, GYTs and the National Assembly for wider discussion.

3. Bhutan is faced with two problems that have security implications for the country. One is the issue of people in the camps in eastern Nepal. Bilateral discussions towards finding an early and durable solution to the problem are continuing between Bhutan and Nepal. The Joint Verification Team (JVT) appointed by the two governments is currently categorizing the people of one camp for which the field verification work was completed. The 13th Ministerial Joint Committee Meeting held in Thimphu on 25 March 2003 reviewed the progress of work of the JVT and issued further directives to expedite the process. The other issue relates to the presence of armed militant groups from India who have taken shelter in the dense jungles of southern Bhutan. The Royal Government is making efforts to get the militant groups to leave the country peacefully, failing which, the use of military force could be exercised in keeping with the resolution of the National Assembly of Bhutan.

B. Economic Assessment and Outlook

4. Consistent with the trend of recent years, economic activity remained buoyant with an estimated gross domestic product (GDP) growth rate of 7.7% in 2002, higher than the 7.2% recorded in 2001. GDP growth was mainly due to the contribution of the power sector, followed by the construction and transport sectors. The Government maintained a prudent macroeconomic management stance during 2002. Current fiscal balance recorded a surplus of 1.2% of GDP. The estimated overall fiscal deficit narrowed to 4.8% of GDP in 2002, compared to 5.4% in the previous year and 11.1% in 2000.¹ Monetary conditions remained moderate with broad money supply (M2) accelerating to 17.6% in 2002 from 5.5% in the previous year. The surplus on the balance of payments and the consequent rise in banking system net foreign assets were the dominant factors of the expansion of M2. Measured by the consumer price index, the annual inflation rate moderated to 2.7% from 3.6% a year ago.

5. The trade account deficit decreased from 21% of GDP in 2001 to 18% of GDP in 2002 reflecting an increase in power exports to India and a decline in imports from India as some major hydropower projects neared completion. However, the current account turned from a surplus in 2001 to a deficit in 2002 due in equal measure to a fall in current transfers and a substantial decrease on account of lower interest income of financial sector assets held abroad. Capital inflows in the form of loans and grants substantially exceeded the 2002 current account deficit of 0.1% of GDP. Bhutan’s foreign exchange reserves, as of June 2002, stood at $317 million, equivalent to 20 months of merchandise imports compared to $294 million in 2001, equivalent to 16 months of imports. Total external debt increased from 52.1% of GDP in 2001 to 58.4% of GDP in 2002, mostly in the form of official concessional loans. The debt service ratio increased marginally from 4.6% in 2001 to 5.0% in 2002. According to a recent assessment of debt sustainability,² Bhutan’s public debt dynamics appear sustainable under a number of domestic and external shocks. In the baseline scenario, the Government debt-to-GDP ratio is expected to rise rapidly from 58% in 2001/02 to 80% by 2004/05³ on account of external loans from India necessary to complete the Tala Hydropower Project, but would decline to 63% of GDP by 2009/10. These generally favorable debt dynamics reflect a combination of high-expected growth, low average interest costs, and moderate primary deficits. As these parameters are subject to change over time, continuation of the existing prudent fiscal stance would be necessary.

6. The outlook for growth over the medium term appears favorable. The NFYP aims to achieve average annual GDP growth rate of 8.2%, significantly higher than the Eighth Plan (EP) average annual achievement rate of 6.7%. Compared to the EP, the proposed size of the NFYP at Nu.70 billion represents a 75% increase with a resource gap equivalent to 19% of the total plan outlay. Progressive increase of surpluses on the recurrent fiscal account and higher tax revenues would be necessary to progressively reduce the existing total reliance on external resources to finance the capital budget. In the medium term, power, construction and transport sectors are likely to maintain their lead role as the primary drivers of continued high growth. However, given the low employment elasticity of these sectors, the task of absorbing 70,000 educated youth estimated to enter the labor market over the next 5 years is quite challenging and adds urgency to the promotion of private sector activity. Implementation of planned financial sector reforms would result in increasing competition and enhancing corporate governance. Expansion of existing and planned subregional economic cooperation would diversify Bhutan's exports, and broaden its economic base.

C. Implication for Country Strategy and Program

7. The strategic thrust of this Country Strategy and Program Update (CSPU) is fully consistent with the NFYP emphasis on strengthening infrastructure, improving the quality of social services, ensuring good governance, promoting private sector growth, employment generation, and preserving and promoting Bhutan's culture and environment. As detailed in the CSPU, the program is geared to assist the Government in meeting its priority development objectives by continued and follow-on interventions for the development of road infrastructure, rural electrification and promotion of the private sector. These pro-poor interventions are also consistent with Asian Development Bank’s (ADB's) overarching objective of poverty alleviation in its developing member countries.

8. Decentralization of development planning, execution, implementation and monitoring would require capacity building at the local level. Absorption of the rapidly growing pool of educated youths would require a greater role for the private sector in the country’s economic and social development. To stimulate private sector investment and facilitate employment generation, a new program for small and medium enterprise development is included in the three-year assistance program. Greater competition in the financial sector would prove beneficial for private sector growth, employment generation and poverty alleviation. To facilitate deepening and consolidation of financial sector reforms, including development of existing and new bank and non-bank financial institutions and financial instruments, a follow-on financial sector reform program⁴ is included in the CSPU. To open-up additional rural areas, promote development of export-oriented micro enterprises, and provide market access to farmers an integrated rural development project has been included in the CSPU.

Back Country Strategy and Program Update 2004-2006: Bhutan	Next II. Implementation of the Country Strategy and Program