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p. 38 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world II. Economic trends and prospects in developing Asia East Asia Southeast Asia South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Central Asia The Pacific III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia : South Asia

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Bhutan

Strong economic growth, due principally to hydropower, is likely to continue in the medium term. While the country remains on track to achieve the Millennium Development Goals, the challenges of economic diversification, employment generation, private sector development, and domestic resource mobilization require continued attention.

Macroeconomic assessment of 2004

In 2004, GDP is estimated to have grown by 7.0%, moderately higher than the 6.5% achieved in 2003. The power and construction subsectors continued to be the main drivers, with the industry sector accounting for essentially all of the pickup in GDP growth. In September, 32 megawatts of additional generating capacity came on line at the Basochu hydroelectric plant. Tourist arrivals grew by about 48% to reach 9,249, a record, with the industry earning $12.5 million, or about 1.6% of GDP. Tourism was boosted during the year by the opening of a luxury hotel while other high-end projects also financed by FDI are under way. Major investments under construction include the 1-gigawatt Tala hydropower project, housing projects, and road network expansion.

Domestic revenues in FY2004 (ended 30 June 2004) were up by 10.7% from the previous year. An increase of 27.4% in nontax receipts offset an 8.1% decline in tax revenues, with the tax-to-GDP ratio declining further to 8.4% in the year. While domestic revenues remained sufficient to cover recurrent expenditures, the financing of most capital spending relies on external assistance. Total expenditures fell by 11.8% from the previous year’s level, due mainly to lower capital expenditures on the Tala hydropower project, which is nearing completion. The combination of much larger inflows of grant assistance--stemming from completion of aid discussions with India--and a reduction in capital expenditures resulted in an overall budget surplus of 4.5% of GDP, a marked contrast to the previous year’s deficit of 10.4%.

During FY2004, broad money (M2) expanded by 4.1%, while net foreign assets of the banking system declined by 6.1%. These developments reflected a marked drawdown in and use of private sector foreign currency deposits held at commercial banks, and were consistent with a surge in imports during the year. Credit to the private sector was buoyant, increasing by 30.0%, while the government budget surplus held total banking system credit expansion to 12.5%. Subsectors most favored for private sector lending are, in order: building and construction, manufacturing, trade and commerce, and services (including tourism). Interest rates declined over FY2004: the 1-year deposit rate subsided from 7% to 6%, while the lending rate decreased from 16-12% to 16-10%. Average inflation in FY2004 was 1.3%; however, this measurement reflects an outdated basket, and a new CPI is being introduced.

Balance-of-payments preliminary estimates for FY2004 show unusually rapid growth in exports (up by 39.7% to $157.6 million) and imports (up by 29.6% to $245.6 million) (Figure 2.15). Robust exports reflected increased sales of power as well as agricultural and manufactured products. The import expansion was due to large imports for the Tala project but also the import of two Airbus A319 aircraft. The current account remained in surplus at $48.9 million (7.1% of GDP) due to a continued large inflow of official transfers. Apart from official aid, the capital account included $3.5 million in FDI for hotel development and the first loan from the International Finance Corporation to the private sector.

At end-FY2004, outstanding external debt was $529.2 million with convertible currency debt at $216 million and the balance in Indian rupees. The debt service ratio was only 4.1%, as most debt is on concessional terms. Gross international reserves increased to $383 million at end-FY2004, providing nearly 19 months of import cover.

Macroeconomic policy developments

Significant policy actions were undertaken in 2004. The Government published a “cover note” to the Ninth Five-Year Plan (July 2002 to June 2007) and together these two documents constitute the Government’s Poverty Reduction Strategy Paper (PRSP). An extensive document, the cover note was prepared by the Government in broad consultation with IMF and the World Bank. In an effort to strengthen the budget process and the management of public expenditures, the Government has introduced a 2-year rolling budget from FY2005. A medium-term expenditure framework has been developed covering the 2 preceding and next 3 financial years.

A lower (food) poverty line and an upper (income) poverty line, using the data of the 2000 Household Income and Expenditure Survey, supplemented by the 2003 Bhutan Living Standards Survey, were established and the findings were used in the PRSP. These estimates show a national poverty incidence of 25.3%--2.9% urban and 29.0% rural--using the lower poverty line, while the upper poverty line shows national poverty at 36.3%--6.4% urban and 41.3% rural. A poverty monitoring and assessment system is being developed.

Outlook for 2005-2007 and medium-term trends

Reflecting the Government’s preliminary medium-term expenditure framework, GDP growth is expected to average about 8.0% annually over FY2005-FY2007. Total budget expenditures as a share of GDP are projected to decline, while a projection of revenues as a share of GDP sees an improvement of 2 percentage points in domestic resource mobilization by FY2007. A 5 percentage point expected decline in external resources (grants and loans), however, points to a moderate projected fiscal financing gap averaging about 2.5% of GDP over the forecast period.

The outlook for economic growth over the medium term appears favorable, despite the continued heavy reliance on only two subsectors--power and construction. The hydropower project at Tala is expected to be commissioned by end-2005. Its export of power to India will eventually decrease the trade deficit and increase government revenues, facilitating the progressive reduction of the existing reliance on external resources. However, given the low employment elasticity of power, the task of fully absorbing the 70,000 people estimated to enter the labor market during the period of the Ninth Plan is challenging, and adds urgency to promoting private activity.

Implementation of planned financial reforms would result in increased competition and enhanced corporate governance. Tourism, which is the major source of hard currency income, has expanded rapidly and, with FDI in luxury hotels and resorts, will materially contribute to private sector development and absorb part of the incoming labor force. Expansion of subregional economic cooperation activities will aid export diversification and expansion of the economic base.

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