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p. 30 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia People’s Republic of China Southeast Asia South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia : South Asia

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Bhutan

Economic growth momentum remained strong in 2000 and this is likely to continue in 2001 and 2002. However, institutional and human resources will need to be further developed to enhance steps toward good governance.

Recent Trends and Prospects

Initial estimates suggest that GDP expanded by 6.1 percent in 2000, with the industry and services sectors acting as the main engines of growth (see Figure 2.14). Paradoxically, the heavy rains and flooding during August 2000, which resulted in heavy damage to infrastructure and industry, are likely to have significantly boosted construction activity in restoration and rehabilitation.

Growth in the agriculture sector is estimated to have slowed to 2.4 percent in 2000 from 3.0 percent in 1999. Its share of GDP has declined from over half in the early 1980s to roughly a third today. This sectoral shift away from agriculture toward industry and services partly reflects the rise of hydropower in the country in the late 1980s. Initial estimates suggest that growth in the industry sector slowed to 10.3 percent in 2000. The August flooding forced several major industries to suspend their operations for several months. Manufacturing expansion, as a result, is expected to have slowed significantly.

Growth in services accelerated to 5.6 percent in 2000 from 4.5 percent in the previous year. Transport and communications outperformed the services sector average with a growth rate of 11.8 percent in 2000, which was largely attributable to transport needs generated by hydropower construction. The number of tourist arrivals rose to 7,162 in 1999, roughly a 16 percent increase over the previous year’s level.

Given that an estimated 85 percent of the population live in rural areas, agriculture remains by far the largest source of employment, engaging around 75 percent of the employed labor force. Government (public administration and defense), the next largest source of employment, accounted for only 4.7 percent of employees in 1999. The estimated unemployment rate in 1999 was 1.4 percent, and though this seems very low, it is plausible given the overwhelmingly rural population and the predominance of agriculture as a source of employment. Unemployment was higher in urban than in rural areas, and among the young: 15–34-year-olds accounted for 69.1 percent of the unemployed. These figures are particularly worrying given the high rate of population growth, the existing constraints on both agriculture and public sector growth, and the fact that younger people tend to be better educated than their parents. The private sector—the engine of both growth and job creation in most industrial countries—employed a mere 2.9 percent of the workforce in 1999 and its progress remains stunted by a range of structural problems, including a skills mismatch in the labor market.

India is by far Bhutan’s largest trading partner, accounting for 94.4 percent of Bhutan’s exports and 75.1 percent of its imports in 2000. Driven by a revision of the tariff rate on electricity exports to India (exports to India grew by 7.3 percent), overall exports in dollar terms rose by 6.6 percent in 2000 compared with the previous year. Overall growth of imports, however, markedly outstripped that of exports, strengthening by 12.8 percent, mainly due to a surge in imports of materials and equipment for hydropower projects from India (imports from India increased by 18.5 percent).

The trade deficit with India, which deteriorated by 76.4 percent in 2000 to $33.7 million, was a major factor in the increase in the overall trade deficit of 23.5 percent to $73.4 million. Combined with a large amount of aid-related service transfers—again mainly with India—this resulted in a 27.4 percent increase in the current account deficit to $127.0 million in 2000 from $99.7 million in 1999.

Despite registering deficits on both the trade and current accounts, Bhutan managed to increase its gross international reserves by 13.1 percent to $293.0 million (equivalent to 19 months of imports), largely as a result of official capital inflows. Total debt as a proportion of GDP fell slightly from 40.2 percent in 1999 to 39.6 percent in 2000. The stock of external debt (all concessionary official loans), however, increased by 12.2 percent to $176.3 million, reflecting the Government’s continued reliance on external funding for development expenditures. Debt servicing remained manageable, at 5.0 percent of merchandise exports.

Problems with the reliability of savings and investment data for the economy limit analysis to a discussion of broad trends. Changes in the country’s savings and investment patterns are, perhaps unsurprisingly, closely linked to the development of hydropower projects, which underlines the economy’s heavy reliance on that sector. Prior to the commissioning of the first hydropower project in the late 1980s—Chukha, with current generating capacity of 360 megawatts (MW)—gross domestic savings barely met domestic investment requirements. Government expenditures regularly exceeded revenues. With the income from Chukha, however, government revenues rose significantly. The increase in gross fixed capital formation in 1999 was, likewise, driven largely by the surge in construction activity related to hydropower projects. Private savings fell significantly in 1999 as banks introduced new types of consumer loans and borrowers took advantage of them to buy large consumer goods, such as vehicles. As a consequence of greater investment and reduced savings, the savings-investment gap widened markedly in 1999, and given the current data, it would seem that it may have widened further in 2000.

Broad money supply remained at 21.4 percent in 2000, the same rate as in the previous year. Inflation, as measured by the consumer price index, fell from 9.2 percent in 1999 to 3.6 percent in 2000, its lowest ever recorded level. The fall was largely attributable to lower edible-oil prices and to stable rice prices.

Current fiscal expenditures in 2000 exceeded current fiscal revenues, despite a widening of the tax base and improved tax administration. Capital expenditure, however, significantly outstripped grant receipts (the conventional source for this type of spending) and the overall deficit grew to 3.9 percent of GDP, from 1.8 percent in the previous year.

Tax revenue, accounting for more than half of total revenue in 1999, surged by 50.6 percent in 2000, from 8.6 percent of GDP to 11.3 percent. This was largely due to the receipt of arrears on excise duties from the Government of India (for 1996 and 1997) and to the greater contribution of corporate income tax from the Chukha hydropower project following the change to the export power tariff. Nontax revenue rose by 4.5 percent in 2000 compared with 1999, mainly as a result of higher dividend receipts from Chukha. The power sector continues to be the leading source of revenue by far, accounting for 44 percent of the total.

The largest allocation in the initial budget for 2001 was for the social sector (26 percent), followed by energy (13 percent), and communications and agriculture (11 percent each). The effects of August 2000’s flooding will probably, though significantly, change the overall budget and sectoral shares. The floods are likely to have a double impact on government finances, inflicting a heavy expenditure burden due to the costs of flood-related reconstruction, while cutting projected revenues due to the damage done to infrastructure and industry. The budget deficit is, therefore, expected to widen to 5.9 percent of GDP in 2001.

Growth momentum is likely to continue in 2001 and 2002 at about 5–6 percent a year, on the back of construction related to flood reparations and hydropower projects. However, a higher growth rate and significant job creation will require a takeoff in private sector activity. Prudent macroeconomic management is likely to continue, although the economy remains largely dependent on economic events in India.

The electricity and gas subsector is forecast to grow substantially in the near future with the completion in 2001–2002 of two hydropower projects (Kurichu and Basochu). Their combined capacity of about 120 MW will increase the country’s electricity-generating capacity by a third. The Tala hydropower project, with a generating capacity of 1,020 MW, is scheduled to come onstream in 2006 and will make electricity and gas together the largest component of GDP.

Issues in Economic Management

Despite a gradually improving standard of living over the last two decades, some areas of the country face episodic food insecurity, while the nutritional status of women and children needs to be improved. Therefore, enhancing infrastructure is critical to effectively address poverty and disparities that may emerge as a result of development. Necessary institutional and capacity development to produce timely and high-quality data will be essential to properly plan, monitor, and evaluate the impact of development, particularly to target future poverty interventions.

Although the Government is likely to remain reliant on external resources for major development activities over the medium term, it needs to continue exploring modalities for expanding the domestic revenue base. Current preparations for the introduction of personal income tax, user fees for nonessential health services, and appropriate charges for other social services and public utilities will improve fiscal sustainability as well as the efficiency of these sectors.

The pegging of the local currency, the ngultrum, to the Indian rupee and the presence of a large and freely circulating volume of Indian rupees in the economy greatly limit the scope for monetary policy. Consequently, the Royal Monetary Authority of Bhutan has employed conventional instruments of central bank policy mainly to pursue nonmonetary policy goals, such as financial sector development and the setting of prudential norms. Some monetary instruments, such as the cash reserve ratio—introduced for prudential purposes—have proved rather costly to the Authority (e.g., in the case of the cash reserve ratio, through interest payments to commercial banks). Their ineffectiveness as monetary policy tools has led to a reassessment of their value and a consequent move to reduce their use.

Policy and Development Issues

The process of modernization and development is bringing new problems to Bhutan, two of which are urbanization and unemployment. Urban planning has failed to keep up with rapid growth, especially in Thimphu, the capital, and Phuentsholing. As a result, the country now has to contend with unplanned urban expansion and a lack of urban infrastructure. The Government needs to reduce the rate of migration from rural areas by improving village life and to build infrastructure for existing and new urban centers. While urbanization is inevitable, it is important to plan and manage it in a holistic manner in the next five-year development plan, which starts in July 2002.

Recent substantial improvements in access to education have led to greater numbers of graduates entering the labor market every year. The creation of new job opportunities is therefore urgent, but is constrained by the country’s nascent private sector. The Government needs to address the requirements of this weak private sector as well as those of a fragile financial sector. It also needs to maintain its efforts to promote an enabling environment through diversification of job opportunities by offering relevant skills training, encouraging competition, strengthening infrastructure, implementing appropriate fiscal policies, and removing bureaucratic constraints for those starting new enterprises.

Efficiency, transparency, and accountability are the goals of the Government’s ongoing restructuring exercise. The decentralization process will be accelerated with the adoption of information technology and planning based on village clusters in the next five-year plan. However, the necessary institutions and human resources at national, district, and village cluster levels will need to be appropriately developed to ensure sustained benefits of the restructuring and decentralization efforts.

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