## _cr11123 — Section 2(a)

## Source details

**Canonical URL:** [_cr11123 — Section 2(a)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11123.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11123.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11123.pdf.json)

---

### Executive summary and key policy messages
- Bhutan’s rapid growth has been underpinned by hydropower sector development with donor support and strong ties with India.
- Since 2008/09 the fiscal position deteriorated because of higher spending and sluggish revenue, and inflation has risen.
- Medium-term outlook remains favorable provided near-term challenges are addressed and structural reforms implemented.
- Policy recommendations:
  - Tighten fiscal policy in the near term by controlling current spending; the current balance should remain in surplus to limit domestic financing.
  - Broaden the revenue base and improve public financial management by adopting a multi-year rolling budget to help ensure debt sustainability.
  - Improve monetary operations and liquidity management; align the policy rate better with India’s money market rates and more actively manage convertible currency reserves to address rupee shortages.
  - Strengthen regulatory and supervision capacity of the Royal Monetary Authority (RMA) to safeguard financial stability amid rapid credit growth.
  - Advance structural reforms to facilitate private sector investment and boost competitiveness, as envisaged in the authorities’ new Economic Development Policy (EDP).

### Macroeconomic developments, outlook, and risks
- Recent developments:
  - Growth accelerated to an estimated 7.5 percent in 2009/10.
  - Inflation doubled to 9 percent at end-2010 from the year before.
  - Current account deficit increased to about 13 percent of GDP due to hydropower-related imports.
  - Overall balance of payments remained in surplus due to sizable grants and loans disbursements; reserve position remained comfortable.
  - Real effective exchange rate stable and close to its ten-year average.
- Outlook:
  - Near term: Growth expected to remain at around 8 percent.
  - Inflation expected to decline while remaining somewhat elevated (at around 6 percent), in line with India.
  - Medium term: Growth projected to remain robust at 8–9 percent over the remainder of the 10th FYP (2011–13).
  - Current account deficit expected to widen as construction of Puna and other hydropower projects picks up; financing from India and development partners projected to remain adequate.
- Risks:
  - Near-term risk: rapid credit growth and overheating could increase vulnerabilities.
  - Medium-term risks: failure to implement key structural reforms; aid inflows—particularly current grants—are expected to decline.
  - Aid projection: Current grants in the form of budgetary support are projected to decline by 7 percentage points to about 10 percent of GDP over the next couple of years; capital transfers tied to hydropower projects envisaged to remain high.

### Hydropower sector: contribution, pipeline, and fiscal linkages
- Sector importance and capacity:
  - Hydropower sector constitutes around 20 percent of Bhutan’s economy.
  - Bhutan currently harnesses a little over 1,480 MW of hydropower electricity, about 5 percent of its estimated potential.
  - Government aims for total installed capacity of 10,000 MW by 2020.
  - Growth in electricity production and related construction accounts for about one third of GDP growth.
- Selected pipeline projects (as reported):
  - Puna-I: Capacity 1,200 MW, Construction Schedule 2008-2015, Development Model IG 1/
  - Puna-II: Capacity 990 MW, Construction Schedule 2010-2016, Development Model IG
  - Mangdechhu: Capacity 720 MW, Construction Schedule 2010-2016, Development Model IG
  - Sankosh Storage: Capacity 4,060 MW, Construction Schedule 2011-2020, Development Model IG
  - Kuri-Gongri: Capacity 1,800 MW, Construction Schedule 2012-2019, Development Model IG
  - Source: Royal Monetary Authority of Bhutan Annual Report 2009/10; 1/ Inter-governmental undertakings with the Government of India; 2/ Joint venture undertakings with Indian public sector companies.
- Exports and fiscal linkages:
  - Domestic consumption accounts for only about 20 percent of electricity generation.
  - Hydropower exports to India account for almost 40 percent of Bhutan’s total goods exports in 2009/10, or about 15 percent of GDP.
  - Hydropower projects financed by Government of India through loans and grants; four future projects to be joint ventures with Indian public sector companies with debt-to-equity ratio of 70:30 and Indian partner allowed 51 percent equity.
  - Hydropower earnings (corporate income tax and transfers of dividends) accounted for 23 percent of total revenue in 2009/10.
  - Hydro-related revenue as a share of GDP projected to decline until new projects come on stream because electricity export price is fixed and construction is tax-exempt.
- Seasonality and fiscal management:
  - Hydropower revenue subject to strong seasonality; more than 50 percent of annual revenue generated in the third quarter.
  - Seasonal low-water months (January–March) create domestic power shortages and require expensive electricity imports from India.
  - Public debt from hydropower projects accounts for about half of total debt, which currently stands at around 80 percent of GDP and is projected to exceed 110 percent in 2014/15.

### Dealing with revenue volatility
- Revenue volatility drivers and magnitudes:
  - Nontax revenue rose from 8.5 percent of GDP in 2005/06 to 17.9 percent in 2008/09 when the Tala project came on stream, then declined to 10 percent in 2009/10 when Tala became a corporation and revenue appeared as corporate tax and dividends.
  - Electricity’s share in aggregate revenue estimated to average 27 percent during the 10th FYP period (2008/09–2012/13).
  - Grants amount to 37 percent of total revenue, with 80 percent of them tied to specific projects.
  - Sales tax was 1.5 percent of GDP in 2008/09.
  - Only new power sector project expected to come on stream during the 10th Plan is the Dagachu project (114 MW).
- Policy options recommended:
  - Introduce a medium-term fiscal framework and consider a smoothing mechanism requiring surpluses in good times to offset declines in hydro-related revenue.
  - Develop a cash management system and note that introduction of T-bills in 2009 is a positive step.
  - Increase non-hydropower sector revenue (options include replacing sales tax with a broader-based VAT and unifying business income tax and personal income tax).
  - Strengthen Public Financial Management to avoid "resource curse" outcomes.

### Fiscal position, projections, and staff fiscal advice
- Recent and near-term fiscal figures:
  - Current balance declined to an estimated surplus of 4 percent of GDP in 2009/10 and is anticipated to fall further to 2 percent of GDP in 2010/11.
  - Overall balance is estimated at about 2½ percent of GDP in 2009/10 and is expected to drop sharply to minus 4.5 percent of GDP in 2010/11.
  - Deterioration reflects: (i) decline in non-tax revenue; (ii) sluggishness in tax revenue; (iii) higher current spending following a 35 percent hike in civil servant wages in January 2009 and 20 percent in early 2011; (iv) an increase in capital spending.
- Staff near-term advice:
  - Fiscal policy should be tightened by cutting non-priority current spending and saving any revenue overperformance.
  - A fiscal tightening of about 2 percent of GDP (combined) in 2011 and 2012 would be desirable.
  - Introduce a nominal ceiling on current spending (excluding interest) and implement escape clauses for tail risks.
  - Improve tax administration; broaden the revenue base (including consideration of VAT) and implement multi-year rolling budgets with three-year rolling ceilings on current spending.
- Medium-term projection:
  - Buoyancy of non-hydropower tax revenue and planned decline in spending projected to reduce the non-hydropower deficit from 10 percent of GDP to 6 percent of GDP.
- Authorities’ views:
  - Authorities view fiscal policy as generally prudent but concur current settings pose challenges; receptive to a nominal current spending ceiling but stressed it would not substitute for more revenue.

### Public debt and debt sustainability (DSA highlights)
- Public debt dynamics:
  - Public debt declined nearly 20 percentage points to 68 percent of GDP between 2005 and 2009, but increased in 2009/10 due to new hydropower projects.
  - Public debt is expected to rise to 81 percent of GDP by the end of the current fiscal year.
  - DSA indicates a moderate but still significant risk of distress as most indicative debt thresholds are temporarily breached.
  - Based on the DSA, public debt is projected to exceed 110 percent of GDP in 2014/15.
- Key baseline assumptions:
  - Baseline presumes Bhutan stays on schedule for planned expansion to 10,000 MW by 2020 and incorporates Puna I (1,200 MW), Puna II (990 MW), and Mangdechu (720 MW).
  - Interest payments accumulated during construction expected to be repaid following project completion, but without being capitalized.
  - New hydropower projects financed by Government of India through a combination of loans and grants.
- Projections and sensitivities:
  - Baseline public debt-to-GDP ratio expected to peak at 110 percent of GDP in 2014/15 and decline to 35 percent by end 2029/30.
  - Baseline external debt-to-GDP projected to rise by 26 percentage points between 2009/10 and 2012/13.
  - Debt ratios most vulnerable to exchange rate shocks, export growth shocks, and unfavorable financing terms; a 30 percent nominal depreciation in 2009/10 raises the PV of debt to more than 140 percent of GDP.
  - "High investment, low growth" scenario: if hydropower investment generates no growth, public debt would peak at 125 percent of GDP.
- Mitigating factors:
  - Concentration of debt in commercially viable hydropower projects; Puna I, Puna II and Mangdechu expected internal rates of return about 11–14 percent and effective cost of financing estimated at about 8 percent.
  - Strong track record of project implementation and India’s strong energy demand.
  - Operational risk reduction through debt repayment suspension if electricity cannot be delivered to India.

### Monetary and financial sector: developments, risks, and staff advice
- Developments and indicators:
  - Inflation accelerated and became more volatile; monetary transmission hampered by persistent excess liquidity averaging 40 percent of reserve money in 2010.
  - Short-term interest rates declined since end-2009 to 2 percent in early 2011; spread with Indian money market rates is currently at minus 500 basis points (historical average minus 250-300 basis points).
  - Private sector credit growth accelerated to nearly 45 percent yoy; private sector credit to GDP reached 40 percent at end-June 2010.
  - Banks’ CAR was 17 percent in September 2010.
  - Gross NPL ratio fell to 8.6 percent as of September 2010 from 15.6 percent at end-September 2009; loan provisions increased to 43.6 percent of NPLs.
- Staff advice:
  - Raise interest rates in the near term to cool aggregate demand, reduce imports, and lower demand for Indian rupees.
  - Improve liquidity management and promote development of the interbank market with the Ministry of Finance.
  - Adjust prudential regulations (e.g., general provisioning) to curb large exposures and strengthen supervision; require periodic (quarterly) stress tests and reporting to the RMA.
- Authorities’ view:
  - Agreed on need to monitor credit growth but did not see immediate need for higher interest rates citing RMA profitability concerns; noted further fiscal tightening would alleviate need for monetary measures.

### External sector, reserves, and structural reforms
- External and reserve position:
  - REER stable and close to its ten-year average; REER estimated to be only 5 percent above its historical average.
  - Reserve position comfortable, with import coverage at about 10½ months.
  - Convertible currency reserves (currently about 90 percent of the total) rising; rupee reserves volatile and cover about 2¼ months of rupee denominated imports.
  - Large trade deficits arise from hydropower-related imports; current account deficit increasingly due to construction of the Puna hydropower project (Phase I).
- Staff advice:
  - Ngultrum peg to the Indian rupee appropriate given strong ties with India.
  - Fiscal and monetary tightening would help contain appreciation pressures.
  - Consider more active reserve management and revisiting the import coverage floor for convertible currencies.
  - Promote export diversification beyond hydropower (e.g., tourism) and carefully assess cost of tax incentives under the EDP.
- Authorities’ view:
  - Agreed tightening aggregate demand policies would contain balance of payments pressures; supported more flexibility in reserve management by lowering the convertible currencies import coverage floor to prudent levels based on stress tests.
  - Reiterated need for existing exchange restrictions on current account transactions while reserves are largely aid-driven.

### Ease of doing business, structural constraints, and reform priorities
- Doing Business indicators:
  - Bhutan ranks 142nd among the 183 economies in Doing Business 2011.
  - Weak performance particularly in: getting credit, protecting investors, trading across borders, and closing a business.
- Constraints:
  - Access to finance considered a major constraint despite rapid private sector credit growth.
  - Time and costs to comply with government regulations higher than regional and international averages; landlocked geography raises transport costs.
- Potential gains and authorities’ vision:
  - Empirical study cited: improving from worst quartile of business regulations to the best implies a 2.3 percentage point increase in annual growth.
  - Vision 2020 expects hydropower-driven future with diversification into high-value agriculture, clean manufacturing, and hospitality.
  - Emphasis on human capital investment in tertiary education and vocational training.

### Key national and macroeconomic indicators (selected figures)
- Nominal GDP (2009): US$1,265 million
- Population (2009): 0.697 million
- GDP per capita (2009): US$1,815
- Quota: SDR 6.3 million
- Selected time series (Real GDP at market prices, percent change): 10.8 (2007/08), 5.7 (2008/09), 7.5 (2009/10), 8.2 (2010/11 est.), 8.3 (2011/12 proj.)
- Consumer prices (percent change, period average): 6.3, 7.1, 4.8, 6.8, 5.8
- Total revenue and grants (percent of GDP): 35.1, 35.6, 41.0, 39.5, 30.9
- Tax revenue (percent of GDP): 9.0, 9.9, 13.6, 13.5, 12.9
- Foreign grants (percent of GDP): 11.4, 11.3, 17.3, 17.3, 10.1
- Total expenditure and net lending (percent of GDP): 34.7, 33.3, 38.4, 44.1, 37.7
- Overall balance (percent of GDP): 0.4, 2.3, 2.5, -4.6, -6.8
- Public sector debt (percent of GDP) 2/: 66.2, 67.7, 70.9, 81.3, 95.3
- External sector (current account balance, percent of GDP): -2.1, -1.6, -13.2, -14.9, -18.8
- Electricity exports (percent of total goods exports): 41.9, 42.3, 39.2, 36.1, 31.0

### IMF relations, consultations, and policy follow-up
- Bhutan maintains restrictions under Article XIV and an exchange restriction subject to Fund approval under Article VIII, Section 2(a); staff does not recommend approval as no timeframe for removal was provided.
- It is recommended that the next Article IV consultation take place on the 24-month cycle in accordance with the Decision on Article IV Consultation Cycles (Decision No. 14747-(10/96) (9/28/2010)).
- Staff appraisal (summary):
  - Growth and outlook: economy expected to grow at 8 percent this year and to continue growing strongly over the medium term, underpinned by hydropower, manufacturing, and services.
  - Policy stance: with rapid growth and elevated inflation, monetary and fiscal policies should be tightened to reduce risk of overheating.
  - Financial sector: strengthen supervision and monitoring in light of rapid credit growth.
  - Fiscal framework: introduce spending and revenue reforms, broaden the revenue base, and implement multi-year rolling budgets.
  - Exchange rate and diversification: peg to the Indian rupee has served Bhutan well; competitiveness measures and diversification (EDP) are important.

*Italic: Source – _cr11123 - Section 2(a).*

### Section 2(a).

### _cr11123 - Section 2(a)

### Executive summary and key policy messages
- Bhutan’s rapid growth has been underpinned by hydropower sector development with donor support and strong ties with India.
- Since 2008/09 the fiscal position deteriorated because of higher spending and sluggish revenue, and inflation has risen.
- Medium-term outlook remains favorable provided near-term challenges are addressed and structural reforms implemented.

Policy recommendations (from the document)
- Tighten fiscal policy in the near term by controlling current spending. The current balance should remain in surplus to limit domestic financing.
- Broaden the revenue base and improve public financial management by adopting a multi-year rolling budget to help ensure debt sustainability.
- Improve monetary operations and liquidity management. The policy rate should be better aligned with India’s money market rates to ensure the sustainability of the exchange rate peg. More active management of convertible currencies reserves would help address rupee shortages.
- Strengthen regulatory and supervision capacity of the Royal Monetary Authority (RMA) to safeguard financial stability amid rapid credit growth.
- Advance implementation of structural reforms to facilitate private sector investment and boost competitiveness, as envisaged in the authorities’ new Economic Development Policy (EDP).

### Context
- Political transition: Parliamentary democracy since 2008; local elections January 2011; 10th five-year plan (FYP) encompasses ambitious socio-economic goals.
- External linkage with India:
  - India absorbs about 95 percent of Bhutan’s exports (about half of which is hydroelectricity) and supplies three-fourths of its imports.
  - For the whole document, rupee refers to Indian rupee.
- Recent social progress:
  - Primary school enrollment ratio has risen significantly over fifteen years.
  - Infant mortality nearly halved since 1995.
  - Bhutan is on track or has achieved most Millennium Development Goals.

### Macroeconomic developments, outlook, and risks
- Recent developments
  - Growth accelerated to an estimated 7.5 percent in 2009/10, underpinned by services, construction, and hydropower.
  - Inflation doubled to 9 percent at end-2010 from the year before; initial pressures mainly food, later generalized.
  - Current account deficit increased to about 13 percent of GDP due to hydropower-related imports.
  - Overall balance of payments remained in surplus due to sizable grants and loans disbursements; reserve position remained comfortable.
  - Real effective exchange rate stable and close to its ten-year average.

- Outlook
  - Near term: Growth expected to remain at around 8 percent.
  - Inflation expected to decline while remaining somewhat elevated (at around 6 percent), in line with India.
  - Medium term: Growth projected to remain robust at 8–9 percent over the remainder of the 10th FYP (2011–13), partly driven by new hydropower construction.
  - Current account deficit expected to widen as construction of Puna and other hydropower projects picks up; financing from India and development partners projected to remain adequate and associated loan disbursements to increase, keeping the overall balance of payments manageable.

- Risks
  - Near-term risk: rapid credit growth and overheating could increase vulnerabilities.
  - Medium-term risks: failure to implement key structural reforms and capacity constraints could slow private sector development; aid inflows—particularly current grants—are expected to decline as per capita income rose rapidly.
  - Aid projection: Current grants in the form of budgetary support are projected to decline by 7 percentage points to about 10 percent of GDP over the next couple of years; capital transfers tied to hydropower projects envisaged to remain high.
  - Authorities’ view: broadly share staff assessment on growth and risks, see main external risk stemming from India; do not see an immediate overheating risk but monitor credit growth closely.

### Hydropower sector issues (Box 1)
- Contribution and capacity
  - Hydropower sector constitutes around 20 percent of Bhutan’s economy.
  - Growth in electricity production and related construction accounts for about one third of GDP growth.
  - Bhutan currently harnesses a little over 1,480 MW of hydropower electricity, about 5 percent of its estimated potential.
  - Government aims for total installed capacity of 10,000 MW by 2020.
- Pipeline projects (selected entries as reported)
  - Puna-I: Capacity 1,200 MW, Construction Schedule 2008-2015, Development Model IG 1/
  - Puna-II: Capacity 990 MW, Construction Schedule 2010-2016, Development Model IG
  - Mangdechhu: Capacity 720 MW, Construction Schedule 2010-2016, Development Model IG
  - Sankosh Storage: Capacity 4,060 MW, Construction Schedule 2011-2020, Development Model IG
  - Kuri-Gongri: Capacity 1,800 MW, Construction Schedule 2012-2019, Development Model IG
  - (Other projects listed with capacities and schedules in the source)
  - Source: Royal Monetary Authority of Bhutan Annual Report 2009/10
  - 1/ Inter-governmental undertakings with the Government of India
  - 2/ Joint venture undertakings with Indian public sector companies
- Exports and fiscal linkages
  - Domestic consumption accounts for only about 20 percent of electricity generation; low domestic tariffs contribute to competitiveness.
  - Hydropower exports to India account for almost 40 percent of Bhutan’s total goods exports in 2009/10, or about 15 percent of GDP.
  - Hydropower projects financed by Government of India through loans and grants; four future projects to be joint ventures with Indian public sector companies with debt-to-equity ratio of 70:30 and Indian partner allowed 51 percent equity.
  - Hydropower earnings (corporate income tax and transfers of dividends) accounted for 23 percent of total revenue in 2009/10.
  - Hydro-related revenue as a share of GDP projected to decline until new projects come on stream because electricity export price is fixed and construction is tax-exempt.
- Seasonality and fiscal management
  - Hydropower revenue subject to strong seasonality; more than 50 percent of annual revenue generated in the third quarter.
  - Seasonal low-water months (January–March) create domestic power shortages and require expensive electricity imports from India.
  - Public debt from hydropower projects accounts for about half of total debt, which currently stands at around 80 percent of GDP and is projected to exceed 110 percent in 2014/15.
  - Risks mitigated by commercial viability given India’s strong energy demand.

### Dealing with revenue volatility (Box 2)
- Revenue volatility drivers and magnitudes
  - Nontax revenue rose from 8.5 percent of GDP in 2005/06 to 17.9 percent in 2008/09 when the Tala project came on stream, then declined to 10 percent in 2009/10 when Tala became a corporation and revenue appeared as corporate tax and dividends.
  - Electricity’s share in aggregate revenue estimated to average 27 percent during the 10th FYP period (2008/09–2012/13).
  - Grants amount to 37 percent of total revenue, with 80 percent of them tied to specific projects.
  - Sales tax was 1.5 percent of GDP in 2008/09, less than half the average of Asian LICs.
  - Only new power sector project expected to come on stream during the 10th Plan is the Dagachu project (114 MW).
- Policy options recommended
  - Introduce a medium-term fiscal framework to ensure sustainable fiscal position and minimize volatility impact; consider a smoothing mechanism requiring surpluses in good times and allowing offsetting declines in hydro-related revenue.
  - Develop a cash management system based on accurate and timely forecasting of government cash inflows and outflows; introduction of T-bills in 2009 is a positive step.
  - Increase non-hydropower sector revenue (options considered include replacing sales tax with a broader-based VAT and unifying business income tax and personal income tax).
  - Strengthen institutional framework and Public Financial Management to avoid "resource curse" outcomes.

### Ease of doing business and structural reform (Box 3)
- Doing Business indicators
  - Bhutan ranks 142nd among the 183 economies in Doing Business 2011.
  - Weak performance particularly in: getting credit, protecting investors, trading across borders, and closing a business.
- Constraints and implications
  - Access to finance considered a major constraint despite rapid private sector credit growth.
  - Time and costs to comply with government regulations are higher than regional and international averages.
  - Landlocked geography raises cost of transportation and trading across borders.
  - Improving ease of doing business can facilitate non-tradable sector growth and diversification.
- International experience and potential gains
  - Zambia cited as an example of rapid Doing Business improvements through reform (PSDRP).
  - Empirical study cited: improving from worst quartile of business regulations to the best implies a 2.3 percentage point increase in annual growth.
- Authorities’ vision
  - Vision 2020 expects hydropower-driven future but with diversification into high-value agriculture, clean manufacturing, and hospitality to generate productive employment.
  - Emphasis on human capital investment in tertiary education and vocational training.

### Policy discussions: preserving macro stability and sustaining growth (start of Section III)
- Overall guidance
  - A recalibration of policy settings desirable to maintain momentum.
  - RMA should adjust monetary settings to help curb credit growth and increase monitoring of financial institutions.
  - Fiscal framework could be bolstered by introducing a spending ceiling to increase predictability of current expenditure over near and medium term.
  - EDP goals of diversifying the economic base are appropriate; tax incentives should be carefully evaluated.

_Italic: Source – _cr11123 - Section 2(a)._

### 11.      Fiscal policy has been accommodative, which has contributed to the risk of

### 11.      Fiscal policy has been accommodative, which has contributed to the risk of

### Fiscal position and near-term projections
- Current balance declined to an estimated surplus of 4 percent of GDP in 2009/10 and is anticipated to fall further to 2 percent of GDP in 2010/11.
- Overall balance is estimated at about 2½ percent of GDP in 2009/10 (compared with a deficit of 6 percent envisaged in the revised budget), and is expected to drop sharply to minus 4.5 percent of GDP in 2010/11.
- Deterioration in the overall balance reflects:
  - (i) a decline in non-tax revenue;
  - (ii) sluggishness in tax revenue;
  - (iii) higher current spending following a 35 percent hike in civil servant wages in January 2009 and 20 percent in early 2011;
  - (iv) an increase in capital spending.
- The overall balance excluding the hydropower sector (mostly corporate income tax and profit transfers) is projected to deteriorate in the near term due to higher public investment and the decline in grants.
- In the medium and longer term, buoyancy of non-hydropower tax revenue (due to base broadening) and the planned decline in spending are projected to reduce the non-hydropower deficit from 10 percent of GDP to 6 percent of GDP.

### Public debt and debt sustainability
- Public debt declined by nearly 20 percentage points to 68 percent of GDP between 2005 and 2009, but increased in 2009/10 due to the start of new hydropower projects.
- Public debt is expected to rise to 81 percent of GDP by the end of the current fiscal year as a result of investments in the hydropower sector and rising current spending.
- Debt sustainability analysis (DSA) indicates a moderate but still significant risk of distress as most indicative debt thresholds are temporarily breached.
- Based on the DSA, public debt is projected to exceed 110 percent of GDP in 2014/15.
- Mitigating factors cited by staff:
  - concentration of debt in commercially viable hydropower projects, which account for about half of total debt and benefit from India’s strong energy demand;
  - strong project implementation record and good governance;
  - comfortable reserve position;
  - operational risk reduction through debt repayment suspension if electricity cannot be delivered to India.

### Staff advice — fiscal policy (near term and medium term)
- Near term:
  - Fiscal policy should be tightened to address overheating by cutting non-priority current spending and saving any revenue overperformance.
  - A fiscal tightening of about 2 percent of GDP (combined) in 2011 and 2012 would be desirable to help cool growth in aggregate demand.
  - The proposed fiscal adjustment would encompass primarily current spending and could entail spending reallocation toward capital projects and other projects with high social returns, especially in case of grant shortfalls.
  - Tax administration should be improved to help reverse sluggishness in tax revenue.
- Institutional/fiscal framework:
  - RGB could consider introducing a nominal ceiling on current spending (excluding interest) to increase predictability and reduce procyclicality (example: link wage adjustments to inflation forecasts).
  - The spending ceiling would not encompass capital spending (mostly financed with capital grants); classification of spending would need close monitoring.
  - Escape clauses could address tail risks such as natural disasters.
  - The proposed ceiling could take the form of an amendment to the existing fiscal rule that stipulates that current spending should be covered by domestic revenue.
- Medium term:
  - Domestic financing should remain limited to ensure sustainable debt dynamics, requiring both revenue and expenditure reforms.
  - Revenue base should be broadened to reduce revenue volatility and dependence on the hydropower sector and external financing.
  - Introducing the VAT and improving tax administration should remain key priorities.
  - Implement multi-year rolling budgets, including specifying three-year rolling ceilings on current spending consistent with medium term revenue.

### Authorities’ views on fiscal policy
- Authorities view fiscal policy as generally prudent but concur that current fiscal settings pose challenges.
- Fiscal measures aimed at ensuring domestic revenue continues to finance current spending.
- Wage hikes will need to be financed with higher tax revenues; non-priority spending should be cut to help create fiscal space.
- Authorities receptive to a nominal current spending ceiling but stressed it would not substitute for the need for more revenue.
- Authorities emphasized the need to boost revenue to address envisaged decline in foreign aid flows and noted that tax incentives will likely impact tax buoyancy.
- Authorities broadly agreed with medium- and long-term debt projections in the staff’s DSA, while reiterating confidence in commercial viability of projects, implementation capacity, and donor support.

### Monetary and financial sector — background and risks
- Inflation has accelerated and become more volatile, reflecting price developments in India and accommodative domestic policies.
- Monetary transmission hampered by persistent excess liquidity averaging 40 percent of reserve money in 2010.
- Short-term interest rates declined since end-2009 to 2 percent in early 2011 (negative in real terms); spread with Indian money market rates is currently at minus 500 basis points (compared with a historical average of minus 250-300 basis points).
- Financial stability indicators:
  - Private sector credit growth accelerated to nearly 45 percent yoy, driven by housing, construction, and personal loans.
  - Banks’ CAR was 17 percent in September 2010.
  - Gross NPL ratio fell to 8.6 percent as of September 2010 from 15.6 percent at end-September 2009.
  - Loan provisions (as a percent of NPL) increased by 4 percentage points to 43.6 percent.
  - Private sector credit to GDP has nearly doubled since 2006, reaching 40 percent at end-June 2010.

### Staff advice — monetary and financial sector
- Monetary conditions need to be tightened to lower excess liquidity and credit growth:
  - RMA should raise interest rates in the near term to cool aggregate demand, reduce imports, and lower demand for Indian rupees.
  - Over the medium term, RMA should improve liquidity management and promote development of the interbank market in conjunction with the Ministry of Finance.
- Rapid credit growth warrants close monitoring:
  - RMA should be ready to adjust prudential regulations and norms, such as general provisioning, to curb large exposures to specific sectors.
  - Steps would bolster capacity to withstand potential deterioration in asset quality and funding strains, especially for new banks.
- Financial sector supervision should be strengthened:
  - Ensure major commercial banks and other financial institutions conduct stress tests on a periodic (quarterly) basis and report findings to the RMA.

### Authorities’ views on monetary and financial policy
- Authorities agreed on the need to monitor credit growth closely but did not see the need for higher interest rates at this juncture.
- Concern that higher interest rates would reduce RMA’s profitability because the monetary authority would bear interest cost of mopping up excess liquidity.
- Noted that further fiscal tightening would alleviate the need for monetary measures.
- Authorities monitor financial sector risks, consider banks’ risk assessments adequate as evidenced by NPL levels, and agree periodic stress tests would be useful.

### External sector and structural issues
- Real effective exchange rate (REER) stable and close to its ten-year average; REER estimated to be only 5 percent above its historical average.
- Despite sluggish exports, debt service has remained stable in relation to exports of goods and services.
- Reserve position comfortable, with import coverage at about 10½ months.
- Convertible currency reserves (currently about 90 percent of the total) have been rising; rupee reserves have been volatile and cover about 2¼ months of rupee denominated imports.
- Large trade deficits arise from hydropower-related imports; current account deficit increasingly due to construction of the Puna hydropower project (Phase I).
- Economic diversification envisaged in the EDP launched in early 2010 to boost merchandise exports and services (including “green” sectors) via tax incentives and other initiatives.

### Staff advice — external sector and structural reforms
- The ngultrum remains broadly in line with its medium-term equilibrium level and parity with the Indian rupee is appropriate given strong ties with India.
- Fiscal and monetary tightening would help contain appreciation pressures.
- More active reserve management recommended given volatility from hydropower projects and exports:
  - Consider revisiting the import coverage floor for convertible currencies to reduce costs of drawing on rupee credit lines.
- Over the medium term, export diversification beyond hydropower (e.g., tourism) would help.
- Authorities should carefully assess the cost of tax incentives under the EDP and consider reforms to lower the cost of doing business as a more effective way to develop new sectors.

### Authorities’ views on external policy
- Authorities agreed with staff on exchange rate assessment and that tightening aggregate demand policies would contain balance of payments pressures and rupee demand.
- Noted importance of convertible currency reserves for the credibility of the peg and supported more flexibility in reserve management by lowering the convertible currencies import coverage floor to prudent levels based on balance of payments stress tests.
- Reiterated need for existing exchange rate restrictions on current account transactions while reserves are largely aid-driven, with scope to ease restrictions as exports strengthen.
- Authorities monitor the REER and are taking measures to improve competitiveness and incentivize private sector development.

### Staff appraisal — summary judgments and recommendations
- Growth and outlook:
  - Bhutan’s growth has remained robust and medium-term prospects are favorable; economy expected to grow at 8 percent this year and to continue growing strongly over the medium term, underpinned by hydropower, manufacturing, and services.
- Policy stance:
  - With rapid growth and elevated inflation, monetary and fiscal policies should be tightened to reduce the risk of overheating.
  - Near-term fiscal objectives likely to be met, but saving any revenue overperformance and cutting non-priority spending would help contain aggregate demand.
  - Monetary tightening by raising interest rates would help cool credit growth and prevent balance of payment pressures.
- Financial sector:
  - In light of rapid credit growth, financial sector supervision should be strengthened and monitoring of financial institutions enhanced to assess systemwide risks.
- Fiscal framework:
  - Fiscal policy should be tightened in the near term; spending and revenue reforms are needed to bolster the fiscal framework.
  - Over the medium term, reverse sluggishness in tax revenues, create fiscal space to address declining foreign aid inflows and finance infrastructure, and establish a nominal ceiling on current spending to create fiscal space and make policy more countercyclical.
  - Broaden the revenue base to increase tax buoyancy and implement multi-year rolling budgets to better align spending plans with fiscal resources and policy priorities.
- Exchange rate and diversification:
  - Exchange rate peg to the Indian rupee has served Bhutan well; REER has appreciated only modestly.
  - No obvious signs of Dutch disease so far; competitiveness measures and diversification (EDP) are important.
  - Hydropower-driven growth will continue but is unlikely to generate sufficient jobs for the prospective labor force; EDP aims to identify job-generating activities and promote FDI and private sector development in line with sustainable development and GNH.

*Source: IMF staff report excerpt (content unit: _cr11123 - 11.      Fiscal policy has been accommodative, which has contributed to the risk of).*

### 37.      Bhutan maintains restrictions under Article XIV. A careful and gradual easing of

### _cr11123 - 37.      Bhutan maintains restrictions under Article XIV. A careful and gradual easing of

### Findings
- Bhutan maintains restrictions under Article XIV.
- Bhutan also maintains an exchange restriction subject to Fund approval under Article VIII, Section 2(a).

### Analysis and implications
- A careful and gradual easing of these exchange restrictions would facilitate Bhutan’s acceptance of the obligations under Article VIII of the IMF’s Articles of Agreement with minimal impact on the balance of payments.
- Staff does not recommend approval of this restriction as the authorities have not provided a timeframe for its removal.

*Source: _cr11123 - 37.*

### 38.      It is recommended that the next Article IV consultation take place on the 24-month cycle

### _cr11123 - 38.      It is recommended that the next Article IV consultation take place on the 24-month cycle

### Recommendation
- It is recommended that the next Article IV consultation take place on the 24-month cycle in accordance with the Decision on Article IV Consultation Cycles (Decision No. 14747-(10/96) (9/28/2010)).

### Real and External Sector Developments
- After the commission of the Tala hydropower project in 2007, Inflation has risen, following price developments in India.
- Growth has moderated though remains strong.
- India remains Bhutan's most important trading partner.
- The real exchange rate has appreciated in 20010, but is broadly in line with the historical average.
- The current account swung into deficit as debt service of the Tala hydropower project began and the construction of the Puna I project started.
- However, with adequate foreign inflows, overall reserves rose.
- Figure 1 highlights:
  - India CPI - industrial workers and Bhutan CPI (series shown Mar-06 through Dec-10).
  - Foreign Trade (In millions of US dollars) for 2003/04 through 2009/10 showing Exports from India, Exports from other countries, Imports from India, Imports from other countries.
  - Balance of Payments and Reserves (In millions of U.S. dollars) for 2003/04 through 2009/10 showing Current account balance and Gross reserves (RHS).
  - Current Account and Components (In millions of US dollars) for 2003/04 through 2009/10 showing Income, Services, Goods, Transfers.
  - Sources of Growth (Contribution to real GDP growth; in percent) for 2003/04 through 2010/11 showing Services, Construction, Power, Other, GDP.
  - REER index (Jun-03 to Dec-10) with Average.

### Monetary, Financial, and Fiscal Developments
- The policy rate spread with India has turned negative.
- Excess liquidity has come down but has remained large.
- Credit growth has been fast; credit growth strong particularly in construction.
- Although the NPL ratio has improved, credit growth has been strong.
- Fiscal performance has deteriorated somewhat since 2008/09 reflecting sluggish non-tax revenue and volatile foreign grants.
- Figure 2 highlights:
  - Gross NPL ratio (percent) series Jun-06 through Mar-11.
  - Bhutan 3-Mon RMA/Treasury Bill Rate and India 3-Mon T-Bill Rate and spread (left/right axes).
  - Credit Growth and Contributions (percent) Jun-07 through Oct-10 with components Other, Building & construction, Manufacturing, Credit growth.
  - Excess Liquidity (Nu. millions) and Cash Reserve Requirement (Nu. millions) Jun-06 through Jun-10 and Excess Liquidity as % of Reserve Money.
  - Fiscal Deficit and Financing (In percent of GDP) 2002/03 through 2009/10 showing Overall deficit, Domestic financing outturns.
  - Total Revenue and Grants (In percent of GDP) 2002/03 through 2009/10 showing Grants, Non-tax revenue, Tax revenue.

### Key National and Macroeconomic Indicators (selected figures)
- Nominal GDP (2009): US$1,265 million
- Population (2009): 0.697 million
- GDP per capita (2009): US$1,815
- Quota: SDR 6.3 million
- Table 1: Selected Economic and Financial Indicators, 2007/08–2011/12 (selection)
  - Real GDP at market prices (percent change): 10.8 (2007/08), 5.7 (2008/09), 7.5 (2009/10), 8.2 (2010/11 est.), 8.3 (2011/12 proj.)
  - Consumer prices (percent change, period average): 6.3, 7.1, 4.8, 6.8, 5.8
  - Nominal GDP (at market prices; billions of ngultrum): 52.1, 58.0, 66.2, 76.4, 87.8
  - Total revenue and grants (percent of GDP): 35.1, 35.6, 41.0, 39.5, 30.9
  - Tax revenue (percent of GDP): 9.0, 9.9, 13.6, 13.5, 12.9
  - Foreign grants (percent of GDP): 11.4, 11.3, 17.3, 17.3, 10.1
  - Total expenditure and net lending (percent of GDP): 34.7, 33.3, 38.4, 44.1, 37.7
  - Current balance (excluding grants, percent of GDP): 5.0, 5.2, 4.1, 2.1, 1.4
  - Overall balance (percent of GDP): 0.4, 2.3, 2.5, -4.6, -6.8
  - Public sector debt (percent of GDP) 2/: 66.2, 67.7, 70.9, 81.3, 95.3
  - Broad money (percent change): 2.3, 24.6, 30.1, 26.7,...
  - Credit to private sector (percent change): 39.7, 29.3, 41.1, 45.5,...
  - Deposits (less than 1 year) interest rates (end of period, in percent): 4.8, 4.8, 5.0, 5.0,...
  - External sector: Current account balance (in percent of GDP): -2.1, -1.6, -13.2, -14.9, -18.8
  - Exports (goods, US$ millions): 599, 516, 544, 549, 583
  - Imports (goods, US$ millions): 671, 607, 843, 896, 930
  - Grants (current transfer, US$ millions): 161, 151, 270, 291, 188
  - Capital account balance (US$ millions): 140, 106, 150, 243, 335
  - Overall balance (US$ millions): 45, 119, 419, 22, -
  - Gross official reserves (US$ millions): 646, 773, 868, 887, 909
  - External debt (percent of GDP): 63.5, 65.6, 67.7, 76.5, 85.8
  - Of which: power sector debt (percent of GDP): 38.9, 35.5, 34.7, 37.4, 45.9
  - Debt service ratio (percent of G&S exports): 14.2, 13.4, 14.3, 13.9, 14.2
  - Electricity exports (percent of total goods exports): 41.9, 42.3, 39.2, 36.1, 31.0
  - Unemployment rate (percent): 3.7 (2007), 4.0 (2008), 3.3 (2009), ......
- Table 2: Government Budget Summary (2007/08–2011/12), selected levels (millions of ngultrum)
  - Revenue and grants: 18,282 (2007/08), 20,624 (2009/10), 27,107 (2010/11 est.), 30,173 (2011/12 proj.), 27,132 (2012/13 proj.)
  - Domestic revenue: 12,346; 14,049; 15,638; 16,963; 18,278
  - Tax revenue: 4,666; 5,725; 8,975; 10,282; 11,337
  - Nontax revenue: 7,681; 8,324; 6,663; 6,680; 6,941
  - Foreign grants: 5,935; 6,575; 11,469; 13,211; 8,854
  - Expenditure and net lending: 18,065; 19,310; 25,431; 33,683; 33,139
  - Current expenditure: 9,726; 11,061; 12,903; 15,342; 17,045
  - Capital expenditure: 9,993; 9,829; 12,929; 19,217; 17,244
  - Overall balance (millions): 216; 1,314; 1,676; -3,509; -6,007
  - Foreign financing (millions): -1,319; -1,219; -483; 785; 1,039

### Balance of Payments and Medium-Term Projections
- Table 3: Balance of Payments, 2007/08–2014/15 (selected lines)
  - Current account: -27 (2007/08), -20 (2008/09), -188 (2009/10), -228 (2010/11 est.), -316 (2011/12 proj.), -361 (2012/13 proj.), -404 (2013/14 proj.), -456 (2014/15 proj.)
  - Trade balance: -72, -90, -299, -347, -347, -398, -461, -535
  - Exports, f.o.b.: 599, 516, 544, 549, 583, 623, 665, 721
  - Imports, c.i.f.: -671, -607, -843, -896, -930, -1,022, -1,126, -1,256
  - Services: -39, -19, -22, -22, -16, -12, -8, -4
  - Income: -32, -37, -57, -60, -66, -76, -78, -74
  - Current transfers: 117, 126, 190, 201, 113, 126, 142, 158
  - Grants (component of transfers): 161, 151, 270, 286, 184, 205, 231, 257
  - Capital and financial account: 140, 106, 150, 243, 335, 446, 466, 627
  - Loans (net): 258, 84, 7136, 160, 202, 166, 205
  - Overall balance (US$ millions): 45, 119, 419, 22, 89, 66, 217, ...
  - Gross official reserves (US$ millions): 646, 773, 868, 883, 902, 987, 1,048, 1,219
  - Ngultrum per U.S. dollars (fiscal year average): 40.4, 47.8, 46.7, .........
  - Nominal GDP (US$ millions): 1,291, 1,214, 1,419, 1,506, 1,665, 1,854, 2,091, 2,320
- Table 5: Medium-Term Macroeconomic Framework, 2007/08–2014/15 (selected projections)
  - Real GDP (percent change): 10.8 (2007/08), 5.7 (2008/09), 7.5 (2009/10), 8.2 (2010/11 est.), 8.3 (2011/12 proj.), 8.2 (2012/13 proj.), 9.7 (2013/14 proj.), 8.6 (2014/15 proj.)
  - Consumer prices (period average): 6.3, 7.1, 4.8, 6.8, 5.8, 4.8, 4.3, 4.0
  - Revenue and grants (percent of GDP): 35.1, 35.6, 41.0, 39.5, 30.9, 29.3, 29.2, 29.2
  - Expenditure and net lending (percent of GDP): 34.7, 33.3, 38.4, 44.1, 37.7, 35.8, 33.7, 33.2
  - Overall balance (percent of GDP): 0.4, 2.3, 2.5, -4.6, -6.8, -5.3, -4.3, -4.0
  - Current account balance (including grants, US$ millions): -27, -20, -188, -224, -313, -357, -400, -451
  - Gross foreign reserves (US$ millions): 646, 773, 868, 887, 909, 997, 1,062, 1,238
  - External debt (percent of GDP): 63.5, 65.6, 67.7, 76.5, 85.8, 92.1, 91.5, 90.1
  - Power sector debt (percent of GDP): 38.9, 35.5, 34.7, 37.4, 45.9, 54.0, 58.2, 61.0
  - External debt service (percent of exports of goods and services): 14.2, 13.4, 14.3, 13.9, 14.2, 13.5, 14.7, 14.3

### Monetary Survey (selected lines)
- Table 4: Monetary Survey, 2006/07–2010/11 (millions of ngultrum)
  - Net foreign assets: 24,459 (2006/07); 25,923 (2007/08); 33,074 (2008/09); 35,236 (2009/10); 41,994 (2010/11)
  - Net domestic assets: 750; -142; -961; 6,542; 12,868
  - Claims on nongovernment: 12,073; 15,627; 19,937; 27,184; 28,751
  - Broad money: 25,209; 25,781; 32,114; 41,779; 54,862
  - Narrow money: 13,542; 14,392; 18,374; 22,538; 27,706
  - Reserve money: 13,319; 12,871; 14,697; 20,575; 28,133
  - Memorandum: Broad money growth (12-month percent change): 8.6, 2.3, 24.6, 30.1, 26.7
  - Credit to private sector (12-month percent change): 34.6, 39.7, 29.3, 41.1, 45.5
  - Money multiplier: 1.9, 2.0, 2.2, 2.0, 2.0
  - Velocity of money: 1.8, 2.0, 1.8, 1.6, 1.4
  - Broad money/GDP: 0.56, 0.49, 0.55, 0.63, 0.72

### Millennium Development Goals and Social Indicators (selected)
- Poverty headcount ratio at national poverty line: 31.7 (1990? or 2003) (2003), 23.2 (2007)
- Net primary enrollment ratio (in percent of relevant age group): 58.7, 74.2, 84.2
- Percentage of cohort reaching grade 5 (in percent): 91.0, 93.2, 96.1
- Youth literacy rate (ages 15–24): 74.4
- Ratio of girls to boys in primary and secondary education (percent): 86.0, 93.0, 97.8
- Under 5 mortality rate (per 1,000): 147.9 (1990?), 125.2 (1995?), 106.0 (2000?), 89.8 (2005?), 81.2 (2008)
- Infant mortality rate (per 1,000 live births): 91.3, 78.8, 68.0, 58.8, 53.9
- Immunization, measles (percent of children under 12 months): 93.0, 85.0, 76.0, 93.0
- Maternal mortality ratio (modeled estimate, per 100,000 live births): 440.0
- Births attended by skilled health staff (percent): 23.7; 71.4 (2007)
- Incidence of tuberculosis (per 100,000 people): 307.5, 307.5, 253.2, 187.5, 164.6
- Forest area (percent of total land area): 64.6, 77.1, 78.4, 83.2, 83.8 (2007)
- Fixed line and mobile telephones (per 100 people): 0.3, 1.0, 2.5, 10.6, 40.5
- Population (millions): 0.5, 0.5, 0.6, 0.6, 0.7
- Gross national income (US$ millions): 297.7, 291.6, 418.7, 754.5, 1,300.8
- GNI per capita (US$): 560.0, 560.0, 730.0, 1,190.0, 1,900.0
- Life expectancy at birth (years): 52.6, 56.7, 61.4, 64.9, 66.1
- External debt (percent of GNI): 28.1, 36.3, 48.7, 85.8, 49.7
- Investment (percent of GDP): 32.4, 48.0, 48.2, 56.2, 46.6
- Trade (percent of GDP): 61.3, 85.1, 81.8, 94.8, 107.0

### IMF—Bhutan Fund Relations (as of February 28, 2011)
- Membership Status: Joined 9/28/1981; Article XIV
- Quota: 6.30 SDR Million (100.00 percent of quota)
- Fund holdings of currency (Exchange Rate): 5.28 SDR Million (83.81 percent)
- Reserve Tranche Position: 1.02 SDR Million (16.20 percent)
- SDR Department net cumulative allocation: 5.99 SDR Million (100.00 percent)
- SDR holdings: 6.42 SDR Million (107.15 percent)
- Outstanding Purchases and Loans: None
- Latest Financial Arrangements: None
- Projected Obligations to Fund: None
- Implementation of HIPC Initiative: Not applicable
- Implementation of Multilateral Debt Relief Initiative (MDRI): Not applicable
- Exchange system: Since its introduction in 1974, the ngultrum has been pegged to the Indian rupee at par. Bhutan continues to avail of transitional arrangements under provisions of Article XIV.

*Prepared by the Staff Representatives for the 2011 Article IV Consultation with Bhutan; May 13, 2011. Sources: IMF; Royal Monetary Authority of Bhutan; Data provided by the Bhutanese authorities; World Development Indicators database; and Fund staff estimates and projections.*

### Section 2. Bhutan also maintains exchange restrictions subject to Fund approval under

### _cr11123 - Section 2. Bhutan also maintains exchange restrictions subject to Fund approval under

### X. Article IV Consultation
- Bhutan is on a 24-month consultation cycle.
- The 2009 Article IV consultation was concluded by the Executive Board on December 15, 2009.

### XI. Technical Assistance — Fiscal (FAD)
- 1982, 1983 - Tax policy, budgeting, and accounting
- 1984 - Tax legislation
- 1984–86, 1988–89 - Technical experts assigned as General Fiscal Advisor to the Ministry of Finance
- 1987, 1989 - Tax system and public enterprises
- 1992, 2003 - Income taxation
- 2003 - Workshop on tax auditing and revenue forecast
- 2004 - Accounting (with MFD)
- 2009 - Indirect tax system, scope for VAT introduction
- 2009 - Sales tax/VAT

### XI. Technical Assistance — Legal (LEG)
- 1982–84 - Tax legislation
- 2004, 2005 - Central banking and financial services legislation and foreign exchange regulations (with MFD)
- 2011 - TA in Payments Law

### XI. Technical Assistance — Monetary and Financial (CBD/MAE/MFD/MCM)
- 1983 - Set-up the Royal Monetary Authority (RMA)
- 1980–92 - Technical experts assigned as General Advisors to RMA
- 1989 - Financial system review
- 1991 - Financial sector legislation/development of supervisory capabilities
- Technical experts assigned as Advisor for Bank Supervision
- 1992 - Issuance of government securities
- 1993–96 - Implementation of issuance of government securities
- 2003 - Monetary and exchange operations / financial systems
- 2004 - Accounting
- 2004, 2005 - Central banking and financial services legislation and foreign exchange regulations
- 2005, 2007 - Risk based internal audit policies and practices
- 2006, 2007 - Implementation of accounting reforms
- Debt management and financial markets development
- 2007 - Follow-up on excess liquidity issues
- Follow-up on reserve management
- 2008 - Foreign exchange issues

### XI. Technical Assistance — Statistics (STA)
- 1988 - Trade statistics
- 1990 - Statistics database
- 2004 - Multisector statistics/GDDS mission
- 2005 - Balance of payments statistics
- 2009 - Balance of payments statistics
- 2010 - GDDS: Metadata Development
- 2011 - Balance of payments statistics

### XII. Resident Representative/Advisor
- None.

### II: Bhutan — Relations with the World Bank Group (As of April 10, 2011)
- The National Assembly finalized the Tenth Five-Year Plan (10FYP) (2008/09–2012/13) in January 2009; this is also the RGoB’s Poverty Reduction Strategy Paper (PRSP).
- Strategic priorities for the 10FYP: (i) vitalizing industry; (ii) strengthening national spatial planning; (iii) synergizing rural-urban development; (iv) expanding strategic infrastructure; (v) investing in human capital; and (vi) fostering an enabling environment through good governance.
- The Country Partnership Strategy (CPS) covering FY11–14 aligns closely with the 10FYP / PRSP; prepared jointly by IDA and IFC.
- CPS emphasis: selectivity; two broad engagement areas — (i) economic diversification, job creation, and financial inclusion; and (ii) spatial planning and public services. Cross-cutting themes: capacity building for good governance, and environment.
- The World Bank’s Board of Executive Directors approved the CPS in November 2010.
- Establishment of an in-country office in FY11 with a permanent World Bank Representative and an IFC Country Coordinator.

### International Development Association (IDA)
- Bhutan is an IDA only country, and qualifies for 100 percent credits.
- In FY10, Bhutan exceeded the IDA Gross National Income per capita operational cutoff for the third year in a row, and became a "gap" country. “Gap” countries receive IDA on hardened terms and are not eligible for grants, regardless of results of Debt Sustainability Analyses.
- Bhutan received resources beyond its original indicative allocation of SDR26.2 million for the IDA 15 cycle (FY09–11).
- In FY09, Bhutan had the option of cumulatively frontloading up to 80 percent of its overall IDA 15 indicative allocation for FY09-11. Bhutan chose to frontload about SDR5.7 million, to add to its original FY09 allocation of SDR8.0 million.
- Bhutan received an additional IDA credit allocation of SDR2.3 million in two stages from the South Asia Region Pilot Crisis Response Window facility in FY10.
- Bhutan was impacted in 2009 by natural disasters caused by Cyclone Aila in May and earthquakes in September and December, which caused estimated losses amounting to US$65 million.
- The World Bank sanctioned an emergency IDA credit amounting to US$10 million for Bhutan, to be committed by end-FY11.
- Accounting for frontloading and additional allocations, Bhutan received IDA 15 credits of SDR8.3 million for FY10 and SDR13.6 million for FY11.
- Bhutan received US$5 million credit from intra-regional IDA reallocations for participation in Strengthening Regional Cooperation for Wildlife Protection in Asia in FY11.
- In January 2011, Bhutan received a grant of US$5 million from the Food Price Crisis Response Trust Fund.
- The indicative IDA 16 (FY12-14) allocation for Bhutan is approximately US$53 million.
- Starting from IDA16, Bhutan will be eligible to receive IDA credits with a 25-year maturity, 5-year grace period and 1.25 percent interest charge in addition to the standard service and commitment charges.
- During FY11, Bhutan received credits with a 20-year maturity, 10-year grace period, and no interest charges.

### IDA Lending and Nonlending Assistance — Projects (data as of March 31, 2011)
- Note: Percent disbursed is as share of original project commitment at Board approval, and does not take into account any additional financing that may have subsequently been processed.

- Committed projects (USD and Percent Disbursed, Board Approval):
  - Education Development Project — 32.60 — 107.0% — 8/21/2003
  - HIV/AIDS and STI Prevention — 5.77 — 94.3% — 6/17/2004
  - Decentralized Rural Development — 7.00 — 97.1% — 3/1/2005
  - Second Rural Access Project — 10.00 — 84.7% — 4/10/2007
  - Private Sector Development Project — 8.00 — 48.5% — 6/20/2007
  - Institutional Capacity Building Project for Procurement — 1.50 — 74.8% — 6/10/2008
  - Urban Development II — 12.01 — 16.3% — 4/29/2010
  - Bhutan Development Policy Credit 1 — 24.75 — 0.0% — 11/30/2010

- Pipeline:
  - Strengthening Regional Cooperation for Wildlife Protection in Asia — 2.25 — TBD
  - Improving Rural Livelihood — 12.00 — 5/22/2012

- Non-Lending (non-IDA):
  - Sustainable Land Management (GEF) — 7.66 — 73.4% — 1/17/2006
  - Introduction of Multi-Year Rolling Budgets (IDF) — 0.33 — 68.8% — 5/13/2007
  - Avian Influenza Control — 2.50 — 76.8% — 7/19/2007
  - Strengthening Institution Capacity for Implementation of Environmental Safeguards (IDF) — 0.40 — 20.0% — 4/16/2008
  - Strengthening of Public Procurement Policy Division (IDF) — 0.48 — 31.3% — 4/7/2009
  - Institutional Strengthening of Ministry of Labour and Human Resources (IDF) — 0.49 — 28.0% — 5/1/2010
  - Bhutan Disaster Risk and Recovery Program (GFDRR)* — 0.30 — 45.2% — 11/17/2010
  - First Grant Developing and Strengthening the Regulatory Framework — 0.12 — 7.7% — 11/28/2010
  - Trust Fund for Statistical Capacity Building — 0.30 — 0.0% — 12/3/2010
  - Strengthening the Institutional Capacity of Druk Holding and Investments to Improve Corporate Governance (IDF) — 0.50 — 0.0% — 2/1/2011

- *The total Grant is US$ 600,000, of which US$ 300,000 has been received.

### Lending Program — IDA 14 and IDA 15 highlights
- IDA 14 cycle (FY06–08) committed more than SDR32 million in grants to Bhutan, financing:
  - US$15 million First Development Policy Grant approved in May 2006
  - US$10 million Second Rural Access Roads Project approved in April 2007
  - US$12 million Second Development Policy Grant approved in June 2007
  - US$8 million Private Sector Development Project approved in June 2007
  - US$1.5 million Institutional Capacity Building Project for Procurement approved in June 2008
  - US$1.5 million in additional financing to the ongoing Education Development Project

- IDA 15 cycle (FY09–11) Board-approved operations:
  - US$20.22 million Development Policy Financing for Institutional Strengthening approved in May 2009; closed in March 2010 and has satisfactorily achieved its development objectives. Objectives included strengthening institutions to: (i) promote good governance through sound fiscal and public financial management and procurement, and strong accountability institutions; (ii) foster dynamic labor markets, ensure skills match, and generate employment; and (iii) expand access to infrastructure in an environmentally sustainable manner.
  - US$12 million Second Urban Development Project approved in April [text truncated in source].

*Source: _cr11123 - Section 2. Bhutan also maintains exchange restrictions subject to Fund approval under*

### 2010.  The project development objectives are to: (i) support Bhutan’s municipal reform

### _cr11123 - 2010.  The project development objectives are to: (i) support Bhutan’s municipal reform 

### Project development objectives and municipal reform
- Project objectives:
  - (i) support Bhutan’s municipal reform program by strengthening municipal finance and management systems in Thimphu and Phuentsholing; and
  - (ii) improve infrastructure services in northern Thimphu where no formal services are currently available.
- Purpose and activities:
  - Support the RGoB’s municipal reform agenda and implementation of the new legal framework for urban local governments through technical assistance, policy support, training programs, and studies.
  - Help establish an effective intergovernmental fiscal transfer system.
  - Address urgent need for serviced urban land in rapidly growing Thimphu City due to substantial and increasing migrant population settling in peripheries.

### Development Policy Credit and programmatic budgetary operations
- The Board approved the US$24.75 million First Development Policy Credit in November 2010.
- DPC1 overarching objectives are to strengthen institutions to:
  - (i) promote government efficiency and effectiveness through sound fiscal and public financial management and procurement, and strong public administration;
  - (ii) foster private sector development by improving the policy environment and facilitating productive employment opportunities; and
  - (iii) expand access to infrastructure in a sustainable manner.
- DPC1 is designed as the first in a new programmatic series of budgetary operations, in support of the RGoB’s medium term reform agenda as articulated in the 10FYP.

### Additional financing and regional project proposals
- The Board approved US$5 million additional financing to the ongoing Decentralized Rural Development Project in January 2011 from the Global Food Crisis Response Program Multi-Donor Food Price Crisis Response Trust Fund.
  - Original project objective: improve market access and increase agricultural output for rural communities in selected areas of Bhutan.
  - Additional financing focus: increased support to rehabilitation of irrigation canals, and to rice, potato, and maize as crops with best potential to address food insecurity.
- A regional project for Strengthening Regional Cooperation for Wildlife Protection in Asia is under preparation towards Board approval in FY11.
  - Project development objective: assist participating governments to build or enhance shared capacity, institutions, knowledge and incentives to collaborate in tackling illegal wildlife trade and other select regional conservation threats to habitats in border areas.
  - RGoB proposes to access regional IDA funding for US$1.5 million, in addition to utilizing US$0.75 million of its IDA country allocation, seeking IDA support in the form of a Credit of US$2.25 million.

### Nonlending program, trust funds, and IDF grants
- The Bank provides analytical and advisory services in macroeconomic and fiscal analysis, public expenditure management, financial management, procurement, private sector development, statistics, and education quality.
- Grants and projects financed during FY06-09 and later:
  - US$7.6 million Sustainable Land Management Project (global trust fund).
  - US$2.5 million National Influenza Preparedness and Response Project (global trust fund).
  - Trust Fund for Statistical Capacity Building (US$250,000) approved in FY07 (closed).
  - Institutional Development Fund (IDF) Grants that became effective: Introduction of Multi-Year Rolling Budgets (US$330,000); Improving Public Financial Management (US$290,000); Strengthening Institution Capacity for Implementation of Environmental Safeguards (US$400,000); Strengthening of the Public Procurement Policy Division (US$484,000).
- Five new Grants for Bhutan in FY10 and FY11:
  - US$498,500 IDF Grant for Institutional Strengthening of Ministry of Labor and Human Resources (approved May 2010).
    - Sub-components: (i) developing a National Employment Policy and reviewing Occupational Health and Safety regulations; (ii) developing PPPs for skills development training for disadvantaged youth; (iii) building capacity of regional Labour and Employment offices.
  - US$600,000 Bhutan Disaster Risk and Recovery Program (approved November 2010, funded by GFDRR).
    - Supports: (i) multi-hazard risk and vulnerability assessment and development of a risk atlas; (ii) capacity building for seismic resistant building design and construction techniques; (iii) strengthening emergency communications and disaster response; (iv) conferences focusing on cultural heritage in the context of disaster management.
  - US$123,000 First Initiative Trust Fund for Developing and Strengthening the Regulatory Framework for Pension, Provident Fund, and Other Such Schemes in Bhutan (approved November 2010).
    - Objectives: (i) review the National Pension Policy, if needed; (ii) redraft the Pension Act and regulations to be consistent with the Employment and Labor Act of 2007 and the National Pension Policy of 2010; (iii) review investment policies and opportunities for private pensions.
  - US$300,000 Trust Fund for Statistical Capacity Building (TFSCB) (approved December 2010).
    - Development objective: strengthen capacity of the National Statistics Bureau (NSB) in priority areas according to Bhutan’s National Statistics Development Strategy (NSDS), supporting: (i) the National Accounts and price statistics, (ii) data infrastructure, (iii) data dissemination, and (iv) research and data analysis capacity at the NSB.
  - US$500,000 IDF Grant for Strengthening the Institutional Capacity of Druk Holding and Investments to Improve Corporate Governance in Bhutan (approved February 2011).
    - Focus: (i) enhancing DHI policies, developing CG norms, improving performance monitoring for DHI companies; (ii) improving capacity of DHI and its holdings through training directors; (iii) awareness-raising seminars for media and stakeholders on importance of CG.

### International Finance Corporation (IFC) engagement
- IFC membership and presence:
  - Bhutan joined IFC in 2003; IFC opened an office in Thimphu with dedicated staff since November 2009.
- IFC strategic pillars in Bhutan (aligned with IFC South Asia Regional Strategy and WBG’s CPS):
  - (i) inclusive growth;
  - (ii) climate change mitigation and adaptation;
  - (iii) global / regional integration.
- IFC activities and support areas:
  - Investment climate improvement, financial sector modernization, real sectors and infrastructure development, PPPs and linkages.
  - Advisory support areas: investment climate; financial sector infrastructure including financial inclusion; PPPs; skills development and SME sector.
  - South Asia Enterprise Development Facility (SEDF) partnership with DFID and NORAD central to advisory support.
- Specific interventions and results:
  - Assisted RGoB in upgrading the FDI Policy (revised Policy came into effect in June 2010).
  - Assisted optimization of the company registration process; Licensing Simplification Project to improve business entry efficiency and establish e-License Portal.
  - Provided Bank of Bhutan and Bhutan National Bank with four trade line facilities totaling US$1.8 million under Global Trade Finance Program (GTFP) since FY2009; combined with advisory support on risk management and IT strategy.
  - Prepared to support modernization of payment systems and expand availability of financial services including payments and leasing for Micro, Small and Medium Enterprises.
  - Supported tourism, agribusiness, education and infrastructure via investments and advisory engagements focusing on linkages and PPPs; supported Association of Bhutan Women Entrepreneurs to scale-up commercial agriculture initiative for women in remote villages.
  - IFC PPP advisory activities exploring private sector participation in city bus service operation and solid waste management; completed operational and financial diagnostic review of Druk Air and preliminary assessment of two sites for industrial estates or potential SEZ.
- IFC portfolio as of February 2011:
  - US$6.9 million, consisting of a hotel project committed in FY2004 and trade guarantees under the GTFP.

### Relations with the Asian Development Bank (ADB) and pipeline
- Bhutan membership and classification:
  - Bhutan became ADB member in 1982; ADB began lending in 1983.
  - Bhutan classified under group “A” with a 50:50 mix of ADF loan and ADF grant assistance since 2011 and 80 percent cost-sharing limit for project financing.
- Alignment and program:
  - ADB’s work follows Bhutan’s Tenth Five-Year Plan, 2008–2013, guided by CSP approved September 2005 and country operations business plan 2011–2013.
  - Country assistance program evaluation (2010) concluded strategy of poverty reduction through program and project assistance in four core sectors (transport, energy (including rural electrification and renewable energy), urban sector development, and finance and private sector development) is closely aligned with government priorities.
- Indicative financing and pipeline (2011−2013):
  - Indicative cumulative value for 2011−2013 is $55 million.
  - Programmed/project pipeline:
    - Urban infrastructure project programmed for 2011.
    - Domestic airport development and rural road infrastructure projects in pipeline for 2012.
    - Urban infrastructure development project in pipeline for 2013.
  - Nonlending program of $1.7 million per year programmed for 2011−2013.
- Ongoing Loans and Grants (As of March 31, 2011) — Project, Year of Approval, Project Amount ($ million), Disbursements ($ million):
  - LOANS:
    - Road Network Project, 2005, 27.3, 24.799
    - Financial Sector Devt Program (Program Loan), 2006, 11.0, 8.312
    - Financial Sector Devt Program (Project Loan), 2006, 2.0, 0.951
    - Urban infrastructure development, 2006, 24.6, 6.477
    - Green Power Development Project (OCR Loan), 2008, 51.0, 36.774
    - Green Power Development Project, 2008, 29.0, 19.589
  - GRANTS:
    - Micro, Small & Medium-sized Enterprise Sector Devt Program, 2007, 6.0, 2.000
    - Micro, Small & Medium-sized Enterprise Sector Devt Program, 2007, 9.0, 3.249
    - SASEC Information Highway Project, 2007, 4.7, 0.074
    - Green Power Development Project, 2008, 25.3, 19.014
    - Road Network Project II, 2009, 38.8, 0.968
    - Rural Renewable Energy Development Project, 2010, 21.6, ----

### Statistical issues and data adequacy (as of March 15, 2011)
- General assessment:
  - Data provision has some shortcomings, but is broadly adequate for surveillance.
  - Most affected areas: national accounts, balance of payments, and fiscal data.
- Real sector and national accounts:
  - Japan-funded technical assistance project for Implementation of the System of National Accounts and the International Comparison Project over next three years; STA to provide technical assistance to improve national accounts and develop a producer price index.
  - Key national accounts shortcomings: heavy reliance on production data collected by line ministries with quality control issues, long lags in estimates, large revisions of historical data, ad hoc estimation procedures, lack of reliable data on expenditure components, shortage of qualified personnel and facilities, and absence of a Statistics Act constraining NSB.
- Price statistics:
  - Since 2004, CPI compiled quarterly, with greatly expanded commodity prices and broader geographical scope.
  - An STA technical assistance mission planned for April 25–May 6, 2011 to assist development of a producer price index.
- Government finance statistics (GFS):
  - Recent improvements, but fiscal data subject to frequent and substantial revisions, particularly in expenditure.
  - Compilation and dissemination of budget execution data and GFS are very limited: only annual budget execution data compiled and disseminated with a long lag; no GFS disseminated nationally; sub-annual budget execution data unavailable.
  - Inconsistencies between fiscal and monetary data regarding bank financing due to differences in government definition.
- Monetary statistics:
  - Generally consistent with Fund guidelines but need improvements: valuation of financial assets based on purchase price rather than market or market-price equivalents; need list of government units and nonfinancial public enterprises to avoid misclassifications.
  - Technical assistance mission on Monetary and Financial Statistics (MFS) in March 2010 improved timeliness of data reporting to STA.
  - RMA submitted Financial Soundness Indicators (FSI) for Bhutan on a quarterly basis to STA; published on IMF’s FSI website.
- Balance of payments:
  - Shortcomings: limited coverage of services transactions; trade data compiled on a quarterly basis while other external transactions compiled on a fiscal year basis.
  - Errors and omissions are large, hampering accurate assessment of external flows.
  - Missions: June 2009 and March 2011 missions developed International Investment Position for Bhutan and a plan for BOP improvements including a quarterly business survey, improved estimation methods, and increased timeliness.
  - RMA plans to compile and disseminate quarterly balance of payments data in the future; Bhutan began supplying BOP data for publication in IFS in November 2010.
- Data standards and participation:
  - Bhutan participates in the General Data Dissemination System (GDDS); posted metadata for first time on the Fund’s DSBB in May 2010.
  - No data ROSC available.

### Debt sustainability summary (IMF-World Bank Joint DSA, May 13, 2011)
- Framework:
  - Bhutan’s external and public debt dynamics analyzed within the IMF-World Bank Debt Sustainability Framework for Low Income Countries (LIC-DSA).
- Key findings and assessment:
  - Development of the hydropower sector will lead to a substantial increase in external debt—with debt ratios breaching some country-specific LIC-DSA indicative thresholds.
  - Staff assessment: external debt dynamics remain subject to a moderate risk of distress.
  - Factors informing assessment: commercial viability of hydropower projects; risk sharing agreement with India for hydropower loans; Bhutan’s strong track record of project implementation; rapid growth in energy demand from India; committed donor support; and Bhutan’s high level of international reserves.
- Policy implications highlighted:
  - Importance of sustaining rapid economic growth going forward.
  - Importance of containing domestically financed fiscal deficits.

*Prepared by the staffs of the International Monetary Fund and the International Development Association (extracted from the supplied content).*

### 1. After peaking in 2004/05, Bhutan’s public and publicly guaranteed debt declined

### 1. After peaking in 2004/05, Bhutan’s public and publicly guaranteed debt declined

### Debt evolution and structure
- Public and publicly guaranteed debt declined by 17 percentage points to 68 percent of GDP at end 2008/09.
- Public debt excludes state-owned enterprise debt except hydropower project loans and the purchase of one aircraft for state-owned Druk Air in 2004/05.
- Rupee-denominated hydropower sector debt equals 41 percent of GDP and accounts for 62 percent of external debt.
- External debt accounts for more than 95 percent of total public debt.
- Convertible currency debt reached 34 percent of GDP in 2009/10.
- Domestic debt, all denominated in local currency and held by domestic financial institutions, has declined on the back of rapid growth and relatively strong fiscal outturns.

### Underlying debt sustainability analysis assumptions
- Baseline presumes Bhutan stays on schedule for planned expansion to 10,000 MW of installed capacity by 2020.
- Baseline incorporates Punatsangchu I (Puna I), Punatsangchu II (Puna II), and Mangdechu hydropower projects.
- Puna I’s capacity is 1,200 MW.
- Puna II’s capacity will be 990 MW.
- Mangdechu’s capacity will be 720 MW.
- Debt service for these projects will begin after commissioning and will continue for 12 years.
- Interest payments accumulated during construction are expected to be repaid following project completion, but without being capitalized.
- The intergovernmental implementation agreements on Puna II and Mangdechu were signed in April 2010; pre-construction works are underway; repayments will start after projects come on stream in 2019.
- New hydropower projects financed by the Government of India through a combination of loans and grants.
- External financing for non-hydropower activities expected to remain predominantly from multilateral and bilateral donors on concessional terms.

### Baseline macroeconomic assumptions
- Real sector:
  - Real growth excluding hydropower-related activity projected to remain about 6–7 percent over the medium and long term.
  - Inflation projected to average 7-8 percent in the near term and decline gradually to 4–5 percent over the medium term.
- External sector:
  - Electricity exports are expected to more than triple from current levels upon completion of hydropower projects.
  - Balance of payments surpluses are expected from 2019.
- Fiscal sector:
  - Revenues are expected to stabilize at around 20 percent of GDP once new hydropower projects come on stream around 2017/18.
  - Primary deficits arise over the medium term mainly because the decline in aid inflows does not lead to a similar compression of public investment.

### Key historical public debt statistics (from table "Bhutan: Structure of Public Sector Debt")
- Total debt (percent of GDP) by year:
  - 03/04: 73.3
  - 04/05: 80.7
  - 05/06: 84.9
  - 06/07: 84.8
  - 07/08: 74.6
  - 08/09: 66.2
  - 09/10: 67.7
- Domestic debt (percent of GDP) by year:
  - 03/04: 2.7
  - 04/05: 1.6
  - 05/06: 6.6
  - 06/07: 4.6
  - 07/08: 3.5
  - 08/09: 2.7
  - 09/10: 2.1
- External debt (percent of GDP) by year:
  - 03/04: 70.6
  - 04/05: 79.0
  - 05/06: 78.2
  - 06/07: 80.3
  - 07/08: 71.1
  - 08/09: 63.5
  - 09/10: 65.6
- Of which: hydropower projects (percent of GDP) by year:
  - 03/04: 54.3
  - 04/05: 54.9
  - 05/06: 54.9
  - 06/07: 47.0
  - 07/08: 42.1
  - 08/09: 42.2
  - 09/10: 40.6
- Of which: convertible currency debt (percent of GDP) by year:
  - 03/04: 32.3
  - 04/05: 30.9
  - 05/06: 32.3
  - 06/07: 30.3
  - 07/08: 27.1
  - 08/09: 28.7
  - 09/10: 33.8

### External debt sustainability: baseline projections and sensitivities
- Baseline: External debt-to-GDP projected to rise by 26 percentage points between 2009/10 and 2012/13 as disbursements for new hydropower projects increase.
- Debt ratios remain above LIC-DSA indicative thresholds for strong performers until:
  - 2016/17 for the PV of external debt as a share of exports and revenue.
  - 2019/20 for the PV of external debt to GDP.
- Debt service-to-export and debt service-to-revenue ratios expected to remain below indicative thresholds for the entire projection period.
- Sensitivity analysis:
  - Debt ratios most vulnerable to exchange rate shocks, export growth shocks, and unfavorable financing terms.
  - A 30 percent nominal depreciation in 2009/10 raises the PV of debt to more than 140 percent of GDP, but this overestimates vulnerability because a large share of receipts are in rupees, providing a natural hedge.
  - Export growth shocks and more unfavorable financing terms increase debt ratios.
  - Slower growth than envisaged leads to only slight deviations from the baseline debt distress indicators.
  - Under the most extreme shock scenario, the debt service-to-revenue ratio would temporarily breach the indicative threshold as Puna II and Mangdechu’s debt service begins, but would remain below the threshold for the rest of the projection period.
  - Historical scenario shows explosive debt dynamics as it does not fully capture the hydropower construction/operation cycle.

### Public debt sustainability: baseline projections and sensitivities
- Baseline public debt dynamics driven by external debt.
- Public debt-to-GDP ratio expected to:
  - Peak at 110 percent of GDP in 2014/15.
  - Decline to 35 percent of GDP by end 2029/30.
- Domestic financing projected to increase temporarily during 2010–2015 to offset declining grants; domestic debt projected to reach about 20 percent of GDP by 2014/15 and remain broadly stable around that level thereafter.
- Sensitivity analysis:
  - Public debt most vulnerable to exchange rate shocks given the large share of external debt.
  - A one-time depreciation shifts public debt indicators upward but does not change their broad path.
  - Historical scenario (assuming a primary deficit of 2⅓ percent of GDP) would lead public sector debt to rise and remain at a high level long term.
  - If borrowed resources are not used productively, debt ratios deteriorate markedly.
  - "High investment, low growth" scenario: if hydropower investment generates no growth, public debt would peak at 125 percent of GDP and decline much more slowly.

### Staff assessment and mitigating factors
- Overall judgement: Bhutan’s external debt dynamics deemed sustainable but subject to a moderate risk of distress.
- Policy-related LIC-DSA thresholds for external debt are breached for several indicators but for a shorter period than in the previous DSA.
- New hydropower projects expected to boost exports and overall GDP growth; debt-service ratios remain below indicative thresholds despite substantial increases in the debt stock.
- Mitigating factors:
  - Commercial viability of new hydropower projects:
    - Puna I expected to have a higher internal rate of return due to lower construction costs and larger capacity.
    - Internal rate of return for Puna II and Mangdechu expected to remain high at about 11–14 percent.
    - Effective cost of financing estimated at about 8 percent.
  - Strong track record of project implementation reduces implementation risk for new hydropower projects.
  - Strong ties with India:
    - India is the main provider of financing for hydropower projects.
    - Given India’s sizable power deficit, demand for Bhutan’s hydropower should remain high for decades.
    - At project level, operational risks (including those related to natural disasters) are to be borne by the Government of India; hydropower-related loans do not represent contingent liabilities for the Royal Government of Bhutan.

*IMF/World Bank Joint Debt Sustainability Analysis (DSA) excerpt, as provided in the source content.*

### 11. The authorities broadly agreed with the debt projections underlying the staff’s

### _cr11123 - 11. The authorities broadly agreed with the debt projections underlying the staff’s

### Authorities' view on debt projections and staff DSA
- The authorities "broadly agreed with the debt projections underlying the staff’s DSA as well as the staff’s assessment."
- They "underscored the importance of the mitigating factors outlined in the staff’s analysis, particularly the commercial viability of the projects and strong donor support."
- "The projects’ internal rates of return were provided by authorities."

### Executive Board and staff assessment (key messages)
- Near-term outlook: growth expected to remain "around 8 percent"; inflation expected to decline while "remaining somewhat elevated (at around 6 percent)."
- Risks: potential overheating from "higher prices, strong economic growth and rapid credit expansion."
- Policy guidance emphasized:
  - Tighten macroeconomic policies to mitigate overheating.
  - Tighter monetary policy (raising interest rates) to curb credit growth and reduce balance of payments pressures.
  - Monitor excess liquidity and improve monetary transmission.
  - Strengthen regulatory and supervision capacity in banking.
  - Tighter fiscal stance, including establishing "a nominal ceiling on current spending" to create space for capital spending and make fiscal policy more countercyclical.
  - Implement revenue measures to finance prospective public investment and diversify the economy.
- Directors assessed Bhutan’s "risk of debt distress remains moderate" given concentration of debt in commercially viable hydropower projects and India’s rapid energy demand growth.

### Authorities' statement: priorities and rationale
- Growth outlook: "Real GDP growth is expected to remain 8 percent or above in the near term."
- Inflation: primarily food-driven; authorities "monitoring the price situation with a readiness to take remedial policy action."
- Current account: widened due to hydropower-related imports; "comfortably financed by loans from India tied to hydroelectricity projects"; reserves "equivalent of nearly a year’s imports."
- Fiscal stance: overall balance likely negative in 2010/11 due to increased capital spending on hydropower; capital spending financed by capital grants and viewed as productive.
- Fiscal priorities:
  - Increase tax revenue to ensure fiscal sustainability and meet development needs.
  - Diversify the tax base, increase non-hydroelectric tax revenue, improve tax administration, reduce revenue volatility, and improve revenue productivity.
  - Consideration of VAT requires "considerable amount of ground work and capacity building."
- Monetary/financial sector:
  - Monetary conditions "stable"; need to monitor inflation risks, credit growth, and excess liquidity.
  - Support for developing an interbank market and deepening macroprudential supervision, including periodic stress tests.
  - Peg with the Indian rupee considered "appropriate."
- Development perspective:
  - Continue rapid social progress and pursuit of "Gross National Happiness" principles.
  - Hydropower sector critical; projects under construction "well on schedule, with a few ahead of timelines."
  - Tourism target: aim to attract "one hundred thousand visitors" vs current "thirty five thousand tourists a year."

### Key quantitative debt and macro indicators (selected, as reported)
- Public sector debt (percent of GDP):  
  - 2007: 74.6  
  - 2008: 66.2  
  - 2009: 67.7  
  - 2010: 70.9  
  - 2011: 81.3  
  - 2012: 95.7  
  - 2013: 103.9  
  - 2014: 107.7  
  - 2015: 111.0  
  - 2010-15 Average: 20.6  
  - 2020: 60.9  
  - 2030: 34.8
- Foreign-currency denominated public sector debt (percent of GDP):  
  - 2007: 71.1  
  - 2008: 63.5  
  - 2009: 65.6  
  - 2010: 67.7  
  - 2011: 76.5  
  - 2012: 86.2  
  - 2013: 92.5  
  - 2014: 91.8  
  - 2015: 90.4  
  - 2010-15 Average: 42.7  
  - 2020: 13.5
- Change in public sector debt (percent of GDP):  
  - 2007: -10.2  
  - 2008: -8.4  
  - 2009: 1.5  
  - 2010: 3.2  
  - 2011: 10.3  
  - 2012: 14.5  
  - 2013: 8.2  
  - 2014: 3.8  
  - 2015: 3.3  
  - 2010-15 Average: -8.3  
  - 2020: -1.5
- Primary deficit (percent of GDP):  
  - 2007: -2.2  
  - 2008: -3.9  
  - 2009: -5.3  
  - 2010: 2.3  
  - 2011: 6.1  
  - 2012: -5.7  
  - 2013: 1.6  
  - 2014: 4.0  
  - 2015: 2.5  
  - 2010-15 Average: 1.7
- Revenue and grants (percent of GDP):  
  - 2007: 35.7  
  - 2008: 35.1  
  - 2009: 35.6  
  - 2010: 41.0  
  - 2011: 39.5  
  - 2012: 30.9  
  - 2013: 30.4  
  - 2014: 29.3  
  - 2015: 29.2  
  - 2010-15 Average: 34.8  
  - Grants (percent of GDP) reported as 13.3 (2007), 11.4 (2008), 11.3 (2009), 17.3 (2010), 17.3 (2011), and 10.1 (2012–2015, constant)
- PV of public sector debt (percent of GDP): examples reported:  
  - 2010: 80.6  
  - 2011: 82.4  
  - 2012: 90.5  
  - 2013: 102.1  
  - 2014: 108.4  
  - 2015: 105.2  
  - 2019/20: 109.3  
  - 2029/30: 60.4
- PV of public sector debt-to-revenue and grants ratio (percent):  
  - 2010: 226.6  
  - 2011: 201.1  
  - 2012: 229.2  
  - 2013: 330.5  
  - 2014: 356.5  
  - 2015: 358.7  
  - 2019/20: 374.9  
  - 2029/30: 173.4
- PV of public sector debt-to-revenue ratio (percent):  
  - 2010: 332.6  
  - 2011: 348.5  
  - 2012: 407.8  
  - 2013: 490.5  
  - 2014: 533.2  
  - 2015: 546.5  
  - 2019/20: 573.0  
  - 2029/30: 244.2
- Debt service-to-revenue and grants ratio (percent):  
  - 2007: 7.3  
  - 2008: 22.0  
  - 2009: 19.0  
  - 2010: 16.0  
  - 2011: 15.5  
  - 2012: 18.3  
  - 2013: 19.0  
  - 2014: 20.5  
  - 2015: 20.1  
  - 2010-15 Average: 18.7
- Debt service-to-revenue ratio (percent):  
  - 2007: 11.6  
  - 2008: 32.5  
  - 2009: 27.9  
  - 2010: 27.8  
  - 2011: 27.5  
  - 2012: 27.2  
  - 2013: 28.4  
  - 2014: 31.2  
  - 2015: 30.7  
  - 2010-15 Average: 26.3
- Primary deficit that stabilizes the debt-to-GDP ratio (percent):  
  - 2007: 8.1  
  - 2008: 4.5  
  - 2009: -6.9  
  - 2010: -8.9  
  - 2011: -8.7  
  - 2012: -10.5  
  - 2013: -5.7  
  - 2014: -2.1  
  - 2015: -1.9  
  - 2010-15 Average: 3.5
- Key macro assumptions (selected):  
  - Real GDP growth (percent): 2007: 12.6; 2008: 10.8; 2009: 5.7; 2010: 8.1; 2011: 2.3; 2012: 7.5; 2013: 8.2; 2014: 8.3; 2015: 8.2; 2010-15 Average: 9.7; 2020: 8.6; 2030: 8.4; 2016-30 Average: 6.8  
  - Average nominal interest rate on forex debt (percent): 2007: 1.9; 2008: 6.0; 2009: 4.3; 2010: 2.0; 2011: 1.8; 2012: 5.4; 2013: 4.4; 2014: 3.9; 2015: 3.2; 2010-15 Average: 2.7; 2020: 2.5; 2030: 3.7  
  - Inflation rate (GDP deflator, percent): 2007: 4.3; 2008: 4.4; 2009: 5.3; 2010: 4.5; 2011: 0.7; 2012: 6.1; 2013: 6.7; 2014: 6.2; 2015: 6.0; 2010-15 Average: 5.3; 2020: 4.5; 2030: 5.8
- External debt (nominal, percent of GDP):  
  - 2007: 71.1  
  - 2008: 63.5  
  - 2009: 65.6  
  - 2010: 67.7  
  - 2011: 76.5  
  - 2012: 86.2  
  - 2013: 92.5  
  - 2014: 91.8  
  - 2015: 90.4  
  - 2010-15 Average: 42.7  
  - 2020: 13.5
- External debt service and ratios (selected):  
  - Debt service-to-exports ratio (percent): 2007: 3.8; 2008: 14.2; 2009: 13.4; 2010: 14.4; 2011: 13.9; 2012: 13.2; 2013: 13.5; 2014: 14.7; 2015: 14.1; 2010-15 Average: 13.4; 2020: 3.0  
  - PPG debt service-to-revenue ratio (percent): 2007: 10.5; 2008: 30.4; 2009: 26.1; 2010: 26.2; 2011: 25.9; 2012: 25.3; 2013: 25.8; 2014: 28.3; 2015: 27.1; 2010-15 Average: 23.4; 2020: 7.7
- Aid flows (Millions of US dollars): total aid and composition (examples):  
  - 2007: Aid flows 166.0; Grants 135.8; Concessional loans 30.2  
  - 2008: Aid flows 184.6; Grants 147.0; Concessional loans 37.5  
  - 2009: Aid flows 266.8; Grants 137.6; Concessional loans 129.1  
  - 2010: Aid flows 294.1; Grants 245.8; Concessional loans 48.3  
  - 2015: Aid flows 217.4; Grants 210.9; Concessional loans 6.6  
  - Memorandum: Aid flows in 2020: 469.7; Grants 421.9; in 2030: 957.2; Grants 885.9
- Grant-equivalent financing (percent of GDP and of external financing) examples:  
  - Grant-equivalent financing (percent of external financing) reported: 70.1; 66.2; 51.2; 51.1; 57.6; 61.6; 94.6; 96.0; 93.6

### Sensitivity analysis highlights (selected outcomes)
- Baseline and alternative scenarios for PV of debt-to-GDP ratio, PV of debt-to-revenue ratio, and debt service-to-revenue ratio are reported for 2009/10–2029/30 with multiple scenarios. Selected baseline trajectory snapshots:  
  - PV of debt-to-GDP ratio (baseline): 2009/10: 82; 2010/11: 91; 2011/12: 102; 2012/13: 108; 2013/14: 105; 2014/15: 109; 2019/20: 60; 2029/30: 30  
  - PV of debt-to-revenue ratio (baseline): 2009/10: 201; 2010/11: 229; 2011/12: 330; 2012/13: 356; 2013/14: 359; 2014/15: 375; 2019/20: 173; 2029/30: 95  
  - Debt service-to-revenue ratio (baseline): 2009/10: 16; 2010/11: 15; 2011/12: 18; 2012/13: 19; 2013/14: 20; 2014/15: 20; 2019/20: 19; 2029/30: 8
- Stress/bound tests: examples of most extreme shocks for 2019/20 often correspond to one-time depreciation or exports shock, producing markedly higher ratios (e.g., PV of debt-to-GDP and PV of debt-to-revenue rise substantially under certain shocks).

### Policy recommendations and scenario implications (from staff and Directors)
- Maintain peg with Indian rupee given strong integration with India.
- Tighten monetary policy and raise interest rates to curb credit growth.
- Improve monetary transmission and closely monitor excess liquidity.
- Strengthen bank supervision and regulatory capacity to preserve financial stability.
- Adopt a tighter fiscal stance and consider a nominal ceiling on current spending to prioritize capital investment.
- Implement revenue measures, diversify tax base, and increase non-hydropower tax revenue; consider VAT subject to capacity-building.
- Continue close engagement with development partners to ensure donor support and favorable financing for hydropower projects.
- Monitor project commercial viability and donor support as key mitigating factors for debt sustainability.

*Source: IMF staff report and Public Information Notice — Article IV consultation materials for Bhutan (IMF Executive Board discussion concluded May 27, 2011; corresponding tables, figures, and country authorities’ statement as provided in the source content).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11123.pdf_