## INTRODUCTION (IMF staff report _cr16206) ## Source details **Canonical URL:** [INTRODUCTION (IMF staff report _cr16206)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16206.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16206.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16206.pdf.json) --- ### Macroeconomic developments and outlook - GDP per capita rose from $1,108 to $2,612 during 2004–2014. - Real GDP growth: - Averaged around 8 percent during the Ninth and Tenth Five-Year Plan (FY 2003/04–2012/13). - Fell to below 4 percent in FY2012/13 and FY2013/14. - Estimated at 5.2 percent in FY2014/15. - Projected to reach 6 percent in FY2015/16. - Projected to accelerate to over 11 percent in FY2017/18 and to around 14 percent in FY2018/19, supported by a tripling of hydropower electricity generation. - Inflation: - Peaked at 11.3 percent in Q4 2013 (y-o-y); fell to 3.5 percent at end-2015; declined to below 3 percent in February and March 2016. - Imported goods inflation: fell from 6.2 percent to 1.8 percent (last twelve months). - Domestic goods inflation: eased from 6.5 percent to 4.2 percent (last twelve months). - Labor market: - Overall unemployment in 2014: 2.6 percent (down from 2.9 percent in 2013). - Youth unemployment and urban unemployment are significantly higher (see Box 2 figures). - External sector and reserves: - FY2014/15 current account deficit increased to close to 29 percent of GDP. - International reserves: $960 million by June 2015, recovered to $1,022 million in February 2016. - Trade deficit: Nu.13.3 billion in July–December 2015 versus Nu.6.8 billion in the same period of 2014. - Ngultrum (Nu) pegged to the Indian rupee at parity since 1974. - Credit and financial sector: - Bank credit to private sector decelerated to below 10 percent in 2013–2014; picked up to about 13–14 percent in 2015; credit around 46 percent of GDP. - NBFI credit almost doubled between end-2013 and end-2015; now 17 percent of total financial institutions’ credit (12 percent in 2013). - Banks’ capital adequacy ratio: 17 percent by September 2015 (minimum required 10 percent). - Non-performing loans (NPLs): around 10 percent of outstanding loans. - Bank credit-to-deposit ratio: 86.4 percent in 2013 → 73 percent in 2014 → about 80 percent in 2015. - Fiscal outcomes and projections: - FY2013/14: surplus of 3.8 percent of GDP. - FY2014/15 revised budget: envisaged deficit of 2.3 percent of GDP; outturn surplus of 1.5 percent of GDP. - Medium-term current account deficit projected to peak at 31.5 percent of GDP in FY2016/17, then fall quickly and eventually turn into a surplus. - Overall balance projected mostly positive, supported by hydropower grants and loans. ### Risks to the outlook - Downside risks predominate: - Domestic: managing high debt and volatile hydropower-related inflows that could fuel rapid credit growth and external pressures. - External: weaker tourism, adverse developments in China affecting exports, Nepal’s earthquake, regional security concerns. - Upside: continued strong growth in India (but reform setbacks there could weaken activity). ### Fiscal policy — staff assessment and recommendations - Recent stance and risks: - FY2015/16 revised budget projected deficit of 3 percent of GDP; outturn projected surplus of 0.6 percent. - Authorities budgeted capital spending jump of over 70 percent (now projected about 30 percent). - If fully implemented, FY2016/17 budgeted capital spending could yield a deficit of over 5 percent of GDP. - Donor financing projected to fall as per capita incomes rise; hydropower-related revenues projected to increase. - Near-term staff recommendations: - Avoid fiscal loosening that would reemerge overheating pressures and large shifts in fiscal stance. - Counsel against excessive boosts in capital spending and large increases in current spending (including wages). - Recommend targeting a smaller fiscal deficit in the range of 1–2 percent of GDP in FY2016/17. - Recommend targeting a small surplus of around ½ percent of GDP in FY2017/18. - Revenue-side priorities: - Tax revenues projected to fall to 13.2 percent of GDP in FY2015/16 and FY2016/17 (from 15.2 percent of GDP in FY2012/13). - Tax exemptions and holidays estimated by authorities to result in revenue loss of up to 2 percent of GDP. - Staff recommends avoiding new exemptions, not renewing expiring exemptions, and phasing out existing exemptions. - Listing and costing all tax expenditures should be integral to the budget. - Authorities working to introduce a modern GST by end-2018 with IMF/World Bank technical assistance; each percentage point increase in the GST is estimated to yield 0.3 percent of GDP in revenues. - Expenditure-side and institutional recommendations: - Over the medium term: contain high public debt, avoid excessive fiscal volatility, and prevent external pressures. - Expenditure objectives: (i) keep current spending growth moderate to support debt reduction; (ii) ensure revenue/grant volatility does not cause high spending volatility. - Consider strengthening fiscal institutional framework to manage spike in hydropower-related revenues. - Options: introduce a fiscal rule to constrain current spending growth; create a separate account (or stabilization fund) to temporarily “park” additional hydropower revenues. ### Authorities’ views on fiscal policy - Observations: - Actual fiscal outcomes typically stronger than budgeted because capital spending tends to lag early in Five-Year Plans. - Absorptive capacity limits increases in capital spending; agencies often under-spend budgets. - Authorities exercise tight control over recurrent spending and expect actual deficits lower than budgeted in some years. - Revenue mobilization: - Financing 85 percent of total spending from domestic revenues at end of 11th FYP will not be met. - Domestic revenues flat; increasing tax revenues requires parliamentary action. - Authorities aim to introduce reformed GST before the 2018 elections. - Hydropower revenue management: - Authorities agree projected hydropower revenues need careful management. - Discussions ongoing on establishing a stabilization fund; no decision made. - Authorities emphasize retaining flexibility to use hydropower revenues to finance development given gradual phasing out of external support. *Source: INTRODUCTION (pages 3–13) of the IMF staff report content unit _cr16206.* --- ### Credit, Monetary Policy, and Financial Sector ### Credit growth and monetary operations - Historical pattern: - Credit to private sector averaged 35 percent growth in 2005–2011; fell to below 10 percent in 2013 and 2014. - After September 2014 termination of the ban on vehicle and housing loans, credit growth picked up in 2015 to the 13–14 percent range for most of the year. - Liquidity management: - To sterilize excess liquidity, RMA increased CRR from 5 to 10 percent in March 2015. - RMA must rely on CRR and SLR as main monetary policy instruments at this stage. - Financial soundness: - In wake of slowdown, some indicators improved modestly. ### Prudential measures and supervision - RMA expanding macro-prudential toolkit; ADB-supported comprehensive framework in 2014. - Implemented measures 2014–2016: loan-to-value and loan-to-income; other tools (counter-cyclical capital buffer, sectoral capital requirements) not yet operationalized. - Macro-prudential measures outlined include: - minimum leverage ratio; - counter-cyclical capital buffer; - sectoral capital requirements; - loan-to-value and loan-to-income restrictions; - debt-to-equity ratio; - time-varying capital provisioning and margin requirements; - restrictions on profit distribution. - Regulatory gap: NBFIs supervised as banks; specific risks (e.g., insurance risk) not properly monitored. ### Staff views and recommended monetary reforms - Current conditions: broadly appropriate; decline in inflation not indicative of slack and likely partly reversible. - Domestic demand appears to be picking up; FY2016/17 fiscal stance likely expansionary. - RMA should monitor liquidity and be ready to respond to resumption of excessive credit growth. - Rupee inflows related to hydropower/projects and grants should be sterilized. - Recommended steps: - (i) develop short-term government securities market with market-determined T-bills; - (ii) improve RMA liquidity forecasting and MoF government cash-flow forecasting; - (iii) promote development of interbank lending market; - (iv) introduce RMA short-term (overnight) standing lending facility at a penalty rate; - (v) consider introducing RMA standing deposit facility for overnight deposits at penalty (low) rates. - Consider reforming base interest rate system (see Box 3). - Benefits of improved monetary operations: - improved monetary policy transmission; - increased supply of government securities for liquidity management and investment; - creation of risk-free benchmark yield curve to develop corporate bonds and equity markets. - Staff supports publication of T-bill issuance calendar and improvements in debt management policy, including long-term domestic debt market development. ### Authorities’ views on monetary policy and financial access - Authorities agree on need to strengthen monetary transmission and monitor India’s monetary stance given the peg. - CRR seen as a blunt instrument; RMA considering overnight lending and deposit windows to replace sweeping overnight balances. - Development of interbank market needs short-term collateral instruments (certificates of deposit, short-term government securities). - Need to develop legal framework for creditor-debtor relationships. - Authorities note widespread dissatisfaction with base interest rate system; envisage review and possible single base rate. - Concern about insufficient access to credit for MSMEs; considering establishing a specialized credit institution. - World Bank Financial Sector Development Action Plan expected to address these issues. --- ### External Sector, Reserves, and External Debt ### External sector and reserves - Current account deficit estimated close to 29 percent of GDP in FY2014/15; about one half was deficit with India. - Exports and imports (goods) growth picked up to about 8 percent in FY2014/15. - Foreign currency reserves recovered to US$1,022 million by February 2016 — covering about 11 months of imports of goods and services and about 53 percent of external debt. - Commissioning of new hydropower plants will sharply increase hydropower exports; current account projected to turn into surplus medium-term. - External PPG debt increased to 94.5 percent of GDP in 2015 (from 93.6 percent in 2014); projected to peak around 113 percent of GDP in 2017 before declining. - All indicative LIC-DSA thresholds are breached in the baseline; breaches indicate a high risk of external debt distress, but unique mitigating factors point to risk remaining moderate. - Unique mitigating factor: explicit guarantees from India covering financial and construction risks for all hydropower projects allow exceptional treatment of hydropower loans from India similar to FDI. - Staff assesses REER as moderately overvalued using adjusted external sustainability approach. - Peg to Indian rupee remains an appropriate nominal anchor. - Reserve adequacy: - As of February 2016, convertible currency reserves represented close to 80 percent of total reserves. - Staff advises gradual increase in share of rupee reserves to better align with liabilities and trade structure. - Staff welcomes swap agreement with RBI and access under SAARC Currency Swap Agreement up to US$100 million or equivalent. - Staff welcomes discussions with RBI to transact INR against USD and gain access to Indian Government securities. - Planned participation in World Bank RAMP expected to improve RMA debt management skills. - Staff welcomes removal of some 2012 exchange restrictions; INR access restrictions for certain imports removed in 2014. - Authorities continue to consider some restrictions under Article XIV necessary. ### Box 5 — Reserve adequacy (highlights) - Reserve developments: - End FY2014/15 reserves: US$958 million = 10.4 months prospective year imports. - February 2016: US$1,022 million. - Currency composition and rupee liquidity management: - RMA converted CC reserves in excess of US$700 million into INR in mid-2013; INR share rose from 1.5 percent to 21 percent. - End FY2014/15: INR share 17 percent (covering 2.3 months of Indian imports); CC holdings US$815 million (35 months of non-Indian import cover). - Reserve adequacy model: - Optimal aggregate gross reserves range: 1½ to 5½ months of import cover, depending on cost assumptions. - INR reserves cover less than model-implied optimal of 2–6½ months of Indian imports. - CC holdings exceed model-implied optimal of 7–10 months of imports. - Composite IMF metric stayed above the 150 percent upper bound during past decade. - Policy implications: - Hydropower pipeline and volatility in India-related flows imply need for active reserve management and adequate INR liquidity. - RBI arrangements useful for short-term rupee mismatches; continue monitoring currency composition. --- ### Debt Sustainability: Hydropower Dynamics and DSA Findings ### Recent debt developments and baseline assumptions - PPG external debt jumped to 94 percent of GDP in 2013 (from 75 percent in 2012) and remained relatively stable in 2014 and 2015. - Hydropower financing: primarily by India with 70 percent loans and 30 percent grants. - External debt composition: ~70 percent in Indian rupees; convertible currency debt ~30 percent of GDP. - Baseline assumes hydropower capacity will reach around 6,800 MW over next two decades (Box 4 baseline) and hydropower expansion will boost exports and revenues. - Five hydropower plants operating currently with total capacity about 1,600 MW; eight new projects to add 5,200 MW by 2026. - Second-generation projects: JV model with 70 percent loan financing from India; 30 percent equity split equally between India and Bhutan; India provides grant for Bhutan’s equity share. ### Key projections and thresholds (preserved values) - External PPG debt projected to peak at 113 percent of GDP in 2017, then 111 percent in 2018. - PPG debt projected to fall: - Below 50 percent of GDP by 2026. - Below 10 percent of GDP by 2036. - PV of PPG external debt-to-GDP declines to 5 percent over long term; crosses 40 percent threshold in 2027. - PV of PPG external debt-to-exports: - Remains above 150 percent until 2024; falls to 15 percent at end of projected period. - PV of PPG external debt-to-revenues: - Peaks close to 722 percent in 2018; falls below 250 percent in 2025; falls to 24 percent by 2036. - PPG debt service-to-exports ratio: - Peaks around 24 percent in 2017 and 2018; falls below 20 percent by 2019; marginally above threshold in 2020–22. - Debt service-to-revenue ratio: - Remains moderately above 20 percent indicative threshold for most of projection period; falls below 20 percent only in 2032. ### Sensitivity analysis and risk assessment - Indicative thresholds for PV of PPG external debt-to-GDP, debt-to-exports, and debt-to-revenue breached under alternative scenarios and stress tests; breaches persist for extended periods. - Standard sensitivity analysis indicates high risk of debt distress. - Unique mitigating circumstances temper risk: - Large share of external debt linked to GoI hydropower loans with GoI guarantees and cost-plus pricing including a 15 percent net return. - India’s large unmet power demand supports future electricity absorption. - Staff advises against nonconcessional borrowing at this stage. - Stress tests highlight vulnerability to export shocks, growth shocks, aid shortfalls, and failure to reverse declining tax revenues. ### Public debt (selected projections) - Public debt-to-GDP projected to peak around 115 percent in 2017. - Projected decline: below 60 percent in 2027 and 49 percent by 2036. - PV of public sector debt (selected): 109.2; 121.8; 129.6; 124.5; 114.8; 96.4; 87.1; 63.4; 46.5. --- ### Staff Appraisal, Policy Priorities, and Recommendations ### Macroeconomic outlook and priorities - Recent: growth picked up after the 2012–13 “rupee shortage crisis”; inflation falling rapidly; unemployment trending down but youth unemployment remains high. - Medium-term: growth will gain momentum with hydropower commissioning; important to avoid overheating and imbalances. - Fiscal policy: - Avoid disorderly easing of fiscal stance. - Caution against big jumps in capital spending; a FY2016/17 deficit in excess of 5 percent of GDP would be an unsuitably large stimulus and risk stretching absorption capacity. - Strengthen fiscal institutions to manage projected spike in hydropower revenues. - Revenue and exchange rate peg: - Address weak revenue performance to sustain fiscal viability and the peg. - Reassess policy of tax exemptions and proceed with sales tax reform to implement GST by 2018. ### Monetary and financial sector priorities - Maintain vigilance on liquidity and credit growth. - Develop short-term government securities and interbank markets to improve monetary transmission. - Expand and operationalize macro-prudential toolkit; close regulatory gaps for NBFIs. - Reform base rate system to improve timeliness and transmission (Box 3 prescriptions). ### Reserve and external management - Continue improving reserve management and currency composition; increase INR holdings gradually to align with liabilities and trade. - Use RBI swap and SAARC Currency Swap Agreement as liquidity backstops (up to US$ 100 million or equivalent). - Continue discussions to access INR against USD and Indian Government securities. --- ### Institutional Engagement, Development Partners, and Statistics ### Development partner programs and financing (selected) - World Bank IDA: around $15-20 million per year new resources. - Net commitment of IDA: $82 million across listed operations. - DPC-2 approved August 2014 for $20 million. - IFC: total committed investment portfolio about $34 million. - Example investments: $12 million hazelnut plantation; earlier $10 million hotel debt assistance liquidated June 2015. - ADB: - COBP 2016–2018 indicative cumulative lending allocation: $327.87 . - Nonlending program programmed amount 2016−2018: $2.3 million. - Ongoing loans and grants listed with project amounts and disbursements as of 31 March 2016 (selected: Urban Infrastructure Project $18.00m, disbursed $2.42m; Second Green Power Development Project OCR loan $70.0m, disbursed $2.42m; Rural Renewable Energy Development Project grant $21.59m, disbursed $16.24m). ### Statistics and data adequacy (as of May 20, 2016) - Data provision timeliness has shortcomings but broadly adequate for surveillance; main weaknesses: national accounts, balance of payments, fiscal data. - National accounts: heavy reliance on line ministries’ production data; long lags; no quarterly national accounts produced. - CPI: compiled quarterly since 2004; monthly CPI series for domestic and imported goods starting April 2013 being released. - GFS: improvements but frequent substantial revisions in expenditure; limited budget execution dissemination. - Monetary statistics: generally consistent with Fund guidelines; valuation of financial assets requires improvement. - BOP and IIP: dissemination moved from annual to quarterly (6th format); RMA expected to report external debt statistics to World Bank QEDS soon. - Bhutan participates in GDDS/e-GDDS; assessed Baseline-2 after e-GDDS in May 2015. --- ### Annex I — Risk Assessment Matrix (selected high-likelihood / high-impact items and mitigation) - Mismatches in rupee inflows and outflows: - Likelihood: H; Impact: H. - Mitigations: build INR buffers by holding larger share of reserves in rupees; develop FX cash-flow forecasting framework. - Delayed project implementation: - Likelihood: M; Impact: H. - Mitigations: constrain non-essential spending; broaden tax base and improve tax administration. - Structurally weak growth in key economies (external risk): - Likelihood: M; Impact: H. - Mitigations: scale back non-essential spending and mobilize domestic revenues to preserve fiscal response scope. - Tourism slowdown (external): - Likelihood: H; Impact: M. - Mitigation: promote other BOP receipts such as FDI. *Source: IMF staff report content unit _cr16206.* ### INTRODUCTION __________________________________________________________________________________ 3 ### INTRODUCTION ### Macroeconomic developments and outlook - Bhutan experienced political stability and more than doubling of GDP per capita during 2004–2014, rising from $1,108 to $2,612. - Real GDP growth: - Averaged around 8 percent during the Ninth and Tenth Five-Year Plan (FY 2003/04–2012/13). - Fell to below 4 percent in FY2012/13 and FY2013/14. - Estimated at 5.2 percent in FY2014/15. - Projected to reach 6 percent in FY2015/16. - Projected to accelerate to over 11 percent in FY2017/18 and to around 14 percent in FY2018/19, supported by a tripling of hydropower electricity generation. - Inflation: - Peaked at 11.3 percent in Q4 2013 (y-o-y). - Fell to 3.5 percent at the end of 2015. - Declined to below 3 percent in February and March 2016. - Imported goods inflation: fell from 6.2 percent to 1.8 percent (last twelve months). - Domestic goods inflation: eased from 6.5 percent to 4.2 percent (last twelve months). - Labor market: - Overall unemployment in 2014: 2.6 percent of the labor force (down from 2.9 percent in 2013). - Youth and urban unemployment are significantly higher than the overall rate. - External sector and reserves: - FY2014/15 current account deficit increased to close to 29 percent of GDP. - International reserves fell marginally to $960 million by June 2015, before recovering to $1,022 million in February 2016. - Trade deficit widened to Nu.13.3 billion in July-December 2015 compared to Nu.6.8 billion in the same period of 2014. - The ngultrum (Nu) has been pegged to the Indian rupee at a parity rate since its introduction in 1974. - Credit and financial sector: - Bank credit to the private sector decelerated in 2012–2014 to below 10 percent, then picked up to about 13–14 percent in 2015 and is around 46 percent of GDP. - Credit outstanding by nonbank financial institutions (NBFIs) almost doubled between end-2013 and end-2015, now representing 17 percent of total financial institutions’ credit, compared to 12 percent in 2013. - Banks’ capital adequacy ratio: 17 percent by September 2015 (above the 10 percent required minimum). - Non-performing loans (NPLs): around 10 percent of outstanding loans. - Bank credit-to-deposit ratio: fell from 86.4 percent in 2013 to 73 percent in 2014, before increasing to about 80 percent in 2015. - Fiscal outcomes and projections: - FY2013/14: surplus of 3.8 percent of GDP (first year of 11th FYP). - FY2014/15 revised budget envisaged a deficit of 2.3 percent of GDP; budget outturn entailed a surplus of 1.5 percent of GDP. - Medium-term current account deficit projected to peak at 31.5 percent of GDP in FY2016/17, then fall quickly in FY2017/18 and eventually turn into a surplus. - Overall balance projected to be mostly positive, supported by hydropower grants and loans. ### Risks to the outlook - Downside risks dominate: - Domestic: managing high debt and potentially volatile hydropower-related inflows that may fuel rapid credit growth and renewed external pressures. - External: weaker tourism, adverse developments in China affecting exports (including ferroalloy producers), Nepal’s earthquake, and regional security concerns. - Upside: continued strong growth in India, with the caveat that reform setbacks there could weaken activity. ### Fiscal policy — staff assessment and recommendations - Recent fiscal stance and risks: - For FY2015/16, revised budget projected a deficit of 3 percent of GDP, but outturn projected to be a surplus of 0.6 percent. - Authorities assumed a large jump in capital spending (budgeted over 70 percent increase, now projected at about 30 percent). - If fully implemented, budgeted capital spending for FY2016/17 could result in a deficit of over 5 percent of GDP. - Donor financing is projected to fall over the medium term as per capita incomes rise, while hydropower-related revenues are projected to increase with new hydropower plants. - Near-term staff recommendations: - Avoid fiscal loosening that would reemerge overheating pressures and large shifts in the fiscal stance. - Specifically, counsel against attempts to boost capital spending excessively and against large increases in current spending (including wages). - Recommend targeting a smaller fiscal deficit in the range of 1–2 percent of GDP in FY2016/17. - Recommend targeting a small surplus of around ½ percent of GDP in FY2017/18. - Revenue-side priorities: - Tax revenues projected to fall to 13.2 percent of GDP in FY2015/16 and FY2016/17, down from 15.2 percent of GDP in FY2012/13. - Tax exemptions and holidays estimated by authorities to result in a loss of revenue of up to 2 percent of GDP. - Staff recommends avoiding new tax exemptions, not renewing expiring exemptions, and phasing out existing exemptions. - Listing and costing all tax expenditures should become an integral part of the budget. - Authorities are working to introduce a modern goods and services tax (GST) by end-2018 with IMF/World Bank technical assistance; each percentage point increase in the GST is estimated to yield 0.3 percent of GDP in revenues. - Expenditure-side and institutional recommendations: - Over the medium term, priorities are to contain high public debt, avoid excessive volatility in the fiscal stance, and prevent external pressures from emerging. - Expenditure objectives: (i) keep current spending growth moderate to support debt reduction; (ii) ensure volatility in revenues and grants does not lead to high spending and fiscal stance volatility. - Consider strengthening the fiscal institutional framework to manage the expected spike in hydropower-related revenues. - Options discussed include introducing a fiscal rule to constrain the growth of current spending and creating a separate account (or stabilization fund) to temporarily “park” additional hydropower revenues to avoid hurried spending and real exchange rate appreciation. ### Authorities’ views on fiscal policy - Observations: - Actual fiscal outcomes are typically stronger than budgeted because capital spending tends to lag in early years of Five-Year Plans while preparatory work and donor coordination occur. - Capital spending is budgeted to increase significantly in FY2015/16 and FY2016/17, but absorptive capacity limits how much can be usefully increased; agencies often do not spend full budgeted amounts. - Authorities exercise tight control over recurrent spending and expect actual deficits to be lower than budgeted in some years. - Revenue mobilization: - Financing 85 percent of total spending from domestic revenues at the end of the 11th FYP will not be met. - Domestic revenues have been flat; increasing tax revenues will require parliamentary action. - Authorities recognize the importance of introducing the reformed GST and aim to have it in place before the 2018 elections. - Hydropower revenue management: - Authorities agree projected increases in hydropower-related revenues need careful management. - Discussions on establishing a stabilization fund have been ongoing, but no decision has been made. - Authorities emphasize the need to retain flexibility to use expected hydropower revenues to finance economic development given likely gradual phasing out of external support. *Source: INTRODUCTION (pages 3–13) of the IMF staff report content unit _cr16206.* ### 21. The slowdown in credit growth during 2013 and 2014 partly reversed in 2015. After a ### _cr16206 - 21. The slowdown in credit growth during 2013 and 2014 partly reversed in 2015. After a ### Credit growth and monetary operations - After a period of rapid growth in credit to the private sector averaging 35 percent in 2005–2011, credit growth fell to below 10 percent in 2013 and 2014. - Following the September 2014 termination of the ban on vehicle and housing loans, credit growth picked up in 2015, though it remained in the 13–14 percent range for most of the year. - To sterilize persistent excess liquidity in the banking system, in March 2015, the Royal Monetary Authority (RMA) increased the cash reserve ratio (CRR) from 5 to 10 percent. - In the wake of the credit slowdown, financial soundness indicators have improved modestly. - At this stage, the RMA needs to rely on CRR and the statutory liquidity ratio (SLR) as the main available monetary policy instruments. ### Prudential measures and financial sector supervision - The RMA is expanding its toolkit of prudential measures, increasing reliance on macro-prudential regulations. - In 2014, with support of the Asian Development Bank (ADB), the RMA outlined a comprehensive framework for macro-prudential policy. - During 2014–2016, some macro-prudential regulations such as the loan to value and loan to income were implemented, while others—including counter-cyclical capital buffer and sectoral capital requirements—are yet to be operationalized and used. - Macro-prudential measures outlined included: (i) minimum requirement for leverage ratio; (ii) counter-cyclical capital buffer; (iii) sectoral capital requirements; (iv) loan-to-value and loan-to-income restrictions; (v) debt-to-equity ratio; (vi) time varying capital provisioning and margin requirements; and (vii) restrictions on the distribution of profits. - Technical assistance on implementation has been provided by the IMF’s Monetary and Capital Market Department (MCM). - Regulatory gap: nonbank financial institutions (NBFIs) are currently supervised as banks; some specific risks, such as insurance risk, are not properly monitored and covered. ### Staff views and recommended monetary reforms - Current monetary conditions appear broadly appropriate; decline in inflation does not reflect slack and is likely to be partly reversed. - Domestic demand and economic activity appear to be picking up, as suggested by accelerating import and growth. - Fiscal policy stance is likely to continue to be expansionary in FY2016/17, adding to demand growth. - RMA should monitor liquidity and stand ready to promptly respond in case of a resumption of excessive credit growth that would lead to a pickup in inflation or external pressures. - Rupee inflows related to hydropower projects and grants should continue to be sterilized. - Recommended steps to strengthen monetary management: - (i) develop the short-term government securities market, with T-bills at market-determined rates providing a tool for liquidity management (which includes meeting the SLR requirements) and an investment alternative; - (ii) improve RMA’s ability to forecast liquidity in the financial sector and the Ministry of Finance’s (MoF) ability to forecast government cash flow; - (iii) promote further development of the interbank lending market as a tool of first resort for banks to meet their short-term financing needs; - (iv) introduce a RMA short-term (overnight) standing facility at a penalty rate, to complement the interbank markets and RMA’s longer-term RSTLAW facility; - (v) consider introducing a similar RMA standing deposit facility, to allow banks to deposit excess liquidity overnight, with penalty (low) rates setting the floor for interbank deposit rates. - Consideration should also be given to reforming the system of base interest rates (Box 3). - Benefits of a more developed framework for monetary operations: - improved monetary policy transmission from policy rate to interbank and government securities rates and onwards to deposit and lending rates; - increased supply of government securities providing tools for liquidity management and investment; - creation of a risk-free benchmark yield curve to help develop corporate bonds and equity markets. - Staff supports discussions on publication of the T-bill issuance calendar and improvements in debt management policy, including development of a long-term domestic debt market. ### Authorities’ views on monetary policy and financial access - Authorities broadly shared staff’s view about monetary conditions and the need to strengthen monetary transmission. - Given the ngultrum’s peg to the Indian rupee and close ties to India, authorities need to closely follow India’s monetary stance. - The CRR is seen as a blunt instrument addressing both frictional and structural liquidity problems. - RMA is considering the introduction of short term (overnight) lending and deposit windows, to replace the system of sweeping overnight balances. - For successful development of the interbank market, short-term instruments to be used as collateral are required, including banks’ certificate of deposits and short-term government securities. - A proper legal framework to regulate creditor-debtor relationships needs development. - Authorities noted widespread dissatisfaction with the current system of the base interest rate and are envisaging a review, possibly introducing a single base rate. - Authorities are concerned about insufficient access to credit for certain borrowers, especially micro, small and medium-sized enterprises (MSMEs); they see excess credit financing consumption rather than investment. - Establishing a specialized credit institution is one option under consideration. - The World Bank’s Financial Sector Development Action Plan is expected to address these issues. ### External sector: deficits, reserves, and external debt - The current account deficit is estimated to have approached 29 percent of GDP in FY2014/15, of which about one half was the deficit with India. - Growth of exports and imports (goods) picked up in FY2014/15, to about 8 percent. - Foreign currency reserves recovered in FY2015/16, reaching US$ 1,022 million by February 2016, covering about 11 months of imports of goods and services, and represent about 53 percent of external debt. - In the medium-term, commissioning of new hydropower plants will increase hydropower exports sharply, and the current account deficit is projected to turn into a surplus. - External public and publicly guaranteed (PPG) debt increased moderately in 2015, to 94.5 percent of GDP, from 93.6 percent of GDP in 2014, and is projected to peak at around 113 percent of GDP in 2017, before starting to decline. - All indicative thresholds of the LIC-DSA are breached in the baseline; the extent and length of the breaches indicate a high risk of external debt distress, but unique mitigating factors point to risk remaining moderate. - Unique mitigating factor: explicit guarantees from India that cover financial and construction risks for all hydropower projects allow exceptional treatment of hydropower loans from India similar to that of FDI. - Staff assesses the real effective exchange rate to be moderately overvalued relative to fundamentals using the adjusted external sustainability approach. - The peg to the Indian rupee continues to remain appropriate as a nominal anchor. - Reserve adequacy: All standard measures of reserve adequacy for Bhutan are met by a wide margin, but composition is suboptimal. - As of February 2016, convertible currency reserves still represented close to 80 percent of total reserves. - Further gradual increase in the share of rupee reserves is advised to better align the currency composition of reserves with Bhutan’s external liabilities and trade structure. - Staff welcomes steps to strengthen reserve management, including the swap agreement with the Reserve Bank of India (RBI) to receive liquidity support. - Under the SAARC Currency Swap Agreement signed with the RBI, the RMA can make withdrawals of US dollar, Euro or Indian Rupee up to a maximum US$ 100 million or its equivalent. - Staff also welcomes discussions with the RBI to sell or buy Indian rupee (INR) against USD and gain access to Indian Government securities. - Bhutan’s planned participation in the World Bank’s Reserve Advisory Management Program is expected to improve RMA’s debt management skills. - Staff welcomes removal of some exchange restrictions introduced in 2012; restrictions on INR access for certain imports were removed in 2014. - Authorities continue to consider as necessary the maintenance of existing restrictions under Article XIV, and those inconsistent with Article VIII obligations (see Information Annex). ### Staff appraisal: macroeconomic outlook and policy priorities - Recent developments: - Growth picked up after deceleration from the “rupee shortage crisis” of 2012–13. - Inflation has been falling rapidly to record-low levels, reflecting a decline in both imported and domestic goods inflation. - Unemployment rate has been trending down, though high youth unemployment continues to pose a problem. - Medium-term: growth is projected to gain further momentum with commissioning of new hydropower plants; important to avoid overheating and imbalances as growth accelerates. - Fiscal policy: - A disorderly easing of the fiscal stance should be avoided. - In the final years of the current 11th Five-Year Plan, capital spending is expected to accelerate as project implementation gathers speed. - Staff cautions against big jumps in capital spending; a FY2016/17 deficit in excess of 5 percent of GDP would provide an unsuitably large stimulus and could stretch absorption capacity. - A stronger fiscal institutional framework could help manage the projected spike in revenues related to increased hydropower production. - Revenue and exchange rate peg: - Addressing weak revenue performance is crucial for long-term fiscal sustainability and maintaining the exchange rate peg. - With external grants expected to gradually decline, authorities emphasize increasing reliance on domestic revenues. - In recent years, tax revenues have been weak due to increased use of tax expenditures that erode the tax base, weaken tax compliance and complicate tax administration. - The policy of granting tax exemptions and incentives needs to be reassessed. - The reform of the sales tax, with the objective of replacing the existing inefficient sales tax with a modern GST, should proceed as planned and be implemented by 2018. *Source: IMF staff report content provided in the supplied document.* ### 40. Staff views monetary conditions to be broadly appropriate. After a sharp slowdown in the ### Staff views monetary conditions to be broadly appropriate ### Monetary conditions and liquidity - After a sharp slowdown following the “rupee shortage crisis” of 2012-13, credit growth has picked up more recently but “remains within a moderate range.” - To absorb excess liquidity, the RMA increased the cash reserve ratio (CRR) in March 2015. - At the time of the assessment, there are “no signs of excess or shortage of banking sector liquidity.” - Recommendations: - RMA needs to remain vigilant, monitor liquidity conditions and credit growth closely, and stand ready to respond as needed. - Bhutan’s “still rudimental system of liquidity management needs further improvement.” ### Financial supervision and regulation - Steps to strengthen supervision and regulation are welcome; RMA has expanded its macroprudential toolkit. - Gaps remain in the regulation of nonbank financial institutions and should be closed. - A more robust and effective regulation and supervision framework is needed to underpin financial deepening without risking financial stability. - Financial soundness indicators: - Capital ratio “remains solid.” - NPLs “have declined moderately.” ### Exchange rate, real effective exchange rate (REER), and the peg with India - The real exchange rate is assessed as “moderately overvalued,” but the exchange rate peg with India “continues to serve Bhutan well.” - Adjusted external sustainability approach (tailored for temporary electricity-related flows) suggests a moderate REER overvaluation. - Policy requirements to sustain benefits of the peg: - Disciplined fiscal and monetary policies supporting moderate inflation. - Measures to improve the business climate to prevent the exchange rate deviating significantly from fundamentals. ### External reserves and reserve management - Standard metrics show Bhutan’s reserves are “adequate.” - External reserves amount to “about one half of GDP,” increasing importance of proper reserve management. - Recommendations for reserve management: - Align the currency composition of reserves with the composition of external debt and trade flows by reducing the share of convertible currency reserves and increasing the share of Indian rupee-denominated reserves. - Implement new reserve management policies and investment guidelines. ### Exchange restrictions and IMF obligations - Authorities did not request, and staff does not recommend, approval of exchange restrictions maintained inconsistent with Article VIII obligations. - Bhutan maintains exchange restrictions under the transitional arrangements of Article XIV, Section 2. - Staff view: - Recognizes limited and unpredictable sources of convertible currency inflows and justifiable concerns over outflows. - Encourages gradual easing of exchange restrictions towards eventual elimination, including those maintained under Article XIV, Section 2, to be eliminated “as soon as Bhutan’s balance of payments positions permits.” - Encourages consideration of accepting obligations under Article VIII, Sections 2(a), 3 and 4 of the IMF’s Articles of Agreement in due course. ### Article IV consultation cycle - Recommendation: the next Article IV consultation should take place on a 24-month cycle in accordance with Decision No. 14747-10/96. ### Box 1 — Inflation: Near-Term Outlook and Long-Term Considerations - Key linkages between Bhutan and India inflation: - Food accounts for “about 40 percent” of the CPI basket in Bhutan and “about 50 percent” in India. - Bhutan imports “90 percent” of its imports from India. - Long-standing FTA and the ngultrum’s peg to the Indian rupee underpin the linkage. - Empirical findings: - Inflation rates in the two countries “co-move in the long-term.” - Indian inflation is “exogenous” to Bhutan’s inflation. - Temporary divergences tend to converge within “about one year.” - VECM-based model extension indicates actual CPI level as of March-2016 exceeded the model predicted level by “about 1 percentage point,” reflecting Bhutan’s positive inflation differential with India over 2014–2015H1. - Outlook and policy implications: - Near-term baseline: Bhutan’s inflation likely to remain slightly below India’s, with error-correction dynamics driving convergence. - India’s adoption of a flexible inflation targeting regime with a “4 percent” headline CPI target and a “+/- 2 percent” band has helped reduce food and non-food inflation in Bhutan. - Bhutan will benefit from India’s improved inflation outlook, but idiosyncratic drivers require continued careful monetary policy management. ### Box 2 — Labor Market: Problems and Solutions - Unemployment and labor statistics (2014): - Overall unemployment rate: “2.6 percent” (11,000 unemployed; compares with 50,000 foreign workers currently in Bhutan). - Male unemployment rate: “1.9 percent.” - Female unemployment rate: “3.5 percent.” - Youth unemployment rate: “9.7 percent.” - Urban unemployment rate: “6.7 percent.” - Rural unemployment rate: “1.2 percent.” - Causes of high youth unemployment: - Skills mismatch between young people and employer demand. - Occupational preferences and perceptions of public sector jobs offering better security and pay. - High reservation wages among urban youth and family support during unemployment. - Hydropower sector’s limited employment for Bhutanese during construction: up to “18,000” workers at ongoing three hydropower projects, but only about “20 percent” are Bhutanese citizens. - Solutions and policy actions: - Government target: reduce unemployment to “2.5 percent.” - Steps undertaken: six hydropower training centers, job fairs, requirement for government agencies to build crèches, programs to send people overseas for employment (mainly to India, Thailand and Middle East). - Support development of labor-intensive SMEs and improve access to finance. ### Box 3 — Base Rate System in Bhutan - Background: - Bhutan’s base rate system in place since “2012” modeled on India’s base rate system implemented in “2010.” - Base rate is a minimum lending rate incorporating cost of funds, costs of complying with regulations (CRR or SLR), overhead costs, and profitability; exemptions exist for priority sectors. - RMA has played an active role in base rate setting, including ad hoc adjustments to promote uniformity across institutions. - Shortcomings: - Annual review practice hampers monetary transmission by imposing a one year-lag. - Lack of uniformity in application and ad hoc adjustments reduce transparency and efficiency. - Banks with access to external aid and hydropower-related funds have had significantly lower calculated base rates. - Most loans in Bhutan are medium- and longer-term fixed-rate, limiting the base rate’s intended role as a reference for floating-rate loans. - Policy recommendations: - Initiate semi-annual computation of base rates (steps already taken). - Consider features similar to India’s Marginal Cost of Funds-based Lending Rate (MCLR): limit funding costs to more recently raised funds, assign greater weight to recent funds, and adopt monthly-based reviews to improve timeliness. - Promote greater use of variable-rate lending to enhance monetary transmission and avoid undue increases in real interest rates. ### Box 4 — External Sector Assessment - Standard EBA results and limitations for Bhutan: - EBA Lite current account (CA) methodology for FY2015/16 suggests current account norm of about “-8.7 percent of GDP.” - External sustainability (ES) approach suggests a norm of about “-5.5 percent of GDP.” - These approaches do not account for temporary hydropower-related imports and future electricity exports and therefore may misinterpret near-term CA deficits as significant overvaluation. - Bhutan is not part of the EBA Lite sample; country-specific constant was set to ensure sample residuals sum to zero during 1995–2013, leading to a 2015 REER estimated to be “undervalued by 7.8 percent.” - Adjusted external sustainability approach: - Adjustment incorporates temporary effects of electricity-related imports during hydropower construction and future electricity exports. - Baseline simulation assumptions: - Bhutan’s total electricity generation capacity will reach around “6,800 MW” over the next two decades. - From then onwards, generation capacity is held constant and annual growth of domestic consumption is assumed at “5 percent.” - From “2075,” when electricity generation is estimated to be sufficient to meet domestic consumption, net electricity exports are assumed at zero. - The adjusted approach suggests a CA norm of a deficit of “around 25 percent of GDP” for FY2015/16. - Based on current account elasticity to REER of “-0.25 percent,” REER overvaluation is estimated at “around 6 percent.” - Overall assessment: - Taking empirical EBA-type estimates and hydropower-related uncertainties into account, the exchange rate is assessed as “mildly overvalued.” - The external position is expected to reverse large CA deficits and negative net foreign asset position over the medium term. - Bhutan’s peg with the Indian rupee and macroeconomic policies are “broadly appropriate” with this arrangement. - International reserves have grown steadily and are adequate for precautionary purposes. *Prepared by IMF staff as presented in the cited IMF staff report section.* ### Box 5. Assessing Reserve Adequacy ### Box 5. Assessing Reserve Adequacy ### Recent reserve developments - After a dip in reserves in FY2011/12 due to overheating pressures, Bhutan’s international reserves have grown steadily over the last three years largely resulting from aid inflows. - At the end of FY2014/15 reserve holdings stood at US$958 million, corresponding to 10.4 months of prospective year imports. - As of February 2016, reserve holdings reached US$1,022 million. - Bhutan’s reserve position is higher than suggested by standard “rules of thumb” metrics, such as coverage of 3 months of imports of goods and services, 100 percent of short-term debt and 20 percent of broad money in the economy. ### Currency composition and rupee liquidity management - A mismatch exists between the currency composition of reserves and the structure of Bhutan’s external liabilities and trade: Bhutan’s currency is pegged to the Indian rupee (INR) and international transactions are predominantly with India, yet the share of INR-denominated assets in reserves has been low. - During 2010-13 overheating pressures led to a shortage of rupee reserves, with rupee-imports coverage ratio falling to less than 1 month, while convertibility of hard currency reserves was hindered. - To ease rupee liquidity the Royal Monetary Authority (RMA) borrowed large INR amounts at costly terms from select Indian commercial banks and tapped its currency swap arrangement with the Reserve Bank of India (RBI). - The RMA subsequently decided to convert convertible currency (CC) reserves in excess of US$700 million into INR, which increased the share of INR reserve holdings from 1.5 percent to 21 percent in mid-2013. - At the end of FY2014/15: - INR reserve holdings had a share of 17 percent, providing cover for 2.3 months of imports from India. - CC reserve holdings stood at US$815 million, corresponding to 35 months of non-Indian import cover. - A recent agreement with the RBI to receive liquidity support will help strengthen reserve management. ### Reserve adequacy assessment (IMF low-income country metrics and model calibration) - The optimal level of international reserves is assessed using IMF metrics tailored to low-income countries and a cost-benefit approach weighing reserves' role in preventing/mitigating absorption drops from large external shocks against the costs of holding reserves. - Calibrating the model for Bhutan yields optimal levels of aggregate gross reserves in the range of 1½ to 5½ months of import cover depending on assumptions about the cost of holding reserves. - When currency composition is taken into account: - INR reserves cover less than the model-implied optimal level of 2-6½ months of Indian imports. - CC holdings significantly exceed the model-implied optimal coverage level of 7–10 months of imports. - The composite IMF metric for Bhutan (constructed by assuming reserves must fully cover debt service requirements, part of the import bill and M2) shows reserve coverage has stayed comfortably above the 150 percent range (upper bound) during the past decade. ### Policy implications and recommendations - The large number of hydropower projects in the pipeline and volatility in external flows to and from India will likely contribute to volatility in rupee reserves, requiring more active reserve management. - The arrangements with the RBI will play a useful role in addressing short-term mismatches in rupee inflows and outflows. - Continued monitoring of currency composition and targeted actions to ensure adequate INR liquidity are implied by the assessment (given that aggregate reserves exceed some model-implied levels while rupee coverage remains below model-implied optimal ranges). *Prepared by Purva Khera. Source: Box 5, "Assessing Reserve Adequacy," IMF staff report.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Domestic Risks - Mismatches in rupee inflows and outflows - Likelihood: H - Impact: H - Description: Mismatches in Indian rupee inflows and outflows, and prospective bulky debt service payments could lead to renewed pressure on rupee reserves and could tighten liquidity conditions. - Policies to Minimize Impact: - Build Indian rupee buffers by holding a larger share of reserves in rupees to meet obligations. - Develop a foreign exchange cash-flow forecasting framework to anticipate pressures and build buffers. - Delayed project implementation - Likelihood: M - Impact: H - Description: Delays in projected completion of hydropower projects could lead to lower electricity exports and larger fiscal deficits. - Policies to Minimize Impact: - Constrain non-essential expenditure growth. - Implement measures to broaden tax base and improve tax administration. - Debt sustainability - Likelihood: M - Impact: M - Description: So far, hydropower projects have been government-to-government. The next generation of hydropower projects will rely on joint ventures, with some risks shifting to the Government of Bhutan. - Policies to Minimize Impact: - Strengthen the capacity to evaluate and manage the risks from joint venture hydropower projects. - Bank balance sheet risks - Likelihood: M - Impact: M - Description: Following a period of rapid credit growth, banks’ asset quality has been volatile and asset-liability maturity mismatch persists. NPLs remain elevated, and liquid assets ratio fell. - Policies to Minimize Impact: - Avoid loosening of liquidity conditions. - Strengthen and intensify supervision and tighten prudential regulations. - Take early action as signs of deteriorating asset quality emerge. ### External Risks - Structurally weak growth in key advanced and emerging economies - Likelihood: M - Impact: H - Description: Delays in structural reform could weaken growth in India, which could adversely affect non-hydro exports, aid and hydropower construction disbursements to Bhutan. - Policies to Minimize Impact: - Scale back non-essential spending plans while mobilizing domestic revenues, to maintain scope for fiscal response. - Renewed pickup of inflation in India - Likelihood: M - Impact: M - Description: The recent slowdown in India’s inflation could be temporary, reflecting decline in global commodity prices. Renewed inflation would push up imported inflation from India which would hurt the poor. - Policies to Minimize Impact: - Tighten monetary conditions and reduce bank liquidity to prevent second-round effects from building. - Tourism slowdown - Likelihood: H - Impact: M - Description: Nepal earthquake and regional security concerns adversely affect tourism receipts. - Policies to Minimize Impact: - Promote other sources of BOP receipts such as FDI. "L"=Low; "M"=Medium; "H"=High. *Source: Annex I. Risk Assessment Matrix (_cr16206 - Annex I. Risk Assessment Matrix).* ### 2014. It supports the Royal Government of Bhutan Eleventh Five-Year Plan (11FYP) (2013–2018) ### _cr16206 - 2014. It supports the Royal Government of Bhutan Eleventh Five-Year Plan (11FYP) (2013–2018) ### Overview: Eleventh Five-Year Plan (11FYP) and CPS focus - The 11FYP (2013–2018) was approved by the Parliament in October 2013. - Government focus: Self Reliance and Inclusive Green Socio-economic Development. - Self-Reliance definition: “ability to meet all national development needs as articulated through 5 year plans by 2020”. - Inclusive development definition: “reducing poverty and inequality by enhancing the standard of living and the quality of life of the most vulnerable sections of the society”. - CPS objectives: protect recent gains in reducing poverty by focusing on improving rural livelihoods, managing urbanization, and protecting natural assets. - CPS results areas: (i) improving fiscal and spending efficiency, (ii) increasing private sector growth and competitiveness, (iii) supporting green development. - Implementation agents: IDA and IFC through financial, analytical and advisory support. ### International Development Association (IDA) — World Bank: portfolio, pipeline, and ASA - New IDA resources provided: around $15-20 million of new IDA resources per year. - Ongoing specific investment operations: net commitment of $82 million of IDA, including: - Three country specific IDA operations: Urban Development II and additional financing; Remote Rural Communities Development. - One regional IDA project: Regional Cooperation on Wildlife Protection. - One GEF grant operation: Sustainable financing for biodiversity conservation. - Additional World Bank-managed small grants: climate resilience, disaster management, public financial management, urban budget processes, REDD+. - Development policy operations: three extended over last six years; most recent Development Policy Credit (DPC-2) approved in August 2014 for $20 million (first of a two-operation series focusing on macroeconomic and fiscal sustainability and improving the investment climate). - Projects under preparation: regional project to facilitate trade and ICT connectivity; second and last operation of the DPC series; a GAFSP-funded agriculture project; a regional hydromet project; a public transport project funded by GPOBA. - Analytical and Advisory Services (ASA) ongoing and recent work: - Ongoing: Public Expenditure and Financial Assessment (PEFA); assessment of environmental and social impact of hydropower; labor market study; agribusiness note; investment climate assessment. - Recent analytic work: policy note on macroeconomic impact of hydropower and the role of public finance; green growth study; food-security policy note; poverty assessment. - Technical assistance: improved investment climate; mining policy; financial sector action plan and implementation; review of Bhutan’s tourism policy; hydromet; disaster management and climate change (Bhutan is a pilot PPCR country); a procurement review for Thimphu municipality to use Alternative Procurement arrangements; support to statistical system to use CAPI solutions for surveys. - Multi-Donor Trust Fund on Public Financial Management expected effective in September 2016, with EU and ADA contributing a total of US$4m. - Bhutan Royal Monetary Authority expected to become a member of the Reserve Advisory Management Program (RAMP) of the World Bank Treasury. ### International Finance Corporation (IFC) - Total committed investment portfolio in Bhutan: about $34 million. - Portfolio composition: predominantly investments in the financial sector and support for expansion of a local hotel. - Investment examples: - IFC and partners investing $12 million in a hazelnut plantation project (using some IFC own funds and mobilizing GAFSP together with ADB). - IFC’s first debt assistance of $10 million to a hotel made in 2003 and successfully liquidated in June 2015. - Advisory portfolio: structuring PPPs; improving investment climate; enhancing access to financial services. - Advisory support to Ministry of Economic Affairs and Druk Holding and Investments to consider setting up a power trading company in India. - Areas explored for assistance: hydropower, tourism, manufacturing, agribusiness, health, education. - Expected continuation: advisory support on investment climate reforms, infrastructure development through PPPs, and the financial sector. ### Multilateral Investment Guarantee Agency (MIGA) - Bhutan became the 181st member of MIGA on October 21, 2014. - MIGA has not provided guarantee coverage for investment in Bhutan to date. ### Relations with the Asian Development Bank (ADB) - Bhutan became a member in 1982; ADB began lending operations in 1983. - Classification: Group A country; eligible for Asian Development Fund (ADF) resources. - Debt classification: moderately debt stressed; receiving a 50:50 mix of ADF loan and ADF grant assistance since 2011. - Cost-sharing ceiling set at 99 percent for loans, technical assistance, and other grants. - CPS (2014-2018) and COBP (2016-2018) implemented in line with the Eleventh FYP (2013–2018) and ADB Strategy 2020. - CPS overarching goal: support three strategic pillars — inclusive economic growth, environmentally sustainable growth, and regional cooperation and integration (RCI). - Core sectors of ADB operations: energy (including hydropower generation and transmission), finance, transport, water and other urban infrastructure and services. - Country assistance program evaluation (2010) rated ADB country operations and programs in Bhutan successful and well aligned with country development needs and Strategy 2020. - Coordination with development partners: parallel financing examples include urban development in Thimphu with World Bank; rural electrification with JICA and ADA. Collaboration with SNV on renewable energy; pilot biogas project in southern Bhutan building on SNV experience. - COBP 2016–2018 indicative cumulative lending allocation: $327.87 . - 2016-2018 lending program to support: SASEC Transport, Trade Facilitation, and Logistics Project; Air Transport Connectivity Enhancement Project; Urban Infrastructure Project; Improved Urban Environmental Infrastructure Project; Amochhu River Training and Flood Prevention Project; SASEC Green Power Investment Program. - Nonlending program programmed amount for 2016−2018: $2.3 million. ### ADB Ongoing Loans and Grants (As of 31 March 2016) - LOANS - Urban Infrastructure Project — Year of Approval: 2011 — Project Amount ($ million): 18.00 — Disbursements ($ million): 2.42 - SASEC Trade Facilitation Program — Year of Approval: 2012 — Project Amount ($ million): 8.30 — Disbursements ($ million): (blank) - SASEC Road Connectivity Project — Year of Approval: 2014 — Project Amount ($ million): 28.41 — Disbursements ($ million): 0.0 - Second Green Power Development Project (OCR loan) — Year of Approval: 2014 — Project Amount ($ million): 70.0 — Disbursements ($ million): 2.42 - Second Green Power Development Project (ADF loan) — Year of Approval: 2014 — Project Amount ($ million): 25.25 — Disbursements ($ million): 0.00 - Strengthening Economic Management Program II — Year of Approval: 2015 — Project Amount ($ million): 20.21 — Disbursements ($ million): 0.00 - GRANTS - Rural Renewable Energy Development Project — Year of Approval: 2010 — Project Amount ($ million): 21.59 — Disbursements ($ million): 16.24 - Air Transport Connectivity Enhancement Project — Year of Approval: 2012 — Project Amount ($ million): 6.92 — Disbursements ($ million): 4.27 - SASEC Road Connectivity Project — Year of Approval: 2014 — Project Amount ($ million): 18.96 — Disbursements ($ million): 1.23 - Second Green Power Development Project — Year of Approval: 2014 — Project Amount ($ million): 25.25 — Disbursements ($ million): 0.00 - Notes: Loans and grants include those funded by ADF and OCR. The first tranche of both the SASEC Trade Facilitation Program and the Strengthening Economic Management Program was released in 2013, and the second/final tranche is expected to be released in 2014. ### Statistical Issues (as of May 20, 2016) I. Assessment of Data Adequacy for Surveillance - General: Data provision — particularly timeliness — has some shortcomings, but is broadly adequate for surveillance. Most affected areas: national accounts, balance of payments, and fiscal data. - Real sector: STA providing technical assistance for Implementation of the System of National Accounts and the International Comparison Project to improve national accounts and develop a producer price index. - National Accounts: Key shortcomings: - Heavy reliance on production data collected by line ministries, which often lack quality control. - Long lags in providing estimates, large revisions of historical data, and ad hoc estimation procedures in certain cases. - Lack of reliable data on expenditure components hampers estimation of national savings and domestic investment. - Shortage of qualified personnel and facilities; absence of a Statistics Act. - No quarterly national accounts produced; STA providing TA on quarterly compilation. Annual data provided with long lags. - Price statistics: - CPI compiled on a quarterly basis since 2004; number of commodity prices expanded and geographical scope broadened. - Monthly CPI series for domestic and imported goods starting from April 2013 are now being released. - 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. - Inconsistencies between fiscal and monetary data regarding bank financing due to differences in definition of government. - Monetary statistics: - Generally consistent with Fund’s guidelines, but improvements needed in valuation of financial assets (currently based on purchase price rather than market or market-price equivalents). - Recommend preparing and sharing a list of government units and nonfinancial public enterprises with reporting financial institutions to avoid misclassifications. - During March 2010 MFS mission, timeliness of data reporting to STA improved to be in line with national publications. - RMA has submitted Financial Soundness Indicators (FSI) for Bhutan on a quarterly basis; FSIs published on IMF’s FSI website: http://fsi.imf.org/. - Balance of payments: - External sector statistics improved recently; BOP and IIP dissemination moved from annual to quarterly, to sixth BOP and IIP format. - RMA expected soon to start reporting external debt statistics to the World Bank’s Quarterly External Debt Statistics Database. - Coverage, accuracy and timeliness of ESS data improved, but shortcomings remain: limited coverage of services’ transactions in the current account; long lags in dissemination and lack of high frequency data. II. Data Standards and Quality - Bhutan participates in the General Data Dissemination System (GDDS); posted metadata on DSBB in May 2010. - After e-GDDS superseded GGDS in May 2015, Bhutan was assessed as Basline-2, disseminating all 15 recommended data categories. - STA providing assistance to create a National Summary Data Page consistent with e-GDDS. - No data ROSC is available. ### Table of Common Indicators Required for Surveillance (as of May 20, 2016) — selected items with dates and frequencies - Exchange rates — Latest Observation: 03/2016 — Date Received: 03/2016 — Frequency of Data: D — Frequency of Reporting: D — Frequency of Publication: D - International reserve assets and reserve liabilities of the Monetary Authorities — Latest Observation: 02/2016 — Date Received: 05/2016 — Frequency of Data: M — Frequency of Reporting: M — Frequency of Publication: M - Reserve/base money — Latest Observation: 02/2016 — Date Received: 05/2016 — Frequency of Data: M — Frequency of Reporting: M — Frequency of Publication: M - Broad money — Latest Observation: 02/2016 — Date Received: 05/2016 — Frequency: M / M / M - Central bank balance sheet — Latest Observation: 02/2016 — Date Received: 05/2016 — Frequency: M / M / M - Consolidated balance sheet of the banking system — Latest Observation: 02/2016 — Date Received: 05/2016 — Frequency: M / M / M - Interest rates — Latest Observation: 03/2016 — Date Received: 05/2016 — Frequency: M / M / M - Consumer price index — Latest Observation: 02/2016 — Date Received: 05/2016 — Frequency of Data: Q/M — Frequency of Reporting: M — Frequency of Publication: M - Revenue, expenditure, balance and composition of financing – general government — Latest Observation: 2013/14 — Date Received: 06/2015 — Frequency: A / A / A - Revenue, expenditure, balance and composition of financing – central government — Latest Observation: 2013/14 — Date Received: 06/2015 — Frequency: A / A / A - Stocks of central government and central government-guaranteed debt — Latest Observation: 6/2015 — Date Received: 12/2015 — Frequency: A / A / A - External current account balance — Latest Observation: 09/2015 — Date Received: 05/2016 — Frequency: Q / Q / Q - Exports and imports of goods and services — Latest Observation: 09/2015 — Date Received: 05/2016 — Frequency: Q / Q / Q - GDP/GNP — Latest Observation: 2014 — Date Received: 12/2015 — Frequency: A / A / A - Gross external debt — Latest Observation: 12/2015 — Date Received: 05/2015 — Frequency: Q / Q / Q - International investment position — Latest Observation: 09/2015 — Date Received: 05/2016 — Frequency: Q / Q / Q ### Debt Sustainability Analysis (DSA) — summary conclusions - Assessment: The assessment of Bhutan’s external risk has not changed materially from the 2014 DSA. - Since FY2010/11, rapid hydropower development led to a substantial buildup of external debt. - External debt ratios breach all indicative thresholds, and these breaches are projected to continue for several more years. - The extent and length of these breaches indicate a high risk of external debt distress. - Despite breaches, staff continue to assess Bhutan’s external risk as moderate based on unique mitigating circumstances (as spelled out in the 2014 DSA), specifically: - A large share of external debt is linked to hydropower project loans from the Government of India (GoI). - GoI covers both financial and construction risks of these projects and buys the surplus electricity output at a price reflecting cost plus a 15 percent net return. - India’s large unmet demand for power and political commitment to increase reliance on clean energy ensure strong demand for Bhutan’s electricity even with low prices of alternative energy sources. - Bhutan’s debt situation expected to improve in medium and long term as significantly higher electricity exports come on stream when hydropower projects are completed. - Caveat: Stress tests to public sector debt dynamics reveal the need for fiscal consolidation and the importance of sustaining economic growth going forward. *Prepared by International Monetary Fund and International Development Association; June 8, 2016.* ### 1. Bhutan’s public and publicly guaranteed (PPG) external debt jumped to 94 percent of GDP in ### Bhutan’s public and publicly guaranteed (PPG) external debt jumped to 94 percent of GDP in ### Overview and recent debt developments - Public and publicly guaranteed (PPG) external debt jumped to 94 percent of GDP in 2013, up from 75 percent of GDP in 2012, and has remained relatively stable in 2014 and 2015. - The earlier rise in public debt was driven mainly by hydropower sector-related external borrowing. - Hydropower projects are primarily financed by India with a mix of loans (70 percent) and grants (30 percent). - External debt is dominated in Indian rupees (and related to hydropower sector debt), which accounts for about 70 percent of total external debt, with convertible currency debt accounting only 30 percent of GDP. - Domestic debt remains a small fraction of public debt. ### Underlying debt sustainability analysis assumptions - Baseline assumes additional expansion of Bhutan’s power generation capacity will triple generation capacity. - Presently, five hydropower plants are operating, with total capacity about 1,600 megawatts (MW). - Hydropower development policy envisages eight new hydropower projects to be commissioned by 2026, adding 5,200 MW to Bhutan’s power generation capacity. - Total techno-economically feasible hydropower potential is estimated to be 24,000 MW. - External financing for non-hydropower sector activities continues to remain predominantly from multilateral and bilateral donors at concessional terms. - Second-generation hydropower projects will be based on joint venture (JV) models: 70 percent of the project financed by loans from India, while the remaining 30 percent financed by equity equally split between India and Bhutan’s governments; India will provide a grant to Bhutan to finance its equity share. - There is uncertainty surrounding the exact timing of the projects, as well as the future of some additional projects under discussion that are not included in the projection. ### Key baseline macroeconomic assumptions and implications of hydropower expansion - Real sector: - Similar to the spike in real GDP when Tala was commissioned in 2006/07, Puna I, Mangdechhu and Puna II will continue to boost economic growth as they come on stream in 2017/18 and 2018/19. - Real growth is projected to average around 9 percent in 2016–21, higher than the 10-year historical average of 7.4 percent. - Growth will accelerate significantly in 2018-2019, with commissioning of the above-mentioned plants, and then moderate to an average 5.5 percent in 2022–36. - Fiscal sector: - Upon completion, commissioning of hydropower projects will temporarily boost the domestic revenue-to-GDP ratio, mainly due to higher nontax revenues (transfer of profits and dividend payments). - External budgetary aid is assumed to decline sharply during the 13th FYP (2024–2028) as Bhutan’s per capita income rises. - On average, the overall fiscal deficit remains broadly balanced over the long term. - External sector: - The current account deficit is projected to remain close to current levels till 2017, then start declining rapidly as electricity exports increase upon completion of hydropower projects. - In the medium-term, electricity exports are estimated to more than quintuple from current levels, and the current account balance should move to a surplus by 2025, with external reserves increasing significantly. - Historical role: Prior to commissioning, construction of these hydropower plants was the second largest contributor after services to real growth during the 10th FYP. ### Baseline external debt sustainability analysis (DSA) — projections and thresholds - External PPG debt as a share of GDP is projected to peak at 113 percent in 2017 with disbursements for hydropower-sector projects, before declining slightly to 111 percent of GDP in 2018. - As the first phase of hydro construction ends and debt repayment starts, the stock of PPG debt is projected to fall: - Below the 50 percent of GDP by 2026. - Below 10 percent of GDP by 2036. - Present value (PV) of PPG external debt-to-GDP gradually declines to only 5 percent over the long term, crossing the 40 percent indicative threshold in 2027. - PV of PPG debt-to-exports ratio: - Remains above the threshold of 150 percent until 2024. - Falls to 15 percent at the end of the projected period. - PV of PPG external debt-to-revenues ratio: - Peaks at close to 722 percent in 2018. - Falls below the 250 percent threshold in 2025. - Falls to 24 percent by 2036. - PPG debt service-to-export ratio: - Peaks at around 24 percent in 2017 and 2018. - Falls below the 20 percent threshold by 2019, before rising above the threshold again marginally in 2020–22. - Debt service-to-revenue ratio: - Remains moderately above the 20 percent indicative threshold for most of the projected period. - Falls below the 20 percent threshold only in 2032. ### Sensitivity analysis — external debt - Indicative thresholds for the PV of PPG external debt-to-GDP, debt-to-exports and debt-to-revenue ratios are breached under alternative scenarios and stress tests. - All these indicators breach their respective thresholds after the shocks in 2016, and most continue to breach the threshold for an extended period. - The standard sensitivity analysis points to a high risk of debt distress. - Historical alternative scenario and bound test with exports in 2017–18 linked to historical average show very large breach; these scenarios fail to capture projected jump in hydropower exports or fiscal revenues. - Bound test of 30 percent nominal depreciation in 2017 overestimates Bhutan's debt vulnerability because a large share of Bhutan’s external income is in Indian rupees, which act as a natural hedge to the largely rupee-denominated external debt. - Debt service ratios: - Indicative thresholds are breached for a large part of the projection period. - The historical scenario shows the largest breach for the debt service ratios for the whole projection period. - Under bound tests, debt service ratios return eventually below their thresholds, but mostly late in the projection period. ### Public debt sustainability analysis (DSA) - Baseline public debt dynamics closely follow external debt dynamics. - PV of public debt exceeds the public debt benchmark by a significant amount. - Public debt-to-GDP ratio: - Projected to peak at around 115 percent of GDP in 2017 (less than the 129 percent peak in the 2014 DSA). - Projected to decline steadily after 2017, falling to below 60 percent in 2027 and to 49 percent by 2036. - Composition and financing implications: - Bhutan’s public debt consists mainly of external debt; unique mitigating circumstances for external debt apply to public debt. - With gradually declining role of external financing, domestic financing is assumed to start playing a larger role; the share of domestic debt in public debt will increase. ### Public debt sensitivity analysis - Public debt ratios are projected to be on a declining path over the long term under alternative scenarios and stress tests. - The scenario with the primary balance unchanged from the 2016 level does not capture additional revenues from commissioned hydropower plants and shows only a very gradual decline in the debt ratio. - Sensitivity analysis suggests debt and debt service ratios are sensitive to negative growth shocks; the size of a negative growth shock in 2017–20 is substantially magnified because growth is projected to peak during this period with commissioning of new hydropower plants. *Source: IMF staff analysis in the provided content unit.* ### 10. The current assessment remains broadly the same as the assessment made in the 2014 ### 10. The current assessment remains broadly the same as the assessment made in the 2014 ### Assessment overview - The current assessment remains broadly the same as the assessment made in the 2014 IMF/World Bank Joint DSA, which found that Bhutan’s debt dynamics are subject to a moderate risk of distress. - Bhutan’s PPG external debt indicators continue to breach external debt thresholds by large margins and for a long period, but unique and mitigating factors discussed in the 2014 DSA remain valid and underpin staff’s unchanged assessment. ### Changes in debt projections and ratings - The current and projected PPG external debt is now somewhat less than projected in the 2014 DSA due to some hydropower projects being put on hold. - In 2015, PPG external debt stock reached 94.5 percent of GDP, 20 percentage points less than projected in the previous DSA. - Bhutan’s CPIA rating worsened from “strong” to “medium”; the overall CPIA score declined to 3.74 and 3.71, marginally below the “strong” rating threshold of 3.75. - Even with the lower CPIA rating (and thus lower debt and debt service thresholds), these thresholds are mostly breached for similar or shorter periods than in the previous DSA, reflecting the lower current and projected debt. ### Hydropower-related mitigants and arrangements - India provides explicit guarantees that cover financial and construction risks for the intra-governmental hydropower projects. - India buys all surplus power that is not consumed domestically, and the price is on a cost-plus basis which includes a net return of 15 percent. - As a result, hydropower loans from India are characterized as more akin to foreign direct investment rather than debt-creating loans. - In power-hungry India, there is little risk of insufficient demand for future hydropower supply. - These arrangements significantly reduced the risk of external debt distress. ### Timing of hydropower benefits and borrowing guidance - Bhutan’s hydropower production, exports and thus the capacity to service its debt will increase only in the medium term. - Staff continue to advise against any nonconcessional borrowing at this stage. - Assuming they are effectively executed and associated macroeconomic challenges properly managed, the additional hydropower projects should eventually bring solid economic dividends, supporting higher exports and income. ### Vulnerabilities and stress testing - Bhutan is vulnerable to adverse shocks. - The DSA’s stress testing illustrates potential vulnerabilities in Bhutan’s external debt situation to: - export shocks, - growth shocks, - shortfalls in aid inflows, - failure to reverse declining tax revenues. - The most extreme stress test is defined as the test that yields the highest ratio on or before 2026. ### Authorities’ views - The authorities agreed with staff’s assessment of external risk. - They emphasized that the projected increase in hydropower exports should help repay a big part of the external debt, and underscored the need to take this factor into account when assessing external debt vulnerability. ### Key statistics and projections (selected, preserved exactly as in source) - PPG external debt stock in 2015: 94.5 percent of GDP. - CPIA scores: 3.74 and 3.71; “strong” rating threshold: 3.75. - Net return included in price for surplus power: 15 percent. - Baseline PV of external debt (selected years shown in Table 1): 107.5; 120.4; 127.6; 123.3; 111.7; 98.3; 88.4; 46.6; 4.6. - PV of PPG external debt—in percent of exports (selected): 374.9; 451.5; 496.3; 418.4; 317.3; 255.7; 230.1; 114.9; 15.3. - PV of PPG external debt—in percent of government revenues (selected): 512.3; 625.1; 700.3; 722.7; 544.2; 368.3; 361.7; 185.8; 23.5. - Debt service-to-exports ratio (in percent, selected): 19.5; 33.6; 22.9; 19.6; 24.1; 24.4; 17.1; 22.6; 21.4; 15.0; 4.5. - PPG debt service-to-revenue ratio (in percent, selected): 27.6; 46.8; 31.3; 27.1; 34.0; 42.1; 29.3; 32.5; 33.7; 24.3; 6.9. - Total gross financing need (Billions of U.S. dollars, selected): 0.5; 0.7; 0.6; 0.6; 0.8; 0.6; 0.4; 0.2; 0.3; 0.0; 0.4. - Key macro assumptions (selected): - Real GDP growth (percent, selected): 3.6; 3.8; 5.2; 7.4; 3.0; 6.0; 6.4; 11.3; 13.9; 8.5; 5.2; 8.6; 6.1; 5.0; 5.5. - Effective interest rate (percent, selected): 4.3; 2.8; 2.3; 3.5; 1.6; 1.4; 1.8; 4.0; 3.8; 5.5; 5.6; 3.7; 6.7; 3.1; 6.0. - Growth of exports of G&S (US dollar terms, percent, selected): -11.5; -2.0; 8.2; 13.8; 30.9; -3.9; 4.0; 29.8; 39.0; 21.2; 7.6; 16.3; 9.7; 5.2; 5.7. - Grant element of new public sector borrowing (in percent, selected): 10.5; 14.3; 13.3; 20.4; 45.2; 51.4; 25.9; 52.6; 2.0; 25.9. - Public sector debt (selected, Table 3): 100.3; 96.2; 96.2; 107.1; 115.0; 112.0; 104.1; 87.8; 80.0; 61.6; 48.7. - Public sector debt—foreign-currency denominated (selected): 94.1; 93.6; 94.5; 105.8; 113.0; 110.7; 101.0; 89.6; 81.3; 44.8; 6.7. - PV of public sector debt (selected): 109.2; 121.8; 129.6; 124.5; 114.8; 96.4; 87.1; 63.4; 46.5. - PV of public sector debt—to-revenue ratio (selected): 377.3; 386.0; 476.7; 456.5; 445.3; 299.4; 299.5; 240.0; 236.9. - Debt service-to-revenue ratio (in percent, selected): 18.8; 27.9; 21.3; 17.6; 21.1; 16.1; 22.6; 20.5; 27.5; 25.0; 22.0. *Source: IMF staff assessment and Debt Sustainability Analysis (DSA) as presented in the chapter.* ### 1. Our authorities’ discussions with the 2016 Article IV mission were constructive and ### Our authorities’ discussions with the 2016 Article IV mission were constructive and productive. ### Engagement with the IMF and technical assistance (TA) - The mission chief was Mr. Jiri Jonas. - The authorities "broadly agree with the assessment made in the Article IV report, and hope to benefit from staff’s recommendations." - Bhutan has been a major beneficiary of Fund technical assistance (TA). - TA mission counts: - "Eighteen TA missions were completed in FY2015;" - "fifteen were completed in FY2016;" - "and three have been completed and six are planned for completion in FY2017;" - TA covered: "budget planning, government finance statistics, balance of payment statistics, AML/CFT, currency management and national accounts." - The authorities welcome Fund encouragement and assistance in capacity development for economic management. ### Development achievements and social indicators - "GDP per capita more than doubled during 2004-14." - Poverty and health indicators: - "During 2000-2014, the percentage of population below poverty line reduced from 36.3 to 12," - "infant mortality fell from 68.4 to 29.7" - "universal primary enrollment was achieved." - Other improvements: "maternal mortality ratio, immunization coverage, road connectivity in rural areas, rural electrification and so on." - Environmental indicators: - "more than 80 percent of the country’s land area is under forest cover," - Bhutan "is a net sink for Global Greenhouse Gas (GHG) emissions," - "the quality of water at the macro level is very high and air pollution is considerably lower than internationally acceptable levels." ### Medium-term outlook, hydropower, and macroeconomic priorities - Authorities "are committed to building on this strong track record and following policies that ensure both macroeconomic stability and strong and inclusive growth." - Key challenges identified: "managing hydropower related inflows, managing the projected spike in hydropower revenues keeping in view the likely phasing out of external aid, and addressing youth and urban unemployment." - Authorities agree with staff that "Bhutan’s medium-term outlook is favorable." - Expectations: - With commissioning of new hydropower generation projects, "growth will significantly accelerate from FY2017/18 and the current account will return a surplus." - Fiscal stance: - Authorities note staff’s emphasis on containing the fiscal deficit in "FY2016/17 and FY2017/18" but "feel that staff’s concerns about fiscal outcomes are somewhat overstated." - The fiscal deficit in "FY2015/16 is projected to be significantly lower than what was budgeted for." - Recognition that "capital spending tends to pick up in the last two years of the five year plans" and commitment to ensure selected projects are within government implementing capacity. - Revenue measures: authorities "are hopeful of introducing a new goods and services tax (GST), with Parliament’s approval, by the end of 2018." - Expenditure measures: "they have taken several measures to contain current spending." - Fiscal framework intent: "strengthen the fiscal framework with a view to containing public debt and avoiding excessive volatility in the fiscal stance," while accounting for rising hydropower exports and likely reduction in external support. ### Monetary policy and financial sector - "Staff’s advice on monetary policy is consistent with the authorities’ own views." - Current stance: "The current monetary policy stance is viewed as suited to the prevailing monetary conditions." - Transmission issues: - "There is certainly a need to improve the monetary policy transmission mechanism which currently relies solely on the cash reserve ratio (CRR)." - Authorities will "carefully consider staff’s suggestions in this regard and follow a graded approach in moving forward, mindful of the need for adequate institutional capacities and supporting legal frameworks." - They "intend to review the base rate system keeping in view both the wide-spread dissatisfaction with it and staff’s suggestions, which include learning from the Indian experience." - Macroprudential framework: - "A comprehensive framework for macro-prudential policy was put in place by the RMA in 2014 and some macro-prudential regulations have already been implemented." - Authorities "intend to implement additional regulations in the coming months" and will use advice from recent TA on banking supervision and regulation. ### External sector, reserves, and hydropower-related flows - Context: "the large current account deficit and the high external public debt should be seen in the background of the large external investment and imports relating to the hydropower projects that are under implementation." - Authorities' view: "The authorities feel that there is no reason for concern on these counts." - Expectations: "the current account should move to a surplus once hydropower exports pick up." - Reserves and debt: - "These reserves are built largely on external aid flows and borrowing for the hydropower related investments." - "Though the current level of international reserves is high, covering about 11 months of imports, this too needs to be seen in the context of the current hydropower centered development strategy." - Authorities note staff’s advice "for further improvement in the composition of foreign reserves." - Rupee liquidity and recent arrangements: - "They would not describe the Rupee shortage of 2012-13 as a crisis." - They "do not consider the risk of another rupee shortage as likely, particularly because of RMA’s recent swap agreement with the RBI which would enable RMA to have access to short-term Indian Rupee liquidity support." - "Moreover, arrangements to sell or buy Indian Rupees against USD and gain access to Indian Government securities are being currently pursued." ### Managing hydropower spillovers and sectoral monitoring - Authorities emphasize importance that "spillovers from development of hydropower are managed well." - They plan to "separately keep track of developments in the hydropower and non-hydropower sectors." - In particular, they want to "separate the impact of developments in the two sectors on the balance of payments." - Fund technical assistance in this area "will be very welcome." ### Employment, skills, and inclusion - Authorities plan to "give attention to the problem of high youth and urban unemployment." - Strategy: "Development of the private sector and diversification of the economy would be critical to addressing this challenge." - Near-term focus: "they see the need for employment of a significantly greater number of Bhutanese citizens in the construction of hydropower projects." - Current level: "from the current low level of 20 percent" Bhutanese employed in construction of these projects. - Objective: "All necessary measures will be taken to substantially raise the percentage of Bhutanese citizens employed in construction of these projects." - On skills and labor supply: - Staff noted "the need for addressing the existing lack of skills." - Authorities disagree with staff that "a lack of willingness to take up jobs requiring manual work could also be a contributing factor." - Authorities view a "more plausible contributing factor" as "lack of awareness about the job opportunities that are likely to be created resulting in lack of acquisition of the required skills." - Authorities "intend to address all such factors." *Statement by Subir Gokarn, Executive Director for Bhutan and Indu Chaturvedi, Senior Advisor to Executive Director; June 22, 2016* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16206.pdf_