Public Information Notice: IMF Concludes Article IV Consultation with Bhutan

June 17, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On June 7, 1999, the Executive Board concluded the Article IV consultation with Bhutan.1


Bhutan is heavily dependent on its hydropower, mineral, forest, and other natural resources. Over the years, the Bhutanese authorities have aimed to strike a balance between the pace of economic development and the need to preserve the country's unique cultural heritage and its delicate environmental balance. These strong national concerns have been reflected, in particular, in the controlled development of tourism and logging-in which Bhutan has considerable potential-as well as in the authorities' cautious attitude toward foreign investment. Despite this measured approach to development, Bhutan has achieved significant economic and social gains in recent decades. Large public investment in hydropower and related energy-intensive industries-mostly financed by grants and soft loans from India-have increased growth and exports and broadened the country's economic base. High and equitable growth has been reflected in sustained improvement in the population's living standards, and large investment in health and education has led to significant gains in the social indicators.

After a surge in the 1980s associated with the launching of the hydropower projects, real GDP growth has stabilized at 5-6 percent in more recent years. Inflation has been relatively stable in the range of 7-9 percent, closely tracking price movements with India in view of the significant economic and financial links between the two countries, including a currency peg. The large inflow of foreign grants and rising electricity exports to India have been reflected in overall balance of payments surpluses (equivalent to 10-11 percent of GDP in the last two years) and a significant build-up of foreign reserves (equivalent to 18 months of imports at end-1998). Imports from India and other countries, however, have been increasing as a result of on-going projects and improved availability of foreign exchange. Bhutan's debt service ratios are small and its entire foreign debt is on highly concessional terms.

The authorities' cautious approach to fiscal management has been underpinned by efforts to meet current expenditure with domestic revenue, while financing capital expenditure with foreign grants and soft loans. Despite the sizable adjustments of civil service wages in 1996 and 1997, the overall fiscal position recorded a surplus estimated at 3.3 percent of GDP in 1997/98 (fiscal year beginning July 1). This outcome primarily reflected the doubling of the export price of electricity in 1997 and the sharp decline in capital expenditure due to delays in project implementation in the first year of the current five year development plan. The fiscal position is expected to be approximately balanced in 1998/99.

Reflecting the sizable accumulation of foreign assets, monetary expansion has averaged 35 percent in the last two fiscal years, well in excess of the growth of nominal GDP. In view of relatively moderate inflation and large balance of payments surpluses, the high rate of money growth suggests rapid monetization of the economy. At the same time, there has been a significant build-up of liquidity with the financial institutions because of the limited investment opportunities in the private sector, partly related to a rigid interest rate structure and inefficient financial intermediation. In response, the monetary authorities have been taking steps to increase the flexibility of financial institutions in setting their interest rates and to promote competition in the financial sector. But, despite these signals, the real lending rates have remained high, particularly in the context of the large excess bank liquidity, thus continuing to constrain private sector activity.

Structural reform measures are being put in place to enhance growth and increase private sector participation in economic activity. The privatization program is progressing steadily; preparatory steps are being taken to formulate a framework for foreign investment; and the legal support for the financial system is being strengthened. Preparations are also well underway to introduce a personal income tax by the year 2000 as a first step to strengthen the tax structure and diversify government revenue which continues to be heavily reliant on the production and exports of electricity.

Executive Board Assessment

Executive Directors commended the authorities for their prudent policies which, together with higher export prices and donor support, have contributed to Bhutan's macroeconomic stability. Economic growth has remained fairly strong, inflation has been relatively low and stable, and the balance of payments and reserves positions have been comfortable. Directors noted that the exchange rate peg with India continued to serve the economy well. They also noted that Bhutan's near-term and medium-term macroeconomic prospects are favorable and that this was further underpinned by the authorities' commitment to prudent economic policies and expectations of continued foreign aid.

Directors commended the authorities for their continuing emphasis on social sector development and supported their strong commitment to preserving the country's unique cultural heritage and its delicate environment. They believed that even as growth-oriented policies are accelerated, this should be done while firmly protecting Bhutan's cultural traditions and environment.

Directors were of the view that the central challenge facing the Bhutanese authorities remains that of improving the population's living standards through more rapid and equitable growth, while reducing the country's vulnerability arising from heavy reliance on electricity production and foreign aid. Accordingly, they endorsed the authorities' medium-term strategy which seeks to broaden the economy's production base by expanding private sector activity through divestiture, improving infrastructure, and developing the country's human resources. Directors stressed that further support could be provided by improving financial sector intermediation, including through interest rate liberalization, reducing the discretionary aspects of foreign trade, and establishing a coherent framework for private investment. They also saw a greater scope for foreign investment to upgrade the country's technology and managerial base, without compromising the national priorities with regard to culture and environment.

Directors commended the authorities' strong commitment to cautious fiscal management and welcomed the planned introduction of a personal income tax as an important measure to improve the revenue structure. In order to meet the rising cost of maintaining the country's social and physical infrastructure, and for efficiency reasons, they suggested further revenue mobilization and greater cost recovery especially in the provision of public services and utilities. Directors recommended that the authorities consider, in the medium term, the introduction of a broad-based general sales tax which could be eventually converted to a value added tax.

Directors welcomed the progress in liberalizing Bhutan's foreign exchange regime, which is allowing the private sector to benefit from the country's strong foreign exchange position. They encouraged the authorities to eliminate the remaining restrictions maintained under Article XIV with a view to accepting the obligations of Article VIII at an early date.

Directors regretted that there has been little improvement in data provision to the IMF for surveillance since the last consultation. They urged the authorities to move forcefully to address Bhutan's data deficiencies by identifying priorities, establishing an action plan, and seeking technical support from bilateral and multilateral institutions. Directors also encouraged the authorities to improve data provision to the IMF between consultations.

Table 1. Bhutan Selected Economic and Financial Indicators, 1994/95-1998/99 1/

Prov. Proj.
1994/95 1995/96 1996/97 1997/98 1998/99

GDP growth and prices (percent change)
Real GDP at factor cost 6.9 6.7 5.7 5.5 5.2
Consumer prices 8.2 9.3 7.4 9.0 8.5
Government budget (percent of GDP)
41.1 42.7 37.0 35.7 37.2
Of which: Foreign grants 20.0 22.5 17.7 14.7 17.0
   Total expenditure and net lending 41.0 40.5 39.4 32.4 36.7
Current balance -0.3 1.5 0.7 3.4 3.0
Overall balance 0.1 2.3 -2.4 3.3 0.5
Money and credit (changes in percent of initial stock of broad money)
Broad money 29.9 30.4 30.9 41.7 29.3
Credit to private sector 33.5 5.1 -3.5 3.4 2.0
Balance of payments (in millions of US$)
   Exports, f.o.b. 2/ 70.0 97.6 99.3 111.3 108.8
Imports, c.i.f. 2/ 97.2 110.9 131.2 136.1 165.2
Current account balance 3/ -34.1 -37.1 -56.4 -46.5 -86.9
(In percent of GDP) -12.1 -12.1 -16.1 -12.2 -22.3
Grants 51.8 79.7 74.4 85.4 124.8
Overall balance 14.0 24.9 22.2 45.4 41.4
External indicators
Gross official reserves (in millions of US$) 120.9 145.1 176.0 218.2 259.6
(In months of imports) 14.9 15.7 16.1 19.2 18.9
Memorandum item:
Ngultrum per US$ (period average) 4/ 31.4 34.3 35.8 38.4 42.5

Sources: Data provided by the Bhutanese authorities, International Financial Statistics; and IMF staff estimates and projections.

1/ Fiscal year beginning July 1.
2/ Exports and imports are on a calendar year basis.
3/ Excluding grants.
4/ Data for 1998/99 refer to period average exchange rate for July to January 1999.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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