Press Release No. 18/401

On October 26, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bhutan.1 

Bhutan continued to make strides in raising per capita incomes and reducing poverty as it concluded the 11^th Five Year Plan in 2018. Notably, poverty declined from 12 percent in 2012 to 8.2 percent, and extreme poverty fell to just 1.5 percent. The country is poised to transition to middle-income status, with per capita incomes at nearly $3,600 in 2018, up from $1,100 in 2004.

Growth has remained robust, averaging 6 percent over the 11^th Plan. In FY2018, growth is expected to slow to 5.8 percent from 7.4 percent in FY2017, reflecting slowing construction activity of hydropower projects set to come on stream in 2018 and beyond. Inflation remains low at around 4¼ percent in December 2017. With lower hydropower-related imports and higher electricity export revenue, the current account deficit narrowed from an average of 26 percent of GDP over FY2012-16 to 22.8 percent in FY2017, and reserve cover at 13 months of imports remains at robust levels. Growth is likely to slow further in FY2019 (to 4.8 percent), due to a contraction in fiscal spending driven by the timing of the new government’s transition to power. Over the medium term, coming on stream of three new hydropower projects is expected to boost growth to around 7 – 7½, along with improvements in the current account, reserves, and the fiscal position. Improving macroeconomic conditions will provide a desirable backdrop for the authorities’ plans to diversify the economy away from dependence on hydropower generation, with access to finance and labor market reforms being core issues. 

Nevertheless, risks are skewed to the downside. Domestic risks include delays in implementing the goods and services tax (GST) and completing hydropower projects and lower electricity exports. Higher fiscal spending in FY2019 and more gradual fiscal consolidation in the medium term could lift growth above the baseline forecast. External risks stem from weaker growth and higher inflation in India, Bhutan’s main trading and development partner, and increases in global oil prices. Key policy challenges relate to avoiding the sharp reduction in capital spending, timely implementation of the GST, and prudent management of anticipated hydropower revenues.

Executive Board Assessment2 

Executive Directors welcomed the significant improvements in per capita income and poverty indicators, with strong economic growth and low inflation. They also welcomed progress made on structural reforms, especially in access to finance and economic diversification. However, Directors observed that while external imbalances are declining, they are still large. In addition, key medium-term policy challenges remain, including domestic revenue mobilization and prudent management of hydropower revenues, while maintaining macroeconomic stability, enhancing competitiveness and further diversifying the sources of growth.

Directors noted that the FY2019 interim budget implies a sharp fiscal withdrawal and may impact growth. Given Bhutan’s infrastructure needs, Directors called for higher capital expenditure supported by additional domestic revenue and a modest increase in domestic financing. They welco0-med the authorities’ commitment to implement a broad-based GST by July 2020 and called for a rationalization and gradual curtailment of tax exemptions. Directors encouraged the authorities to develop a domestic public debt market and further strengthen public financial management. They commended the steps taken to establish a macroeconomic stabilization fund to manage hydropower revenues and business fluctuations and noted the importance of transparent and rule-based principles for the fund’s operations. 

Directors considered the current monetary policy stance to be broadly appropriate. They welcomed efforts by the Royal Monetary Authority (RMA) to modernize the monetary policy framework by enhancing its liquidity management and forecasting capabilities. Directors also encouraged the establishment of an interest rate corridor and steps to develop the interbank market. This framework would help support the ngultrum’s peg with the Indian rupee. Once this framework is fully operational, the minimum lending rate could be abolished.

While the risk of systemic distress remains low, the nascent banking sector needs to be strengthened.

Directors underlined the need to further improve the prudential framework for the financial sector and strengthen oversight to avoid a build-up of risks. They welcomed the priority sector lending program which is expected to improve access to finance for cottage and small industries but emphasized the need to monitor its performance.

Directors agreed that the exchange rate peg to the Indian rupee has served Bhutan well and remains an appropriate nominal anchor. Bhutan’s reserve cover remains adequate but its composition may benefit from a higher share in rupees.

Directors encouraged elimination of exchange rate restrictions as soon as macroeconomic conditions allow.