BHUTAN DEVELOPMENT UPDATE Special section: Recent trends in poverty and shared prosperity: progress and challenges Macroeconomics, Trade, and Investment Global Practice Bhutan | Development Update  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges 2 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Table of Contents Table of Contents Abbreviations and Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Recent Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Outlook and Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Recent Trends in Poverty and Shared Prosperity: Progress and Challenges . . . . . . . . . . . . . . . . . . . . . . . . . 10 I. Recent Economic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 1. Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 2.  Bhutan’s First Economic Census . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 3.  Inflation and Monetary Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 4.  Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 5.  External Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 6.  Fiscal Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 II. Outlook and Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 III. SPECIAL SECTION. Recent Trends in Poverty and Shared Prosperity: Progress and Challenges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 1.  Recent progress in poverty reduction and welfare. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 2.  Drivers of poverty reduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 3.  Priorities for sustainable poverty reduction and welfare improvement . . . . . . . . . . . . . . . . . . . . . . . . . . 36 3 Bhutan | Development Update Table of Contents Recent Trends in Poverty and Shared Prosperity: Progress and Challenges List of Figures Figure 1. Sources of growth (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Figure 2. Hydropower production (GWh) and export revenue (percent of GDP). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Figure 3. Tourist arrivals (thousands) and export revenue (percent of GDP). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Figure 4. Number of establishments by economic sector and region, 2017. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Figure 5. Establishments by legal status and duration of operation, 2017. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Figure 6. Share of establishments and employment by economic sector, 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Figure 7. Bhutan’s ease of doing business 2020, (score 0 center, score 100 outer edge) Figure 8. CPI, Bhutan and India (percent change YoY) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 9. Money supply (percent change YoY). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 10. Credit growth and contribution (percent change YoY, 3-months moving average). . . . . . . . . . . . . . . . . . . . 18 Figure 11. Financial sector soundness indicators (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 12. Current account, components (percent of GDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 13. Gross international reserves (US$ Mio, LHS) and percent share of Rupee reserves in total reserves (RHS). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 14. Fiscal accounts, components (percent of GDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 15. Public debt(percent of GDP). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 16. Fiscal outcomes over FYP cycles (percent of GDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Figure 17. Fiscal framework, as per 12th FYP (percent of GDP) Figure 18. Growth projections 2018/19-2021/22 (percent change) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Figure 19. Hydropower production, estimated capacity (GWh, LHS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Figure 20. Poverty rates according to World Bank’s international poverty line of $3.20 per day (in 2011 PPP terms) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Figure 21. Selected asset ownership of poor and nonpoor, 2007-2017. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Figure 22. Dzongkhag-level poverty rates in 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Figure 23. Quality of various basic services across districts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Figure 24. Contribution to GDP (value added), by sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 25. Share of population whose household head is working in agriculture, working in non- agriculture or not working (%). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 26. Total output (L) and value added per worker (R) in agriculture, forestry and fishery increased . . . . . 34 Figure 27. Average yields (L) and prices (R) of key fruits and crops. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Figure 28. Share of household members that are working (L) and share of households with at least one agricultural worker (M) and agricultural workers only (R). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Figure 29. Share of agricultural households that produce only or mainly for sale, or mainly or only for family consumption. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 List of Tables Table 1. Macroeconomic outlook (annual percentage change unless indicated otherwise). . . . . . . . . . . . . . . . . . . . . . . 9 Table 2. Balance of Payments, contributions, 2015/16-2018/19 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Table 3. Fiscal accounts, 2015/16-2018/19. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Table 4. Monetary poverty vs subjective poverty. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Table 5. Monetary poverty vs happiness. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 List of Boxes Box 1. Fiscal policy under Bhutan’s Five-Year Plans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 4 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Abbreviations and Acronyms Government Fiscal Year: July 1–June 30 Currency Equivalent: Exchange Rate Effective as of January 21, 2020 Currency Unit = Ngultrum (Nu) US$1 = Nu 71.2 Weights and Measures: Metric System Abbreviations and Acronyms BEFIT Bhutan Economic Forum for Innovative Transformation BESF Bhutan Economic Stabilization Fund BLSS Bhutan Living Standards Survey CAD Current Account Deficit CIT Corporate Income Tax CPI Consumer Price Index CRR Cash Reserve Ratio CSI Cottage and Small Industry DSA Debt Sustainability Analysis ECoB Economic Census of Bhutan FDI Foreign Direct Investment FYP Five-Year Plan GDP Gross Domestic Product GNHC Gross National Happiness Commission GST Goods and Services Tax ICT Information and Communications Technology IMF International Monetary Fund INR Indian Rupee IRC Interest Rate Corridor MoF Ministry of Finance LDC Least Developed Countries NCD Non-Communicable Diseases NFA Net Foreign Assets NPL Nonperforming Loan NSB National Statistics Bureau PSL Priority Sector Lending PPP Purchasing Power Parity REER Real Effective Exchange Rate RMA Royal Monetary Authority RWCAR Risk-Weighted Capital Adequacy Ratio THPP Targeted Household Poverty Program 5 Bhutan | Development Update Acknowledgments  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Acknowledgments The Bhutan Development Update is a World Bank report series produced twice a year. It assesses recent eco- nomic and social developments, prospects, and policies in Bhutan. The report is intended for a wide audience, including policy makers, business leaders, researchers and academics, and the community of analysts mon- itoring Bhutan’s economy. The update was prepared by the Macroeconomics, Trade, and Investment Global Practice and the Poverty and Equity Global Practice and included: Yoichiro Ishihara (Resident Representative and Senior Economist), Melanie Trost (Junior Professional Officer) and Tenzin Lhaden (Operations Officer and Economist). The focus section on poverty was prepared by Yeon Soo Kim (Poverty Economist). The report was prepared under the overall supervision of Mercy Tembon (Country Director, Bangladesh and Bhutan), Yutaka Yoshino (Program Leader Equitable Growth, Finance & Institutions), Mona Prasad (Lead Econ- omist) and Manuela Francisco (Practice Manager for Macroeconomics, Trade, and Investment). The team is grateful for valuable discussions with Ministry of Finance, Royal Monetary Authority, and the National Statistics Bureau. The team appreciates the comments provided by Florian Blum (Economist). 6 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Overview Overview Recent Developments Growth is estimated to have remained subdued in 2018/19 as hydropower production declined further. After slowing to 3.8 percent in 2017/18 as a result of reduced hydropower production, growth is expected to have remained subdued at 3.9 percent in 2018/19. The hydropower sector, which currently accounts for around 30 percent of GDP, experienced a further decline in production in 2018/19 due to prolonged maintenance work at the Tala hydropower plant, lower than expected rainfall, and delays in the commissioning of the Mangdechhu hydropower project. The other main growth driver, tourism, showed mixed results. While tourist arrivals in- creased, tourism receipts declined significantly from 3.7 percent of GDP in 2017/18 to 2.9 percent in 2018/19, reflecting lower average spending by tourists. Output expansion during the year was primarily driven by the services sector, including retail trade, transport and communication. Inflation decelerated to its lowest level in 2018/19 since 2003, reflecting a rapid decline in food prices. The annual consumer price index decreased by almost one percentage point from 3.7 percent in 2017/18 to 2.8 percent in 2018/19 and stood at 2.3 percent in November 2019. The deceleration reflects a decrease in food prices, which in turn was the result of a base effect due to unusually high vegetable prices in 2017. More recently, food prices are on the upswing again given the increase in food prices in India. Growth in bank lending to the private sector remained strong in 2018/19 (16.7 percent, YoY) but risks to the financial sector are on the increase. The stock of credit outstanding to the private sector as a share of GDP more than doubled since 2007 and reached 65 percent at the end of 2018. The Non-Performing Loan (NPL) ratio, however, increased to 18.4 percent in September 2019, vis-à-vis 10.4 percent in December 2018, mainly due to an accumulation of NPLs in the non-banking sector. While this reflects mid-year cyclical factors, the NPL ratio has been on an upward trend in recent years. The financial sector overall has adequate cushion to absorb potential losses given its capital adequacy. However, there is variance among institutions with weaknesses particularly concentrated in the non-banking sector.1 The overall risks in the financial sector are on the increase and the sector’s resilience needs to be further strengthened. The current account deficit (CAD) widened in 2018/19 on the back of lower electricity and tourism receipts. Total exports decreased on the back of lower hydropower exports and a drop in tourism receipts. Falling mer- chandise imports – reflecting slowing hydropower construction and fuel imports – could not offset the decline in exports. As a result, the CAD increased from 19.6 percent of GDP in 2017/18 to 23.9 percent in 2018/19. Gross international reserves, however, remain at comfortable levels, standing at US$1,093 million in August 2019, which is equivalent to 11.6 months of imports of goods and services. The fiscal balance improved in 2018/19 due to a sharp decline in capital spending. The fiscal balance im- proved from a deficit of 3.3 percent of GDP in 2017/18 to a surplus of 0.8 percent of GDP in 2018/19 due to a large decline in capital expenditure, which more than offset a decrease in revenues. Hydropower revenues decreased as a result of lower hydropower production, and one-off factors – including the discontinuation of 1 Given the limited investment opportunities in Bhutan, non-banks are notably permitted to undertaking retail lending activities. 7 Bhutan | Development Update Overview  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges the excise duty refunds from India – had a negative impact on non-hydro revenues. While capital expenditure decreased significantly in the run-up to parliamentary elections in 2018, the control on current expenditure remained tight. Public debt as a share of GDP remained high, estimated at 105.4 percent of GDP at the end of 2018/19, but risks of debt distress are moderate as most of the debt is linked to hydropower projects financed by India. Outlook and Risks The medium-term economic outlook remains positive, driven by the on-streaming of two large hydropower projects. Growth is expected to rebound in 2019/20 to 5.5 percent following the operationalization of the Mangdechhu hydropower project, although the plant is expected to reach full potential only in 2020/21. In the medium term, growth is projected to average around 6 percent, supported by an increase in hydropower production (with the expected on-streaming of Puna II in 2022/23) and good growth in the services sector. Tourism activities, including hotel and restaurant, transport, and retail trade, are expected to boost growth in the services sector. Inflation is expected to accelerate in the near term due to rising food prices in India. Inflationary pressures should ease over the medium term as RMA steps up efforts to strengthen monetary management. The external accounts are expected to improve over the medium term, supported by higher hydropower exports. Current account deficits are likely to persist due to imports associated with the hydropower sector. The CAD is however projected to narrow over the medium term, boosted by an increase in electricity exports with the on-streaming of the Mangdechhu and Punatsangchhu II projects in 2019/20 and 2022/23, respectively. However, the ongoing construction of Punatsangchhu II and I and higher public capital spending are expected to raise imports associated with hydropower construction and infrastructure projects. The fiscal deficit is expected to widen compared to 2018/19 but remain below 3 percent of GDP. Hydropower revenue is projected to increase over the medium term in line with higher production levels and one-off profit transfer revenues in 2019/20 and 2020/21 (from Mangdechhu). Non-hydro revenues are expected to increase with improvements in tax policy and administration, including the implementation of the goods and services tax (GST) in 2020. Current expenditures are projected to remain tight while capital expenditures are expected to decrease after an initial pick up in 2019/20 – in line with the reduced grant inflows for the 12th FYP from India. As a result, the overall deficit is projected to increase in 2019/20 with the pickup in capital spending and in 2021/22 due to the absence of profit transfers. The government is in the process of approving fiscal stabiliza- tion measures which will smoothen spending over the medium to long term, especially after the remaining two large hydro projects are commissioned. Total public debt is expected to decline gradually over the medium term as debt servicing starts with the on-streaming of hydropower projects. Risks to the outlook arise primarily from delays in the completion of the remaining large hydro projects, volatile hydropower revenues and slippages in the implementation of non-hydro revenue measures. Further delays in hydro project completion and/or adverse weather events would negatively impact growth, reduce exports and government revenues. Delays in the implementation of non-hydro revenue measures like the im- plementation of the GST constitute a risk to the government’s fiscal stance. This is especially so because of the discontinuation of excise duty refunds from India and lower levels of grant financing from India (as evidenced in the 12th FYP cycle). This risk is mitigated, in part, by the government’s commitment to introduce the GST and the implementation of the fiscal stabilization measures (currently being finalized), which will help smoothen expenditures in later years when no new large hydro projects are likely to be commissioned. 8 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Overview Table 1. Macroeconomic outlook (annual percentage change unless indicated otherwise) Table: Main 2015/16 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22 macroeconomic (actual) (actual) (actual) (estimate) (forecast) (forecast) (forecast) indicators Real GDP growth 7.4 6.3 3.8 3.9 5.5 7.3 5.7 Private Consumption 3.9 0.0 10.1 12.0 4.0 6.8 7.0 Government 7.3 4.3 3.7 4.5 18.6 7.0 4.6 Consumption Gross Capital 14.1 4.5 -3.8 -4.7 1.4 6.6 0.6 Investment Exports -4.2 0.4 5.5 -3.7 6.4 3.1 6.4 Imports 8.6 2.9 -5.3 3.6 0.9 4.8 3.6 Real GDP growth 7.4 6.3 3.8 3.9 5.5 7.3 5.7 Agriculture 4.4 3.6 3.7 4.2 4.2 4.3 4.3 Industry 7.6 4.7 -1.2 -0.5 5.6 8.8 3.3 Non-manufacturing 8.6 4.7 -2.7 -2.3 5.5 9.6 2.5 (incl. hydro) Manufacturing 3.4 4.5 5.0 6.0 6.1 6.2 6.0 Services 9.2 8.2 7.9 8.4 8.6 8.7 8.3 Inflation (CPI) 3.3 4.3 3.7 2.8 3.0 3.6 2.7 Current Account -31.7 -23.6 -19.6 -23.9 -15.4 -17.3 -16.6 Balance (% GDP) Fiscal Balance (% GDP) -1.9 -4.8 -3.3 0.8 -1.9 -1.5 -2.7 Revenue 30.7 28.0 31.9 26.1 29.3 29.3 27.6 Hydropower revenue 3.5 4.4 5.1 4.4 6.4 6.5 5.3 Non-hydro revenue 16.4 15.1 17.7 15.6 15.1 15.6 15.7 Grants 10.9 8.5 9.1 6.2 7.8 7.2 6.6 Expenditure 32.7 32.8 35.2 25.3 31.2 30.8 30.3 Current expenditure 16.7 15.8 16.8 15.9 18.1 18.2 18.1 Interest Payments 1.5 1.3 1.3 0.9 1.2 1.3 1.4 Salary and 6.9 6.2 6.0 6.7 8.7 8.6 8.5 Allowances 9 Bhutan | Development Update Overview Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Table: Main 2015/16 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22 macroeconomic (actual) (actual) (actual) (estimate) (forecast) (forecast) (forecast) indicators Goods and Services 4.5 4.3 4.2 4.2 4.1 4.1 3.9 Subsidies and 2.3 2.7 4.0 2.7 2.7 2.7 2.7 Transfers Other 1.5 1.4 1.4 1.5 1.5 1.5 1.5 Capital expenditure 15.9 17.0 18.3 9.3 13.1 12.6 12.2 Debt (% GDP) 112.4 111.5 110.1 105.4 99.9 92.2 88.5 Memo items: Hydropower production 7,747 7,747 7,265 7,098 7,978 9,741 10,120 Tourist arrivals, 180,006 245,206 253,356 298,502 338,216 441,379 591,281 international and regional Source: WB staff estimates In the medium term, Bhutan faces two key challenges: making growth more inclusive and less reliant on hydropower. Although hydropower has contributed significantly to economic growth, going forward, there are greater uncertainties in the rapidly evolving regional electricity markets. In addition, the capital intensive hydro sector accounts for less than 1 percent of total jobs. Therefore, Bhutan needs to facilitate more pri- vate-sector-led growth to increase employment opportunities and domestic revenues. While Bhutan achieved great strides in poverty alleviation, the pace of progress in shared prosperity has slowed in recent years. Also, disparities in poverty and other development outcomes across districts persist, as discussed below. Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Bhutan has made remarkable progress in reducing poverty and providing access to services, but progress was uneven and disparities across the country persist. The poverty headcount measured by the US$3.20 pov- erty line (in 2011 purchasing power parity (PPP) terms) decreased from 36.4 percent in 2007 to 17.8 percent in 2012 and further to 12.1 percent in 2017. Poverty in rural areas declined significantly throughout the decade, from 48.1 percent in 2007 to 17.4 percent in 2017. However, progress was uneven and differences in poverty rates between districts are large, with 96 percent of the poor residing in rural areas. While educational out- comes and access to health care saw large improvements, there are disparities in the access and quality of services across the country. Similarly, the quality of other basic services (electricity, water, sanitation) is also highly variable across the country. Poverty reduction in rural areas was likely driven by improvements in agricultural productivity and better prices of cash crops, but vulnerability of households remains high. Working in agriculture is highly correlated with being poor: about two thirds of heads of poor households work in agriculture, whereas only about a third of non-poor households do. With agriculture being the largest employer (accounting for nearly 60 percent of employment), the presence of uninsured risks from price and weather shocks contributes to high vulnerability 10 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Overview of households. Simulations show that a 20 percent increase in the 2017 poverty line would almost double the poverty headcount rate, from 12.1 percent to 20.1 percent. This suggests that while welfare improved and pov- erty declined, a large share of households is tightly clustered around the lower end of the welfare distribution and vulnerable to falling back into poverty. The creation of productive jobs is key to achieving long-term welfare improvements. While the public sec- tor-led development model has boosted economic growth and directed large investments in human capital, private sector development has been lackluster and job creation sluggish. Bhutan’s ability to further reduce poverty and enhance welfare will critically depend on its capacity to identify alternative sources of growth beyond hydropower and generate private sector employment. In the short- to medium-term, progress will be difficult to achieve without raising agricultural productivity. Addressing the constraints to growth in the commercial agriculture sector could go a long way towards increasing rural incomes: this would include broad- based support to increase productivity, combined with efforts to develop market systems and integration into larger value chains. A stronger social protection system that focuses on targeted poverty reduction and offers an appropriate package of benefits could further help mitigate the impact of income shocks. Spatial trade-offs in development need to be better understood and reflected in the prioritization and se- quencing of policies. Given the need to continue to invest in human capital and other services, an important trade-off may be needed between expanding access to services and improving the quality of services. Low ur- banization rates mean that most people live dispersed across the countryside and Bhutan’s unique geographic features — characterized by a rugged terrain of deep valleys and steep mountains — make service provision very difficult, costly, and inefficient. Reliance on technological innovations and diversifying modes of service delivery (such as mobile clinics for providing health care in remote areas) could help contain the cost and address quality-related concerns. At the same time, a shift in policies away from a focus on spatially balanced development and towards improving efficiency and promoting the benefits of urban agglomeration could be considered. 11 Bhutan | Development Update I. Recent Economic Developments  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges I. Recent Economic Developments 1.  Growth of 2,326 MW of hydropower capacity has been installed. Hydropower projects drive economic Bhutan’s economy is largely driven by hydro- growth through boosts in aggregate demand, power, which contributed to rapid economic both during the construction phase and when growth in the past two decades through invest- projects are commissioned. On the supply side, ments, export earnings, and contributions to the growth is supported by the services sector, main- budget. The state-led hydropower sector cur- ly transport and communication, retail, and ho- rently accounts for around 30 percent of GDP, 2 tels and restaurants (figure 1). The expansion in and 20 percent of export receipts and domestic tourism has been a key driver for these activities, revenues. Bhutan’s hydropower potential is es- with the annual number of tourists doubling in timated at around 30,000 MW, of which a total the past five years to 300,000. 2 The share of non-manufacturing industry–most of which is hydropower–stood at 30 percent in 2018/19. 12 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges I. Introducing Bhutan Figure 1. Sources of growth (percent) 8.0 7.4 6.5 6.2 6.3 6.0 3.8 3.9 4.0 3.6 4.0 2.0 0.0 -2.0 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 (f) Non-manufacturing (incl. hydro) Manufacturing Agriculture Services Taxes/subsidies GDP growth Source: NBS, WB staff estimates Figure 2. Hydropower production (GWh) and export revenue (percent of GDP) 8,000 15.0 7,800 10.0 7,600 7,400 5.0 7,200 7,000 0 6,800 (5.0) 6,600 6,400 (10.0) 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 Hydropower production, GWh (LHS) Production, % change (HRS) Export revenue, % GDP (RHS) Series 4 Source: MOF Growth is estimated to have remained subdued hydropower project (720MW). The latter was in- in 2018/19 as hydropower production contracted augurated in August 2019, four months behind further. After slowing to 3.8 percent in 2017/18 as schedule (figure 2). As a result, the industry sector, a result of lower hydropower production, growth which includes hydropower, is estimated to have is estimated to remain subdued at 3.9 percent in contracted by 0.5 percent in 2018/19. 2018/19. Hydropower production declined fur- ther from 7,265 GWh in 2017/18 to 7,098 GWh The main driver of growth in 2018/19 was the in 2018/19 reflecting a combination of factors, services sector. The services sector showed robust including maintenance work in the largest hydro growth in 2018/19 at 8.4 percent, supported by project Tala (1,020MW, accounting for 60 percent retail trade, transport and communication. The tour- of total production) over the last two fiscal years, ism sector however showed mixed results. Tourist lower than expected rainfall – hydro production arrivals increased by 17.8 percent in 2018/19, sup- is heavily dependent on weather patterns –, and porting growth in the services sector. Most of this delays in the commissioning of the Mangdechhu increase came from regional tourists from India and 13 Bhutan | Development Update I. Introducing Bhutan  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 3. Tourist arrivals (thousands) and export revenue (percent of GDP) 350 4.5 300 4.0 3.5 250 3.0 200 2.5 150 2.0 1.5 100 1.0 50 0.5 0 0 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 Regional arrivals, thousends (LHS) International arrivals, thousends (LHS) Tourism receipts, % GDP (RHS) Source: MOF Bangladesh who are not subject to a minimum pack- 2.  Bhutan’s First Economic Census age fee.3 Their numbers increased by 24.8 percent in 2018/19 while the number of higher value non-re- The Economic Census of Bhutan (ECoB) 2018/19– gional tourist arrivals grew only by 0.4 percent. While the first economic census conducted in the country– total tourist arrivals increased, tourism receipts de- provides essential information on the real sectors of creased from 3.7 percent of GDP in 2017/18 to 2.9 the economy. The census, conducted by the Nation- percent in 2018/19, mainly due to lower average al Statistics Bureau (NSB), provides firm-level data spending (figure 3). To regulate the rising influx for 13,997 economic establishments4 on parameters of regional tourists, the Tourism Council of Bhutan such as geographic location, legal status, ownership (TCB) has prepared a new Tourism Bill, which will be characteristics, as well as economic activities and discussed in parliament in January 2020. employment. The census also provides information on the main business constraints. The key findings Despite efforts by the government, Bhutan still has include the following: some way to go in the creation of a competitive, job-creating private sector. The key constraints (i) Firms are geographically concentrated in the faced by the private sector include limited connec- Thimphu dzongkhag and in urban areas.5 Al- tivity, lack of skilled manpower, low access to finance most 60 percent of the firms are concentrated and regulatory bottlenecks in the business environ- in 6 out of 20 dzongkhags, with Thimphu dz- ment. The government is undertaking measures ongkhag accounting for around 25 percent on all these fronts and the first economic census of the total. Almost two-thirds (64 percent) (discussed below) was a stock taking exercise in this of the firms are located in urban areas, and direction. Thimphu thromde alone represents 22 per- cent of the total. Almost two-thirds of firms (63 percent) are operating in the trade sector, mostly in retail trade (figure 4). This is fol- lowed by accommodation and food services 3 According to Bhutan’s tourism policy, international visitors need an entry permit to visit the country and have to subscribe to a package costing a minimum of US$250 per person per day. Regional visitors from India, Bangladesh and the Maldives do not require an entry permit. 4 The ECoB covers state-owned enterprises, NGOs, project authorities, farmer’s groups and other legal forms. It does not cover general government offices, household-based businesses, household-based subsistence growing of crops and rearing of livestock, defense services and religious institutions. 5 Bhutan is geographically divided into 20 administrative districts referred to as dzongkhags, and four urban centers, called thromdes (Gelephu, Phuentsholing, Thimphu, and Samdrup Jongkhar). The definition of rural or urban is defined at the Gewog or town level. 14 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges I. Introducing Bhutan Figure 4. Number of establishments by Figure 5. Establishments by legal status economic sector and region, 2017 and duration of operation, 2017 Source: ECoB 2018/19 6000 100% 5000 4000 3000 90% 2000 1000 0 80% Central Eastern Western, incl. Southern Below 5 years 5-10 years More than 10 years Thimohu Agriculture, forestry and fishing Preject authority FDI company Wholesale and retail trade State-owned limited company Public limited company Accommodation and food service activities Private limited company Permanent shed vendor Other economic sector Single proprietorsship or partnership Source: ECoB 2018/19, and WB staff estimates (21 percent) – mainly food and beverage ser- the total workforce. Wholesale and retail, vice providers – and the manufacturing sector accommodation and food services (which (5 percent). The agriculture sector accounts account for 63 and 21 percent of total firms) for 3 percent of total firms and is mainly pres- employ only around 39 percent of workers. ent in the Southern region. In contrast, construction and manufacturing (ii) Bhutan’s real sector is dominated by young (accounting for 1 and 5 percent of total firms) firms–about 55 percent of firms are less than employ 19 and 14 percent of the labor force 5 years old, and 34 percent of firms are 1-2 (figure 6). years old. Almost all young firms operate as (iv) The main business constraints include pay- single proprietorships, partnership or per- ment of rent, competition with the informal manent shed vendor (99 percent of firms sector, access to finance, and electricity less than 10 years old, figure 5). 56 percent supply. Access to finance and electricity are of owners of single proprietorship and part- among the top six constraints in all econom- nership firms are women, concentrated in the ic sectors (ranked in terms of prevalence age bracket of 30–39 years of age. Private and severity). This is reflected in Bhutan’s limited companies, public limited compa- ease of doing business (figure 7).6 While nies, and state-owned companies have been Bhutan scores better in most sub-indices in operation significantly longer (on average and overall compared to the South Asian between 13 and 16 years). The share of FDI regional average (66 vis-à-vis 58.2), getting related companies is relatively small in Bhu- credit is at par with the regional average. tan (0.2 percent or 31 firms), with the majority Furthermore, getting electricity is the only being from India. sub-index with a lower score in 2020 vis-à- (iii) Employment is concentrated in a few large vis 2016. Compared across sectors, the lack firms. While large firms with 100 employees of access to finance is more pronounced or more account for less than one percent in the primary sector, followed by access of total firms, they employ 45 percent of to water and transport. Skill shortages and 6 WB Doing Business 2020. 15 Bhutan | Development Update I. Introducing Bhutan  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 6. Share of establishments and Figure 7. Bhutan’s ease of doing business employment by economic sector, 2017 2020, (score 0 center, score 100 outer edge) Source: WB Doing Business 2020. Since there is no practice regarding Wholesale 63% resolving insolvency in Bhutan, the score isaequal to 0. Starting and retail 24% Resolving Business Dealing with Insolvency 100 Construction Other 10% Permits 22% 80 60 Construction 1% 19% Enforcing 40 Getting Contracts Electricity 20 Accomm/food 21% services 15% 0 Trading across Registering Manufacturing 5% Borders Property 14% 0% Electricity 6% Paying Getting Taxes Credit 0 20% 40% 60% Protecting Minority Investors Share of establishments Share of persons employed Bhutan SAR regional avernge Source: ECoB 2018/19 elevated tax rates are the main constraints The annual inflation rate decreased by almost one in the secondary sector, whereas firms in the percentage point from 3.7 percent in 2017/18 to 2.8 tertiary sector listed the competition from percent in 2018/19. The deceleration was largely the informal sector and payment of rent as driven by food prices, which account for about 40 the main obstacles to doing business. percent of the Consumer Price Index (CPI) basket. Growth of food prices decelerated from 6.5 percent 3.  Inflation and Monetary Policy to 3.5 percent during the period. In November 2019, inflation was still moderate at 2.3 percent; however Monetary policy is anchored by the peg to the Indi- food prices have been increasing since mid-year (4.1 an Rupee (INR). The Bhutanese Ngultrum is pegged percent in November 2019), in line with the increase to the INR at par. The peg, introduced in 1974, in food prices in India (figure 8). served Bhutan well for macroeconomic stability, as India is Bhutan’s largest trading partner. The peg re- The growth of money supply slowed down further mains an appropriate nominal anchor even though in 2018/19 because of a decline in net foreign the real effective exchange rate has recently been assets. Broad money increased by 5.6 percent in moderately overvalued.7 2018/19 vis-à-vis 10.4 percent in 2017/18, the low- est growth in 7 years (figure 9). This was due to a In 2018/19, average annual inflation decreased continued decrease in net foreign assets (NFA), re- to its lowest level since 2003, reflecting a rapid flecting lower capital and financial flows including decline in food prices. With 85 percent of Bhutan’s grants and Foreign Direct Investment (FDI)-related imports coming from India and with the exchange investments. The government continues with its rate pegged to the INR, Bhutan’s inflation rate is efforts to enhance monetary management through closely linked to that of India, albeit with a time lag.8 the introduction of a new policy framework and a 7 IMF (October 2018). 2018 Article IV Consultation. External Sector Assessment. The ngultrum has been moderately appreciating in real effective terms. During the first quarter of 2018 the REER appreciated by 0.4 percent and the NEER depreciated by 2.5 percent. Movements in both the REER and NEER are heavily influenced by the rupee. 8 WB (November 2018). Bhutan Development Update. The time-lagged correlation coefficient between India’s Wholesale Price Index (WPI) and Bhutan’s CPI is statistically significant and suggests that Bhutan’s CPI lags India’s WPI by six months. 16 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges I. Introducing Bhutan Figure 8. CPI, Bhutan and India (percent change YoY) 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 CPI India CPI, food CPI Source: NSB Figure 9. Money supply (percent change YoY) 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Jul-17 Dec-17 May-18 Oct-18 Mar-19 M1 M2 Source: RMA broadening of monetary policy instruments.9 This 4.  Financial Sector includes improved liquidity management and fore- casting capabilities, establishing an interest rate Credit growth to the private sector remained strong corridor and supporting the development of the in 2018/19 (16.7 percent, YoY), similar to the past interbank market. Currently, the Royal Monetary Au- three years. The stock of credit outstanding to the thority (RMA) relies on administrative instruments for private sector as a share of GDP more than doubled managing liquidity and market conditions.10 since 2007 (standing at 65 percent at the end of 2018). Most of the credit is concentrated in con- struction, services and tourism, and trade sectors, 9 WB (July 2019). Bhutan Development Update. 10 RMA has relied on the Cash Reserve Ratio CRR and statutory liquidity ratio (SLR) for monetary policy management. To guide banks’ lending rates, the RMA relies on the Minimum Lending Rate (MLR) since August 2016. The move was intended to introduce a forward-looking and interest rate policy mechanism expected to enhance transparency in the bank credit market, and encourage competition and professionalism among banks. The MLR is a single reference rate for all financial institutions calculated using cost parameters across all banks, including certain regulations (such as CRR or SLR), overhead costs, and profitability. 17 Bhutan | Development Update I. Introducing Bhutan  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 10. Credit growth and contribution (percent change YoY, 3-months moving average) 24.0 21.0 18.0 15.0 12.0 9.0 6.0 3.0 0 (3.0) JUL-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Service, tourism Personal loans Other Construction Trade and commerce Total credit Source: RMA Figure 11. Financial sector soundness indicators (percent) 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 0.5% 10.4% 18.4% 0.0% 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 2018Q2 2018Q3 2018Q4 2019Q1 2019Q2 2019Q3 Gross non-performing loan (NPL) ratio Risk weighted capital edequacy ratio (RWCAR) Statutory Liquidity Requirement (SLR) ratio Minimum regulatory requirement (12.5%) Source: RMA while credit to the agriculture sector remained flat 21 to 14 percent in the same period (figure 10). This at around 5 percent of the total portfolio. Medi- change primarily reflects a pick up in tourism in the um-sized enterprises are the largest recipients of past two years. loans, while the cottage and small industries (CSI) sector–the focus of the Priority Sector Lending (PSL) The gross NPL ratio stood at 18.4 percent in Sep- initiative11–accounted for 5 percent of the total loan tember 2019, adversely affecting the profitability of portfolio. The sectoral composition of credit has financial institutions. The banking sector is nascent. changed in recent years. While the share of the The profitability of the financial sector is low, with services and tourism sector increased from 17 per- some institutions having large NPLs. The NPL ratio cent in the beginning of 2016/17 to 24 percent by increased to 18.4 percent in September 2019, vis- end-2018/19, trade and commerce declined from à-vis 10.4 percent in December 2018 (figure 11).12 11 RMA has launched a PSL program to improve access to credit for the CSI sector in 2018. RMA decided to forgo enforcement of the envisaged priority sector lending targets for the commercial banks at the early stages of implementation. 12 The NPL ratio also increased YoY, from 12.4 percent in September 2018, to 18.4 percent in September 2019. 18 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges I. Introducing Bhutan At the same time, provisions for NPLs decreased by equipment and fuel. As a landlocked, mountainous 11.7 percentage points to 56.9 percent. While these country, Bhutan also largely depends on imports for movements reflect mid-year cyclical factors, the NPL its consumption needs. India is Bhutan’s main trading and provisioning ratios have overall been negatively partner, accounting for 80 and 85 percent of exports impacted in recent years.13 The increase in NPLs was and imports, respectively. Bhutan’s major exports in largely attributable to the non-banking sector, which goods—in addition to electricity (accounting for 33 also has a lower loss absorption tolerance.14 Earn- percent of exports)—are base metal (31 percent) and ings of the financial sector decreased, mainly due minerals (19 percent), most of which are low val- to an increase in interest and operating expenses ue-added. Tourism is the second-largest source of (commercial banks) along with an increase in NPLs foreign-exchange earnings after hydropower. and subsequent increase in provisions for the bad loans (in the non-banking sector).15 The current account deficit (CAD) widened in 2018/19 on the back of lower electricity and tour- While financial soundness indicators remain com- ism receipts. The CAD increased from 19.6 percent fortable in the banking sector, the risks for the fi- of GDP in 2017/18 to 23.9 percent in 2018/19 nancial sector are on the increase, and the sector’s (figure 12). Falling imports–reflecting slowing con- resilience needs to be further strengthened. The struction activity of hydropower projects and fuel banking sector has adequate cushion to absorb po- imports–could not offset a decline in electricity tential losses given its capital adequacy (risk weight- exports. The latter was a result of a combination of ed capital adequacy ratio (RWCAR) at 12.8 percent factors, including maintenance work in existing pow- in September 2019 and 15.1 in December 2018, er plants, lower than expected rainfall, and delays in with the minimum regulatory requirement at 12.5 the construction of the Mangdechhu hydropower percent). There are, however, concerns with regards project. Exports in services dropped significantly to the non-banking sector. The financial sector’s re- from 7.2 percent of GDP in 2017/18 to 5 percent silience needs to be further strengthened and the of GDP in 2018/19 due to a decrease in tourism re- regulatory regime needs to be modernized to avoid ceipts. The CAD was mainly financed by capital flows a build-up of risks. There is a need to bolster pru- from India.17 dential oversight, especially for non-banks, and the insurance sector in particular. It is equally important International reserves, however, remain at com- to develop a medium to long-term strategy for the fortable levels. International reserves have grown non-banking sector, including options to diversify investment opportunities and improve asset-liability steadily over the recent years and reserve adequacy management. measures are met by a wide margin. Gross interna- tional reserves stood at US$1,093 million in August 2019, which is equivalent to 11.6 months of imports 5.  External Sector of goods and services (figure 13). The composition Bhutan has the third largest trade deficit (as a share of reserves also improved after the rupee crisis in of GDP) among South-Asian countries and trades 2012-13, when overheating pressures led to a short- heavily with India.16 The trade deficit is structural, age of INR reserves. The share of INR has increased reflecting hydropower investment, which requires since and is better aligned with the country’s exter- large capital goods imports along with other nal liabilities and trade structure. 13 The financial sector experiences significant fluctuations in its NPL ratio for the following reasons (i) NPLs are written off periodically; (ii) financial instruments are not well aligned with borrowers’ expected cash flow distribution; and (iii) there are seasonal repayments based on the borrowers’ activities. The NPL ratio to total loans stood at 12.3 percent for banks, and 48.7 percent for non-banks by end-September 2019. 14 A systemic insurance company, in particular, is experiencing significant balance sheet pressures. 15 RMA (June 2019). Financial Sector Performance Review Report. 16 WB WDI (2019). Using trade balance as a share of GDP, average 2015-17, Bhutan has the third largest trade deficit after Afghanistan and Nepal. 17 The CA has been financed by surpluses in capital and financial accounts. 19 Bhutan | Development Update I. Introducing Bhutan  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 12. Current account, Figure 13. Gross international reserves components (percent of GDP) (US$ Mio, LHS) and percent share of Rupee reserves in total reserves (RHS) 50.0 50.0 1400 40% 1400 40% 30.0 1200 35% 30.0 1200 35% 30% 10.0 1000 30% 10.0 1000 25% 800 25% (10.0) 800 20% (10.0) 20% 600 (30.0) 600 15% (19.6) (23.9) 15% (30.0) 400 (23.6) (19.6) (23.9) 400 10% (50.0) (27.9) (31.7) (23.6) 10% (27.9) (31.7) 200 5% (50.0) 200 5% (70.0) 0 0 (70.0) 2014/15 2015/16 2016/17 2017/18 2018/19 0 0 Jan-12 Aug-12 Mar-13 Oct-13 May-14 Dec-14 Jul-15 Feb-16 Sep-16 Apr-17 Nov-17 Jun-18 Jan-19 Aug-19 2014/15 2015/16 2016/17 2017/18 2018/19 Jan-12 Aug-12 Mar-13 Oct-13 May-14 Dec-14 Jul-15 Feb-16 Sep-16 Apr-17 Nov-17 Jun-18 Jan-19 Aug-19 Export goods Import goods Secondary goods Export services Export goods Import services Import Secondary Primary income Rupee sharen in GIR, % (RHS) Export services Exports Import services goods, hydro Primary CAB income Rupeeinternational Gross sharen in GIR, % (RHS)USD Mio (LHS) reserves, Exports goods, hydro CAB Gross international reserves, USD Mio (LHS) Source: RMA Source: RMA Table 2. Balance of Payments, contributions, 2015/16-2018/19 2015/16 2016/17 2017/18 2018/19 Table: BOP, % of GDP (actual) (actual) (actual) (estimate) Export 31.0 31.1 31.0 27.1 Goods 24.0 24.2 23.8 22.1 Services 7.1 6.9 7.2 5.0 Tourism 3.9 4.0 3.7 2.9 Import (61.4) (53.8) (50.3) (49.0) Goods (51.4) (44.7) (40.6) (38.9) Services (10.0) (9.2) (9.6) (10.0) Primary income (8.3) (8.6) (8.4) (8.9) Secondary income 7.0 7.7 8.1 6.9 Current Account (31.7) (23.6) (19.6) (23.9) Source: RMA, WB staff estimates 20 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges I. Introducing Bhutan 6.  Fiscal Performance expenditure. Nearly 30 to 35 percent of total capital expenditure is financed through external grants and Fiscal outcomes have been largely dependent borrowings, mostly from India.18 Expenditure fluc- on hydropower revenues and grant inflows from tuates due to FYP cycles (see box 1 on fiscal policy India. Revenue volatility reflects heavy reliance on under Bhutan’s Five-Year Plans). hydro-related revenues, a narrow tax base, and the dependence on grants. Domestic revenues are The fiscal balance improved further in 2018/19 due highly dependent on hydropower revenues, which to a sharp decline in capital expenditure.19 The fis- accounted for around 20 percent of the total in cal balance improved from a deficit of 3.3 percent the past five years. The tax-to-GDP ratio is low by of GDP in 2017/18 to an estimated surplus of 0.8 international standards, standing at 15.6 percent percent in 2018/19. This was primarily due to the in 2018/19, due to a narrow tax base, widespread decline in expenditures, which more than offset exemptions and a nascent private sector. Bhutan the decrease in revenues (figure 14). Grants as a is dependent on foreign resources for its capital share of GDP declined from 9.1 percent in 2017/18 18 Development assistance in the form of grants has played a significant role in the budget, accounting for 8.5 percent of GDP in 2015-2018. India accounted for 6 percent of GDP. 19 Capital expenditure on hydropower projects are not included in the budget, they are however part of the public debt stock. Maintenance and operational cost of past investments in infrastructure are included in the current expenditure. 21 Bhutan | Development Update I. Introducing Bhutan  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Table 3. Fiscal accounts, 2015/16-2018/19 2015/16 2016/17 2017/18 2018/19 Table: Fiscal accounts (actual) (actual) (actual) (estimate) Overall balance (1.9) (4.8) (3.3) 0.8 Primary balance (0.4) (3.5) (2.0) 1.8 Revenue 30.7 28.0 31.9 26.1 Hydropower revenue 3.5 4.4 5.1 4.4 DHI 1.9 1.6 1.4 1.2 Others 0.1 0.1 1.2 1.3 PIT 1.4 2.7 2.5 1.9 Taxes on Goods and Services - - - - Non-hydro revenue 16.4 15.1 17.7 15.6 Excise Duty Refund from India 5.6 5.2 5.9 5.8 Royalties 6.9 7.3 8.1 7.4 Hydropower 3.9 2.6 3.8 2.4 Grants 10.9 8.5 9.1 6.2 Expenditure 32.7 32.8 35.2 25.3 Current expenditure 16.7 15.8 16.8 15.9 Compensation of employees 6.9 6.2 6.0 6.7 G/S 4.5 4.3 4.2 4.2 Interest payments 1.5 1.3 1.3 0.9 Transfers and subsidies 2.3 2.7 4.0 2.7 Other 1.5 1.4 1.4 1.5 Capital expenditure 15.9 17.0 18.3 9.3 Source: MoF 22 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges I. Introducing Bhutan Figure 14. Fiscal accounts, Figure 15. Public debt components (percent of GDP) (percent of GDP) Source: MoF 40.0 120.0 108.9 104.9 105.1 30.0 102.5 96.6 100.0 20.0 10.0 80.0 83.0 81.1 80.2 0.0 78.4 0.8 69.2 (10.0) (0.2) (1.9) (3.3) 60.0 (4.8) ! ! (20.0) 40.0 (30.0) (40.0) 20.0 2014/15 2015/16 2016/17 2017/18 2018/19 3.4 6.6 5.0 1.7 2.9 0 Hydro revenue Grants Capital expenditure 2014/15 2015/16 2016/17 2017/18 2018/19 Non-hydro revenue Current Overall balance expenditure Domestic debt External debt Hydropower debt Source: MoF to 6.2 percent in 2018/19 as capital expenditures to hydropower project loans from India. External remained subdued. At the same time, hydropower debt increased significantly over the past two de- revenues20 decreased from 5.1 percent of GDP in cades, driven by disbursements for hydropower 2017/18 to 4.4 percent of GDP in 2018/19, reflecting projects. Public debt as a share of GDP remains lower hydropower production. Non-hydro revenues high, estimated at 105.4 percent of GDP at the declined as a result of one-off factors, including the end of 2018/19 (figure 15). Hydropower debt ac- discontinuation of the excise duty refunds from In- counted for 74.4 percent of the total debt stock. dia21 (indirect tax revenue) and a decrease in profit According to the 2018 Debt Sustainability Anal- transfer from RMA (non-tax revenue). ysis (DSA), the risk of debt distress however re- mains moderate. Around 95 percent of total debt The decrease in revenues was surpassed by an even is external with a long-term maturity, of which the larger contraction in fiscal spending. Capital expen- majority is linked to hydropower project loans diture decreased significantly, from 18.3 percent of from the government of India (74.3 percent of GDP 2017/18 to 9.3 percent in 2018/19 as a result of GDP). This debt is denominated in INR and elec- the 2018 elections. While the interim budget did not tricity export receipts are also in INR. The loans include new investment projects, the new budget from India are under an intergovernmental agree- was only approved in January 2019, delaying the ment in which the government of India covers initiation of new investment projects. The control on both financial and construction risks of the hydro- current expenditure remained tight. power projects and buys surplus electricity at a price reflecting cost plus a 15 percent net return. Public debt levels remain high, but risks are Domestic debt remains a small share of GDP (2.9 moderate as most of the external debt is linked percent). 20 Hydropower revenue includes corporate income taxes (CIT), royalties, one-time profit transfers (when a project is handed over to the government of Bhutan), and dividends. 21 The government of India collected excise duties on alcohol and other excisable products that were exported to Bhutan, and transferred them to the government of Bhutan. With the introduction of GST in India, this arrangement has come to an end because of removal of excises on exports from India. Since these revenues are transferred with a delay of one year, the impact is evident in the current year. 23 Bhutan | Development Update I. Introducing Bhutan  Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Box 1. Fiscal policy under Bhutan’s Five-Year Plans Fiscal outcomes have been largely dependent on five-year planning cycles in the past. Bhutan’s development strate- gy has been guided by five-year plans (FYPs), a series of national development plans initiated in 1961. While current expenditures have remained largely constant as a share of GDP, capital expenditures tend to increase toward the end of the FYP cycle. This results in a deterioration of the fiscal balance as the plan progresses and leads to a significant increase in aggregate demand (figure 16). Fiscal policy is further complicated by volatile hydropower revenues, which leads to procyclical fiscal policy. For example, the commissioning of the Tala hydropower project in 2007 resulted in a doubling of government revenues, leading to higher government spending–highlighting the need to ensure the sustainability of spending trajectories. The government is implementing measures to reduce volatility in fiscal revenue and expenditure. The government established a stabilization fund in 2017–the Bhutan Economic Stabilization Fund (BESF)–to manage hydropower rev- enues and business cycle fluctuations, and operating rules are currently being designed. The adoption of fiscal stabi- lization measures will help the government to implement counter-cyclical fiscal policies and ensure even distribution of expenditure, thereby reducing fluctuations in aggregate demand and building fiscal space. The 12th FYP ‘Just, Harmonious and Sustainable Society through enhanced Decentralization’ lays out the national economic development plan for 2018-23. The 12th FYP, led by the Gross National Happiness Commission, was final- ized in January 2019. The plan’s overall objective is to increase well-being and happiness for the people of Bhutan, focusing on 17 National Key Result Areas, including, among other, macroeconomic stability, economic diversification, and job creation. The fiscal framework for the 12th FYP (figure 17) projects a total financing gap of Nu 29.2 billion (US$450 million). Measures to increase domestic revenue and develop domestic capital markets are crucial for the implementation of the 12th FYP. Efforts are needed to increase the domestic (non-hydro) revenue base, including through the introduc- tion of the GST regime in 2020 and reforms in tax administration. As Bhutan is expected to graduate from the United Nations’ least developed country status in 2023 and concessional financing is likely to decrease, the authorities need to develop the domestic public debt market and increase public-private partnerships. Figure 16. Fiscal outcomes over Figure 17. Fiscal framework, as per FYP cycles (percent of GDP) 12th FYP (percent of GDP) 25 30 20 20 10 15 0 10 -10 5 -20 -30 0 -40 Actual FYP FYP FYP FYP FYP -5 2018/19 2018/19 2019/20 2020/21 2021/22 2022/23 -10 10th FYP 11th FYP 12th FYP (projected) Domestic Revenues Grants Current expenditure Capital expenditure Overall fiscal deficit Current spending Capital spending Fiscal Balance Source: Gross National Happiness Commission (GNHC) 24 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges II. Outlook and Risks II. Outlook and Risks Economic growth is expected to average at around sub-sectors, buoyed by tourism demand. Growth in 6 percent a year over the medium term, supported agriculture and manufacturing is gradually strength- by an increase in hydropower production and good ening, supported by improvements in the business growth in the services sector (figure 18). Growth environment, such as the implementation of the is projected to rebound in 2019/20 to 5.5 percent 2019 FDI policy. following the operationalization of the Mangdech- hu hydropower project, although the plant is only Inflation is expected to pick up in the near future expected to reach full potential in 2020/21 (figure due to the increase in food prices in India (figure 8). 19).22 The services sector is projected to retain It is however expected to decline over the medium its growth momentum, with the key drivers in the term as RMA steps up efforts to strengthen mone- hotel and restaurant, transport, and retail trade tary management. 22 Bhutanese (November 2019, Vol 08 issue 42). After the commissioning of the Mangdechhu hydropower project in August 2019, the plant was suspended the following month due to computer and mechanical issues that affected all four turbines. 25 Bhutan | Development Update II. Outlook and Risks Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 18. Growth projections 2018/19-2021/22 (percent change) 10.0 8.0 6.0 4.0 2.0 0 -2.0 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 (f) 2019/20 (f) 2020/21 (f) 2021/22 (f) GDP growth Services Agriculture, livestock, for estry Industry Source: MoF, WB staff estimates Figure 19. Hydropower production, estimated capacity (GWh, LHS) 15,000.0 30.0 20.0 10,000.0 10.0 5,000.0 0.0 0.0 (10.0) 2018/19 2019/20 2020/21 2021/22 2022/23 (f) (f) (f) (f) Punachu II Mangdechhu Chukkha Tala Production, % change (RHS) Source: MOF, WB staff estimates External accounts are expected to improve over projects. Although current account deficits are likely the medium term. The CAD is projected to nar- to persist due to imports associated with the hydro- row over the medium term, driven by an increase power sector, they will continue to be financed by in electricity exports with the on-streaming of the capital inflows from India. Mangdechhu and Punatsangchhu II projects in 2019/20 and 2022/23, respectively. Imports are The adoption of fiscal stabilization measures is ex- expected to increase due to the ongoing construc- pected to reduce revenue and expenditure volatili- tion of Punatsangchhu II and I and higher public ty in the medium term. Hydropower revenue is pro- capital spending, thus increasing imports associated jected to increase in the medium term as production with hydropower construction and infrastructure levels increase, boosted by the one-off profit transfer 26 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges II. Outlook and Risks from the commissioning of the Mangdechhu power completion and/or adverse weather events. Lower plant in 2019/20 and 2020/21.23 Grants, as a share of hydropower production results in lower electricity GDP, are expected to decrease in the medium term, exports and a deterioration in fiscal accounts. The in line with reduced grant financing from India over construction of Punatsangchhu I and II projects has the 12th FYP cycle. The planned introduction of the been delayed for several years due to geological green tax on fuel in 2019 and the GST in 2020, as well problems. A one-year delay in project implementa- as a gradual improvement in tax administration are tion is estimated to lower growth by 3-4 percentage expected to support non-hydro revenues and partly points (through lower production levels), reduce offset the decline in grants.24 After an expansionary annual export revenue by US$250-300 million and fiscal stance in 2019/20 due to a pick up in capital government revenue by 0.5 to 1 percent of GDP.26 spending, the overall deficit is expected to remain Electricity production also strongly depends on moderate with a slight increase in 2021/22 because water availability and weather patterns, and the fre- of the absence of profit transfer revenues. Capital ex- quency and intensity of extreme events is expected penditure–constrained by the reduced grant inflows to increase with climate change. Weather related for the 12th FYP from India–is expected to decrease events could also impact tourist arrivals. in the medium term in line with the 12th FYP. Current expenditure is projected to remain tight despite the Delays in the implementation of the GST and other expected salary increase in 2019/20 (which is large- revenue measures constitute another risk. External ly financed by the one-off profit transfer from the grant financing as a share of GDP declined signifi- Mangdechhu hydropower project),25 supported by cantly from an average of 11.6 percent during the last public financial management measures to increase two FYP cycles (2008/09-2017/18) to 6.2 percent in expenditure efficiency and the adoption of fiscal sta- 2018/19, based on the bilateral discussions with In- bilization measures (box 1). dia. In addition, excise duty refunds from India have also been discontinued. The introduction of the GST Public debt is projected to gradually decline over in 2020 and other revenue measures are critical to the medium-term. According to the 2018 DSA, joint- offset the decline in excise duties and grant financ- ly conducted by the World Bank and the IMF, the risk ing in the medium to long term. Delays in the imple- of debt distress remains moderate despite breaches mentation of these revenue measures could lower in all five indicators under the baseline scenario. This the resource envelop available to the government. is because of the intergovernmental arrangement This risk is partly mitigated by the implementation on hydropower projects between India and Bhutan of fiscal stabilization measures (under discussion), which ensures that financial and construction risks of which will help smoothen spending over the medi- the projects are covered by India, which buys surplus um to long term, especially after the completion of electricity at a price reflecting cost plus a 15 percent the existing mega hydropower projects. net return. Total public debt is expected to decline gradually over the medium term as debt servicing In the medium term, Bhutan faces two key challeng- starts with the on-streaming of hydropower projects. es: making growth more inclusive, and less reliant on hydropower activities. Bhutan needs to facilitate The main downside risk to growth is volatile hydro- more private-sector-led growth to increase employ- power production due to further delays in project ment opportunities and domestic revenues and 23 The peak in hydropower revenue in 2019/20 and 2020/21 is due to one-off profit transfer revenues associated with the commissioning of new hydropower plants. Profit transfers are expected to resume in 2023/24 with the commissioning of Punatsangchhu II and I in 2022/23 and 2023/24, respectively. 24 The parliamentary session in January 2020 will discuss the GST bill and various revisions to the income tax act, property tax, and financial incentives act. 25 The government formulated the Fourth Pay Commission in January 2019. The report was prepared based on three principles: (a) protecting ero- sion of income from past-unadjusted inflation, (b) linking salary to performance, and (c) enhancing the post-retirement benefits. Also, to improve effectiveness and efficiency, the report recommends introducing performance-based incentives (PBI). 26 WB (July 2019). Bhutan Development Update. 27 Bhutan | Development Update II. Outlook and Risks Recent Trends in Poverty and Shared Prosperity: Progress and Challenges lessen the country’s dependence on foreign grant Bhutan achieved great strides in poverty allevia- financing. While the hydropower sector has con- tion but the pace of progress in shared prosperity tributed significantly to economic growth, electricity has slowed in recent years. The share of Bhutan’s export markets in South Asia are rapidly changing, population living on less than US$3.20 (in 2011 PPP and the recently adopted framework for cross-bor- terms) decreased from 36.4 percent in 2007 to 12.1 der trade of electricity in India has added to the percent in 2017. Disparities between urban and ru- uncertainty in accessing foreign electricity markets. ral areas remain, with 96 percent of the poor living in Despite efforts by the government to improve the rural areas. Gender disparities in economic opportu- business environment, the private sector remains nities persist and the quality of jobs is lower among underdeveloped and is dominated by small and women as they are more likely to work in low-paying micro firms, with a majority operating in services and sectors including subsistence agriculture.27 The spe- retail trade, as illustrated in Bhutan’s first economic cial section in this economic update outlines recent census (see section A.2). trends in poverty and shared prosperity. 27 WB (2019). Forthcoming Systematic Country Diagnostic (SCD) for Bhutan. 28 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges III. Progress and Challenges III. SPECIAL SECTION. Recent Trends in Poverty and Shared Prosperity: Progress and Challenges 1.  Recent progress in poverty 2012 and then further to 12.1 percent in 2017.28 The reduction and welfare $3.20 poverty line is the World Bank’s poverty line for lower-middle-income countries such as Bhutan. Poverty declined in recent years with rural areas Urban poverty has been low and decreased further making significant strides. At $3.20 per person per from 4.1 percent in 2012 to 1.6 percent in 2017. day (in 2011 PPP terms), the poverty headcount de- Poverty in rural areas declined significantly through- creased from 36.4 percent in 2007 to 17.8 percent in out the decade, from 48.1 percent in 2007 to 17.4 28 The poverty trend presented in this section differs from the official poverty trend for two reasons: (a) the consumption aggregate was harmonized across years to ensure consistency; (b) the World Bank’s $3.20 poverty line (in 2011 PPP terms) is used as a threshold to identify the poor. For more details on the methodology, see WB (2019) “Bhutan Poverty, Vulnerability and Welfare”. 29 Bhutan | Development Update III. Progress and Challenges Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 20. Poverty rates according to Figure 21. Selected asset ownership World Bank’s international poverty line of poor and nonpoor, 2007-2017 of $3.20 per day (in 2011 PPP terms) Source: Calculations using BLSS for 2007, 2012, and 2017. Note: No data on mobile phone ownership in 2012. 50 48.1 100% 40 80% 36.4 60% Poverty rate (%) 30 23.9 40% 20 20% 17.4 17.8 12.1 0% 10 Fridge Mobile TV Fridge Mobile TV 4.1 3.8 phone phone 1.6 0 2007 2012 2017 Poor Nonpoor Urban Rural Total 2007 2017 Source: Calculations using Bhutan Living Standards Survey (BLSS) for 2007, 2012, and 2017. percent in 2017 (figure 20). As almost all of the poor poor people, declined from 53.2 percent in 2007 to reside in rural areas, the large improvements in rural 32.3 percent in 2012 and to 17.5 percent in 2017. areas drove progress at the national level. In contrast, the poverty headcount rates in Dagana and Zhemgang, the two districts with the highest In line with reduction in monetary poverty, asset incidence of poverty, declined strongly between ownership also improved significantly, for the poor 2007 and 2012 but increased again afterwards. As as well as the nonpoor. Among poor households, of 2017, the poverty rate was 42.8 percent in Daga- the ownership of refrigerators rose from 3 percent na and 36.5 percent in Zhemgang. Both are remote in 2007 to 17 percent in 2017, while that of mobile districts located in the central part of Bhutan. Just phones increased from 10 percent to 79 percent over three districts – Dagana, Monggar, and Samtse – ac- the same period. Nevertheless, the gap between the counted for more than a third of the total number of poor and nonpoor remains wide as the latter group poor due in part to their large populations. experienced significant improvements as well (fig- ure 21). The ownership of large assets such as cars While educational outcomes saw large improve- remains particularly low among the poor (2 percent) ments, disparities across districts persist. Educa- compared to the nonpoor (25 percent). tional attainment increased tremendously in the last decades: while the share of 15-29 year-olds with no However, progress was uneven and differences in education was 17.4 percent in 2017; the same fig- poverty rates between Dzongkhags are large. As of ure was 57.2 percent for 30-49 year-olds and 84.4 2017, poverty varies widely across districts (Figure percent for 50-64 year-olds. Progress continued 22) and remains almost exclusively a rural phenom- in recent years, with net secondary enrollment ex- enon, with 96 percent of the poor residing in rural panding rapidly and surpassing 70 percent in 2017. areas. Most districts experienced steady progress Enrollment rates are higher among women at all in poverty reduction between 2007 and 2017: for levels, which is a significant progress considering example, the poverty headcount in Chukha, the that literacy rates and educational achievements are second-most populous district, decreased from 32.2 lower among women in older cohorts. Non-formal percent in 2007 to 16.1 percent in 2012 and further education programs have helped improve basic lit- to 7.4 percent in 2017. The poverty headcount in eracy and numeracy skills. However, there are large Samtse, which accounts for the largest number of disparities across the country: only 20 percent of 30 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges III. Progress and Challenges Figure 22. Dzongkhag-level poverty rates in 2017 40, 45 35, 40 30, 35 Gasa 25, 30 20, 25 Lhuentse Trashi 15, 20 Yangtse 10, 15 Punakha Bumthang 5, 10 0, 5 Paro Thimphu Wangdue Phodrang Trongsa Haa Trashigang Monggar Tsirang Dagana Sarpang Pema Samtse Chukha Zhemgang Samdrup Gatshell Jongkhar Source: Calculations using Bhutan Living standards Survery (BLSS) for 2017. individuals aged 15–29 in Zhemgang have obtained to invest in health infrastructure, with just 3.7 doctors upper-secondary education, which is one-third the (300 total) and 15.1 nurses per 10,000 population rate for Thimphu (59 percent). in 2017, there is an acute shortage of health profes- sionals, especially among specialists. Bhutan’s health system performs well in terms of coverage, affordability and availability of care; how- Similarly, the quality of other basic services is also ever, quality of care and equitable access require at- highly variable across the country. With a rapid ex- tention as changes in the population health profile pansion, almost every Bhutanese has access to elec- place an increasing burden on the system. Access tricity, but the quality of service varies substantially: to health care improved, especially at lower levels the share of households that experienced a power of care. Coverage is almost universal because public outage in the last seven days ranges from 11 percent health services are free. As of 2017, 99 percent of in Tsirang to 95 percent in Dagana. The overall av- the urban and 86 percent of the rural population erage is just below 60 percent. Access to water has live within an hour of a health care facility (outreach improved, but almost 90 percent of the population clinic, basic health unit, or district hospital). Howev- treats water before drinking it. Across districts, the er, it still takes significantly longer to reach a health share of households with 24-hour water supply varies care facility in rural areas than in urban areas. Out- from 51 percent to 83 percent. 81 percent of house- of-pocket expenditure remains low, at 12 percent holds have a flush toilet at home but in three districts in 2014, as access to government health facilities is this figure is less than 60 percent (figure 23). The high, providing financial protection to households. lack of safe drinking water and basic sanitation could A large share of this expenditure is related to trans- contribute to high levels of stunting among children port costs, which may lead to inequitable access to under five, estimated at 21.2 percent. Waterborne services. The incidence of non-communicable dis- diseases such as diarrhea and dysentery are among eases (NCDs) is increasing rapidly, while the burden the diseases with the highest incidence in Bhutan. of communicable diseases remains significant; the existing system is however not well equipped to The share of households that “feels poor” declined meet the challenges of the ongoing epidemiologi- significantly, but the monetary poor are less likely cal transition. While the government has continued to be happy. The share of households that felt “not 31 Bhutan | Development Update III. Progress and Challenges Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 23. Quality of various basic services across districts 100 Bumthang 90 Chhukha Danaga 80 Gasa Haa 70 Lhuentse Monggar 60 Paro Pema Gatshel % of population 50 Punkha Samdrup Jongknar 40 Samtse Sarpang 30 Thimphu Trashigang 20 Trashhi Yanlgtse Trongsa Tsirang 10 Wangdue Phodrang Zhemgang 0 Access to Electricity failure 24-hour water Treats water Flush toilet electricity in last 7 days supply before drinking Source: Calculations using BLSS for 2017. Table 4. Monetary poverty vs subjective poverty Table 5. Monetary poverty vs happiness Monetary poverty measure Monetary poverty measure Indicator of poverty Indicator of happiness Not poor Poor Total Not poor Poor total No 21.3 11.8 20.2 Very unhappy 2.2 3.7 2.4 Neither poor nor unpoor 63.6 56.8 62.8 Moderately unhappy 3.0 7.1 3.5 Poor 11.8 24.7 13.3 Neither happy nor 17.1 25.9 18.1 unhappy Very poor 1.3 5.4 1.8 Moderately happy 39.3 37.8 39.1 Don’t know 2.1 1.3 2.0 Very happy 38.5 25.5 36.9 Total 100.0 100.0 100.0 Total 100.0 100.0 100.0 Source: Calculations using BLSS for 2017. poor” almost doubled from 10.7 percent in 2012 are considered monetary poor also felt poor or very to 20.2 percent in 2017. The share of households poor, whereas only about 13 percent of the nonpoor that felt either “poor” or “very poor” fell significantly felt the same (table 4). In terms of the perception from 25.7 percent in 2012 to 15.3 percent in 2017. of happiness, the poor are significantly less likely to However, poverty was felt differently according to be happy and more likely to be unhappy than the monetary poverty status: 3 out of 10 households that nonpoor (table 5). 32 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges III. Progress and Challenges Figure 24. Contribution to GDP Figure 25. Share of population whose (value added), by sector household head is working in agriculture, working in non-agriculture or not working (%) 100 Source: 80 Calculations using BLSS for 2017. 26.1 70 80 32.4 36.3 38.6 60 50 60 21.3 % of GDP 25.7 40 6.1 32.2 40 34.4 8.0 30 45.1 8.3 20 20 31.4 9.1 10 20.0 13.0 0 0 1981-90 1991-00 2001-10 2011-17 Working in Working in Not working agriculture nonagriculture Agriculture Manufacturing Nonpoor Poor Urban Rural Total Nonmanufacturing industry Services Source: World Development Indicators. 2.  Drivers of poverty reduction urban areas. Most job search is conducted by better educated youth living in urban areas. Economic growth was strong, driven by hydropow- er development, but it was not accompanied by Poverty is highly correlated with being engaged job creation. The hydropower sector contributed to in agriculture. Nearly 60 percent of the employed strong economic growth, which led to an increase were engaged in agriculture in 2016. In rural areas, in the share of industry and services in GDP (figure the share amounted to 78.1 percent, compared 24). While hydropower receipts helped finance large with only 5.9 percent in urban areas. Working in investments in education and health, labor market agriculture is highly correlated with being poor, as outcomes did not improve substantially because the 66 percent of the poor live in households where the capital-intense hydropower sector has not significant- head is engaged in agricultural activities (figure 25). ly contributed to job creation, accounting for less than This is much higher than the estimate for nonpoor one percent of total jobs.29 Meanwhile, hydropower households (38 percent). 11 percent of the poor and construction relies extensively on foreign labor. 42 percent of nonpoor live in a household where the household head works in the non-agricultural sector. The working-age population expanded rapidly but Wage employment remains low and concentrated in labor force participation declined, particularly among urban areas: 70 percent of urban households and women. Between 2013 and 2016, more than 41,000 only 21 percent of rural households rely on wages persons entered the labor market. However, only for their primary source of income. around 11,000 net jobs were added over the same pe- riod. The increase in inactivity occurred mainly among Poverty reduction was likely driven by improve- younger cohorts (ages 15-29) and among women. ments in agricultural productivity and better prices Unemployment rates are low, hovering around 2-3 of cash crops. A critical data gap – i.e., limited infor- percent in recent years and are only slightly higher in mation on agricultural activities at the household 29 Labor Force Survey (LFS) Report Bhutan 2018. 33 Bhutan | Development Update III. Progress and Challenges Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 26. Total output (L) and value added per worker (R) in agriculture, forestry and fishery increased 9 50 2.0 Value added (constant US$, thousands) Value added (constant US$, thousands) 8 7 40 1.6 6 Nu (billions) 30 1.2 5 4 20 0.8 3 2 10 0.4 1 0 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Agriculture, forestry and fishing (right axis) Services Industry (including construction) Source: World Development Indicators. level –, makes it difficult to make direct linkages be- Price and yield trends were generally favorable and tween agricultural activities and poverty reduction. led to higher earnings but have also been volatile, However, aggregate data shows that the output in which raises concern over the sustainability of these the primary sector increased steadily, with a small improvements. Yields remained largely stagnant for acceleration in recent years (figure 26, left). Value fruit crops but showed marked improvements for added per worker also improved accordingly (fig- potato and chili (figure 27, left). However, prices ex- ure 26, right). Most gains were observed in the crop hibited large fluctuations in the 2012-2017 period, subsector where output growth increased steadily particularly for cardamom and chili, the crops with through 2016. The livestock subsector also grew, the highest unit price (figure 27, right). Higher pric- mainly due to increased demand for dairy products. es can lead to higher earnings if agricultural house- holds are net producers. Increased cash crop farming and generally higher returns contributed to higher earnings. A handful Vulnerability is high in the population, partly be- of fruits and crops account for most earnings in cause farmers’ exposure to uninsured risks leads the crop sub-sector: specifically, apples, areca nuts to volatility in earnings. Higher prices can increase and mandarin account for more than 90 percent earnings during good times, but subsequent price of earnings from fruits, and high-value crops such drops can have the opposite effect if farmers are not as cardamom, chili and potato make up more than insured against negative price shocks – that is, expo- 80 percent of earnings from crops. Total earnings sure to frequent shocks can contribute to high levels from these key fruits and crops have generally of vulnerability. There are several sources of risks in improved, but there has been a lot of volatility in Bhutan that could lead to such shocks: for example, average yields and prices (figure 26, figure 27). agricultural production is heavily reliant on irrigation On the other hand, a large share of harvest land is and thus rainfall. Bhutan’s location in the Himalayan devoted to maize and paddy (57 percent in 2017) mountains places the population at substantial risk but their contribution to national crop earnings is of climate change and potentially extreme weather negligible at 2 percent. These are the main staple variations are expected to increasingly affect agricul- crops which are of low value and a large share of tural production. In addition to weather variability, which is produced by farm households for their wildlife predation is a widespread concern which fur- own consumption. ther increases vulnerability. More broadly, external 34 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges III. Progress and Challenges Figure 27. Average yields (L) and prices (R) of key fruits and crops 5,000 50 4,500 45 Yield (kilograms per bearing tree) 4,000 40 Yield (kilograms per acre) 3,500 35 3,000 30 2,500 25 2,000 20 1,500 15 1,000 10 500 5 0 0 2011 2012 2013 2014 2015 2016 2017 Apple Areca nut Mandarin Cardamom Chilli Maize Paddy Potato 1200 1000 800 Mean unit price per kilogram (Nu) 600 400 80 70 60 50 40 30 20 10 2012 2013 2014 2015 2016 2017 Apple Areca nut Mandarin Cardamom Chilli Maize Paddy Potato Source: Agriculture Statistics for each year (NSB, various years). Note: Yield is measured as kilograms per bearing tree for apple, areca nut, and manda- rin (right axis); and as kilograms per acre for cardamom, chili, maize, paddy, and potato (left axis). No yield data for fruits in 2012. Prices are measured as the mean unit price (Nu per kilogram) of main fruits and crops. Prices are deflated using food consumer price index (December 2012 = 100). food price shocks are likely to have wide-ranging equivalent to a 50 percent shock almost triples the effects on consumption because Bhutan imports headcount to 31.7 percent. Alternatively, if the pov- 34 percent of its cereal needs. Meat consumption is erty line in 2017 had been just 15 percent (or Nu 354 also mostly met by imports. per month) higher – equivalent to about US$14 (in 2011 PPP terms) per person per month, or less than Although poverty declined, vulnerability remains half a dollar per day – the poverty headcount rate in high with many households remaining just a small 2017 would have been unchanged from 2012. shock away from poverty. The extent of vulnerability is illustrated with a simple simulation that shows how Off-farm employment could help households di- the poverty rate changes with a small increase in the versify their income sources but there are few such poverty line. For example, a 20 percent increase in opportunities. While the likelihood of working is the 2017 poverty line (US$3.20 in 2011 PPP terms) similar between the poor and nonpoor, almost 80 would almost double the poverty headcount rate, percent of poor households have all of their work- from 12.1 percent to 20.1 percent. A larger shock ing household members engaged in agriculture, 35 Bhutan | Development Update III. Progress and Challenges Recent Trends in Poverty and Shared Prosperity: Progress and Challenges Figure 28. Share of household members that are working (L) and share of households with at least one agricultural worker (M) and agricultural workers only (R) 100 80 % of households or workers 60 40 20 0 Working households members Agricultural workers Households with agricultural workers only Total Poor Nonpoor Source: Calculations using BLSS for 2017. Figure 29. Share of agricultural households that produce only or mainly for sale, or mainly or only for family consumption 60 50 40 % of households 30 20 10 0 Only for sale Mainly for sale Mainly for family consumption Only for family consumption Total Poor Nonpoor Source: Calculations using BLSS for 2017. which indicates that there are not enough non-farm would have benefited from positive albeit volatile employment opportunities (figure 28). Most farm trends in prices and yields, particularly of carda- production is conducted mainly or solely for family mom, potato and chili. These crops also account for consumption, and relatively little for income gener- an increasingly larger share of agricultural exports. ation (figure 29). 3.  Priorities for sustainable poverty To summarize, poverty reduction was helped by reduction and welfare improvement improved earnings in the agriculture sector, but vul- nerability is high and most farming activities are of A few priorities emerge from the analysis. First, subsistence nature. Aggregate trends suggest that the creation of productive jobs is key to achieving households that engaged in commercial farming long-term welfare improvements. Bhutan’s public 36 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges III. Progress and Challenges sector-led development model has boosted eco- workforce can be absorbed by more productive nomic growth and directed large investments in jobs. The labor force is increasingly educated, and human capital. Private sector development has been urbanization is likely to continue as a result of steady lackluster and job creation sluggish. Bhutan’s ability rural to urban migration. This trend, combined with to further reduce poverty and enhance welfare will rising aspirations and increased access to informa- critically depend on its capacity to identify alter- tion, will generate growing pressure to create jobs native sources of growth beyond hydropower and outside the agriculture sector—the latter is partic- generate private sector employment. With a depen- ularly important to sustain poverty reduction and dency ratio that is projected to decline until 2040, promote broad-based shared prosperity in the long the next two decades offer an opportunity for Bhutan run. At the same time, it is important to address the to reap its demographic dividend if the expanding low and declining female labor force participation. 37 Bhutan | Development Update III. Progress and Challenges Recent Trends in Poverty and Shared Prosperity: Progress and Challenges In this context, the trade-off resulting from Bhu- exception of universal programs (such as free elec- tan’s spatial characteristics need to be better un- tricity, health care and education), government-fi- derstood and reflected in policy formulation and nanced programs reach only a small proportion of prioritization–especially given the need to continue households. Moreover, this support is mainly intend- investing in human capital. While urbanization has ed as hardship relief rather than poverty alleviation. progressed relatively rapidly, most people still live For example, the Kidu program, Bhutan’s main dispersed across the countryside and in remote social assistance program and royal prerogative, areas. The mountainous terrain and large rural grants assistance in various forms including land population make service provision costly and inef- endowments, scholarships, and support for people ficient. Coverage of services has expanded rapidly living in destitution, the elderly and the disabled. but quality is increasingly a concern. Given the need However, beneficiaries may not necessarily belong to continue to invest in human capital and other to the poorest households. On the other hand, the services, an important trade-off may be needed Targeted Household Poverty Program (THPP) is a between expanding access to services everywhere household-level intervention program that provides and improving the quality of services. Reliance on support for housing improvements, supply of agri- technological innovations and diversifying modes of cultural equipment, and income-generating activi- service delivery (such as mobile clinics for providing ties such as dairy farming and cash crop cultivation. health care in remote areas) could help contain the However, an assessment conducted in 2017 found cost and address quality-related concerns. At the that the program’s criteria could result in high exclu- same time, a shift in policies away from a focus on sion and inclusion errors.30 spatially balanced development and towards im- proving efficiency and promoting the benefits of Finally, further efforts are needed to strengthen urban agglomeration could be considered. statistical capacity, improve data quality, and fill data gaps. Much progress has been achieved but In the short- to medium-term, progress will be important gaps remain. For example, there is very difficult to achieve without raising agricultural pro- little information on production activities of agri- ductivity. Addressing the constraints to growth in cultural households that would allow for a better the commercial agriculture sector could go a long understanding of drivers of welfare and poverty in way towards increasing rural incomes: this would in- rural areas. Also, there is a lack of information on clude broad-based support to increase productivity household income. The following areas were identi- (through greater input use, irrigation facilities, agri- fied to improve the quality of data: (i) ensure consis- cultural extension services), combined with efforts to tent measurement of poverty over time; (ii) improve develop market systems and integration into larger the quality of data collected and improve sampling value chains. Market infrastructure and wholesale to enhance the precision of estimates derived from systems are largely absent, and marketing activities household surveys; and (iii) ensure regular collection continue to rely heavily on public agencies. of essential socioeconomic data – for example, there is no recent data available on population health. Fi- A stronger social protection system could fur- nally, given that the official poverty line is relatively ther help mitigate the impact of income shocks. low, it should be updated in the next round of the Spending on social assistance accounts for about Bhutan Living Standards Survey Report (BLSS) based 0.9 percent of GDP through a combination of uni- on the latest consumption patterns. versally provided and targeted programs. With the 30 The assessment was part of a World Bank Technical Assessment to evaluate the targeting performance of the THPP. 38 Bhutan | Development Update Recent Trends in Poverty and Shared Prosperity: Progress and Challenges 39