Bhutan’s dependence on hydropower has resulted in weak private sector development and also created macroeconomic vulnerabilities though the country’s growth has been driven mainly by the public sector through hydropower development.
A 2019 World Bank report titled ‘Bhutan development report: a path to inclusive and sustainable development; macroeconomics, trade, and investment global practice’ found that high import content of hydropower construction has resulted in a large external imbalance.
In particular, the report states that the current account deficit, which was 22% of GDP in 2017, was largely financed through external borrowings. As a result, the external debt reached 113% of GDP in 2017.
A large portion of external debt, 75.4% is in Indian denominated rupees but carries limited exchange rate risks. While the report states that hydropower-related spending is off budget, the loans contracted from the government of India (GOI) to finance the projects are a part of public debt. Hence, the fiscal deficit has been low but public debt, high.
“The state-led hydropower development yielded an annual average GDP growth rate of 7.6% since 1981, the third-highest in the world. The country’s power generation capacity increased from 336 MW in 1990 to 1,606 MW in 2015 and has remained the same since then,” states the report.
However, during the same period, gross fixed capital formation mainly hydropower investment contributed to more than 60% of GDP growth while hydropower development is undertaken by Druk Holding and Investments (DHI), which is fully owned by the government. The sector accounted for about 40% of exports in 2016 and 25% of the total domestic revenues as per the report.
“Benefits of hydropower development have been distributed to the population through increased government spending on health and education,” states the report.
Hydropower projects currently under construction altogether amounts to 190% of the country’s gross domestic product (GDP) and a year delay of a mega-hydropower project reduces GDP growth rate by 3-4%.
About 80% of external debt came from export-oriented hydropower projects. However, these hydropower projects are expected to generate substantial earnings after covering their debt obligations and therefore pose limited risks to the government, states the report.
While, non-hydro external debt is low at 22.7% of GDP and comes mainly from concessional loans from multilateral financial institutions and bilateral donors. Domestic public debt is only 0.01% of GDP.
Bhutan’s external debt service to exports ratio remains manageable and in addition, due to Bhutan’s unique mitigating measures, the 2018 World Bank-International Monetary Fund (IMF) Debt Sustainability Analysis categorized Bhutan as being under moderate risk of debt distress.
The development report also highlighted that tax collections at 14% of GDP in 2017/18 is low by international standards since hydropower, especially during construction, does not contribute to tax revenues, as well as the proliferation of tax exemptions and special tax regimes.
“In 2017/18, tax exemptions amounted to Nu 2.8bn, equivalent to 10 percentage points of tax revenues. These exemptions also distort actual returns on investment for the private sector,” states the report.
Further the report marked that Bhutan will have to manage revenue pressures arising from the withdrawal of excise duty rebate from India due to the introduction of India’s Goods and Services Tax (GST) as well as the delays in operationalization of the three hydropower projects.
The comparison with Nepal shows that Bhutan’s tax revenues as a share of GDP has been stagnant since the early 2000s. Although the country’s growth rate has slowed down to 2.4% between 2012 and 2017, it ranked 39 among 92 countries. Between 2000 and 2017, Bhutan’s per capita GDP increased more than four times to USD 3,100.
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Phub Dem from Thimphu