Bhutan at Moderate risk of external and overall debt distress

According to the Ministry of Finance’s (MoF) Debt Sustainability Analysis (DSA) report 2023, Bhutan is considered to be in moderate risk of both external and overall debt distress.

The DSA report is a tool to assess the sustainability of public debt, inform policy makers and the public, revise the Medium-term Debt Management Strategy (MTDS), revise annual borrowing plan, to ensure sustainable socioeconomic growth without falling into debt distress and to periodically assess the risks of public debt.

External debt is the portion of a country’s debt that is borrowed from foreign lenders, including commercial banks, governments, or international financial institutions. Overall debt distress is where countries are unable to fulfill their financial obligations, leading to debt restructuring. This in turn raises the risk of these countries facing higher borrowing costs and losing access to international capital markets.

Meanwhile, the MoF’s report says that Bhutan’s risks of external and overall debt distress continue to be assessed as high mechanically because its external and total public debt indicators breach their respective thresholds and benchmarks under the baseline scenarios.

However, judgment is applied to the unique characteristics of Bhutan’s debt, which is dominated by hydro-power debt extended by the Government of India (GoI) with several risk mitigating factors. As such, debt is assessed to have a moderate risk of external and overall debt distress.

Similarly, the report states that most external debt is on account of hydro-power projects which are deemed commercially viable, with a ready export market in India.

“Hydro-power debt carries low risk as debt servicing for hydro-power loans from the India starts only a year after the commissioning of the project. This ensures revenue inflow before debt servicing starts, thus mitigating liquidity risk. And so, debt sustainability is not jeopardized in case of project delays,” the report states.

In addition, the report states that the electricity export tariff is fixed based on the total cost of the projects plus some margin. “Hydro power projects are insured and re-insured against natural risks. So, the only remaining uninsured risk is hydrological that is, if there is no enough water to produce electricity.”

It states that the majority of domestic debt (mostly T-Bills) would be maturing within one year, “The refinancing risks are low due to current liquidity position in financial institutions- the main investors of T-Bills.”

According to the analysis, almost 98% of public debt is fixed rate debt and all those external debts of cash credit (CC) denominated debt are concessional loans with nominal interest rates from 0% to 1.5%, long grace periods from 8 to 10 years, and repayment periods up to 40 years.

The concessional nature of the CC-denominated debt has ensured that the impact of debt servicing on the government’s cash flow and the forex reserve is spread over a long period, thus mitigating the liquidity risks. 

For instance, the total public and publicly guaranteed (PPG) debt stock as of 30 June 2022 stood at Nu 257.52bn. The debt stock comprises external debt of Nu 229.46bn and domestic debt of Nu 28.06bn.

Scaled by gross domestic product (GDP) estimate for FY 2021-22, the total public debt stood at 125.2%.

While the total external debt is categorized into hydro and non-hydro debt where the hydro-power debt stood at Nu 163.04bn, constituting 71.1% of total external debt and 79.3% of FY 2021-22 GDP.

The non-hydro debt stood at Nu 66.41bn, constituting 28.9% of total external debt and 32.3% of GDP. Furthermore, it is also segregated into INR and CC debt.

Similarly, the report states that with the inclusion of non-guarantee state-owned enterprise (SOEs) debt, the domestic debt increased by 14.7% amounting to Nu 32.89bn, resulting in total public debt of Nu 263.25bn accounting to 14.7% of estimated GDP.

And as of 30 June 2022, the government guaranteed outstanding loan stood at Nu. 5.02bn, accounting for 2.4% of estimated GDP. This includes the sovereign guarantee of Nu 561.320mn provided for credits sanctioned under the National Credit Guarantee Scheme (NCGS).

Similarly, the sovereign guarantee was within the threshold of 5% of GDP prescribed by Public Debt Policy 2016. About 96% of the total debt is in fixed rate and remaining balance of 4% is variable debt, according to the DSA report.

Meanwhile, the DSA was conducted using the revised Debt Sustainability Framework for Low-Income countries (LIC- DSF), which was developed jointly by the International Monetary Fund (IMF) and the World Bank.

According to the analysis, based on the country’s Composite Indicator (CI) classification, Bhutan’s debt carrying capacity is strong.

The CI is calculated based on the World Bank’s Country Policy and Institutional Assessment (CPIA) score and the country’s real GDP growth, remittances, international reserves, and global growth rate as estimated in the most recent World Economic Outlook (WEO) vintage.

A report by the Asian Development Bank (ADB) in 2022 also said that Bhutan’s risk of overall and external debt distress is assessed as moderate, unchanged from the 2018 DSA.

It mentioned that while the mechanical results point to a high risk of overall and external debt distress, with breaches in the indicators under the baseline scenario, judgment was applied given the unique mitigating factors.

First, the majority of the outstanding public and publicly guaranteed debt is linked to hydro-power project loans from the GoI. The report says that these projects are implemented under an intergovernmental agreement in which the GoI covers both financial and construction risks of the projects and commits to buy all surplus electricity at a price reflecting cost plus margin.

Second, the debt dynamics are set to improve further over the medium term, driven by a significant increase in electricity exports and a decline in imports associated with hydro-power construction.

Overall, the analysis shows that external debt sustainability could be vulnerable to export and depreciation shocks, while the overall debt sustainability could be susceptible to contingent liabilities shocks.

Within the moderate rating, Bhutan is assessed to have limited space to absorb additional shocks. Going forward, a gradual fiscal consolidation and revenue mobilization, a stable peg with the Indian rupee, and reforms to improve productivity and competitiveness of the non-hydropower sector, could help support debt sustainability

The IMF developed a formal framework for conducting public and external DSAs as tool to better detect, prevent, and resolve potential crises, which became operational in 2002.

The objectives of the framework are: assess the current debt situation, its maturity structure, whether it has fixed or floating rates, whether it is indexed, and by whom it is held; identify vulnerabilities in the debt structure or the policy framework far enough in advance so that policy corrections can be introduced before payment difficulties arise; in cases where such difficulties have emerged, or are about to emerge, examine the impact of alternative debt-stabilizing policy paths.

The framework consists of two complementary components: the analysis of the sustainability of total public debt and that of total external debt.

Each component includes a baseline scenario, based on a set of macroeconomic projections that articulate the government’s intended policies, with the main assumptions and parameters clearly laid out; and a series of sensitivity tests applied to the baseline scenario, providing a probabilistic upper bound for the debt dynamics under various assumptions regarding policy variables, macroeconomic developments, and financing costs.

The paths of debt indicators under the baseline scenario and the stress tests allow assessing the vulnerability of the country to a payments crisis.

However, the IMF says that DSAs should however not be interpreted in a mechanistic or rigid fashion. Their results must be assessed against relevant country-specific circumstances, including the particular features of a given country’s debt as well as its policy track record and its policy space.

Thus, two types of frameworks have been designed: those for market-access countries and those tailored for low-income countries.

In both cases, the frameworks have been regularly refined with a view to-among other elements-bringing a greater discipline to the analysis and responding to the changing economic and financial environment.

Sherab Dorji from Thimphu