Overview of Bhutan’s Graduation to a Middle Income Country

Overview of Bhutan’s Graduation to a Middle Income Country

Called as the “last mile” of the 12th Five Year Plan (FYP), Bhutan is set to graduate from the status of a least developed country (LDC) by December 2023. The recommendation for graduation is made by the UN Committee for Development Policy (CDP). According to the UN framework, a country graduates from the LDC category three years after the General Assembly takes note of the recommendation of the CPD. In this three-year period, the country remains as LDC and continues to benefit from special support measures to ensure smooth transition.

On March 15, 2019, Professor Jose Antonio Ocampo from the CPD announced Bhutan’s eligibility and recommended for graduation.

While there are debates about Bhutan’s benefits and loses of the graduation, taking into context the size of Bhutan’s economy, trade in the world and other factors, the advantages far out-weights the loses. 

LDCs are defined as “low-income countries suffering from severe structural impediments to sustainable development.” The assessment for graduation is based on three criteria – gross national income (GNI) per capita, human assent index (HAI) and economic vulnerability index (EVI). The thresholds for the three criteria for graduation are a GNI per capita of USD 1,242 or more, which is based on a three-year average; a HAI score of 66 or more; and an EVI score of 32 or below.

A country becomes eligible for graduation if it meets the threshold levels for graduation for at least two of the three criteria during two triennial reviews. It also becomes eligible for graduation under the income only rule if its GNI per capita exceeds at least twice the established threshold regardless of its HAI and EVI scores. Higher the EVI, higher is the economic vulnerability of a country.

While Bhutan easily meets two of the three criterions, economic vulnerability index remain a challenges. According to the CDP’s report, Bhutan’s GNI per capita was estimated at USD 2,982 in 2021.

The Economic Vulnerability Index is a composition of the following eight indicators: Population size, remoteness, merchandise export concentration, share of agriculture, forestry and fisheries in GDP, homelessness owing to natural disasters, instability of agricultural production, instability of exports of goods and services, and the share of population living in low elevated coastal zone. HAI is based on indicators of nutrition, mortality rate, education and literacy rate. EVI is however based on multiple factors like population size, export of goods and services, share of primary sector to the economy and agricultural production.

A graduated country loses access to multilateral LDC specific funds. In trade, graduation could imply a loss of duty free access to foreign markets. But bilateral agreement with India would not be affected and majority of the country’s trade is with India.

Bhutan would lose foreign grant aids and technical assistance that are linked to LDC status; LDC status-linked concessional loans and debt relief, special facilities at the WTO that allows flexibilities in international trade rule enforcement, generalized System of Preferences (GSP) that allows access to exports from LDCs into the United States, EU and other OECD and Global System of Trade Preferences (GSTP) used among developing countries and implemented based on reciprocal principles & ODA (Official Development Assistance).

However, key multilateral development partners of Bhutan are the Asian Development Bank (ADB), European Union institutions, World Bank, United Nations Development Programme (UNDP), United Nations Children’s Fund (UNICEF), International Fund for Agricultural Development (IFAD), World Health Organization (WHO) etc. Among them, ADB and the World Bank have their own criteria for selecting beneficiaries for concessional loans. They mostly follow the World Bank’s income-based classification of low-income, lower-middle-income, upper-middle-income countries in allocating loans. Bhutan is already included within the group of lower-middle-income countries in which there exist significant opportunities for receiving loans on soft terms and conditions.

Amongst others, the assistance from the WHO and IFAD is also not related to the LDC-identity of a country. However, several UN bodies have LDC-specific budgetary quota commitments. For example, UNDP and UNICEF keep certain per cent of core budgetary allocation for the members of the LDC group. Any potential loss of financial support for Bhutan is difficult to measure, as these benefits target LDCs as a group, not as separate countries. But, the UN agencies like the UNDP have elaborate development programmes in most non-LDC lower-middle-income countries.

Amongst, bilateral donors, India and Japan have been longstanding development partners of Bhutan. Japanese support to Bhutan continuously focuses on socio-economic development and poverty alleviation. Japan’s support to Bhutan is not directly related to the LDC status, rather it considers the World Bank income classification. Although interest rates charged for lower middle-income countries are slightly higher than those of the low-income countries, they remain much lower than the commercial rates available to countries.

Home to a pristine environment, clean air and protected forests, the Himalayan kingdom of Bhutan is a carbon-negative country. Absorbing more than 6 million tonnes of carbon per year, Bhutan cleans almost three times more CO2 emissions produced by a population of 728,000. The country has taken significant steps in strengthening the international battle against climate change and promised to maintain 60 per cent forest cover “in perpetuity”. Despite these efforts, Bhutan remains extremely vulnerable to the global phenomena of climate change. The country is heavily reliant on climate-sensitive sectors such as agriculture, hydropower, and forestry. Major threats that are facing Bhutan due to global warming are the formation of supra-glacial lakes from melting ice and glacial lakes outburst floods (GLOFs). Since key economic establishments, settlements and infrastructures are concentrated in the surroundings of large river valleys in Bhutan, GLOFs or landslides can potentially impair growth and development.

Bhutan will lose access to the LDCF fund after graduation but there will be other funds to support its climate change projects. As climate change situation gets accentuated, the post graduation era might require competing against other developing countries for environmental funds. Bhutan’s longstanding reputation for environment-friendly policies and Gross National Happiness (GNH) -targeted policies are expected to keep it as a strong contender for climate related support.

What will be the impact of graduation on preferential market access?

One of the main support measures for LDCs is preferential access to markets. The actual impact of losing LDC-specific preferences depends on what goods the country exports, as well as other factors, including any trade agreements it may be a part of. Impact Assessments compare the tariffs faced by the country’s major export and potential export products in its main markets before and after graduation. While in some cases, the loss of LDC-specific preferences may have significant impacts on the tariffs faced by a country’s exports, in others the impact may be marginal.

What happens in terms of WTO commitments?

Leaving the LDC category will mean the country no longer benefits from LDC-specific special and differential treatment in the fulfillment of WTO commitments or from LDC-specific support for the WTO accession process. Impact Assessments consider the specific situations of each country, which depend on whether the country is a member of the WTO – and in that case the terms of its accession – or whether it is in the process of accession. Some countries are neither members nor in the process of accession, just like Bhutan.

What happens to development cooperation?

The international community has made a number of commitments in support of LDCs as a group and specific instruments have been put in place to support LDCs in developing trade capacity, financing climate change adaptation and others. When a country graduates from the LDC category, it no longer has access to those specific instruments. However, development partners do not base their cooperation programmes exclusively on LDC status. Impact Assessments consider the significance of the loss of LDC-specific support measures for each country in the context of the main development cooperation programmes by identifying and consulting the main development partners on their post-graduation prospects for the country in question.

When countries graduate, an element they lose in the transition period is the preferential access to markets mainly in developed economies. But in case of Bhutan the trade scenario would be largely unaffected, because Bhutan doesn’t have much trade with the US or Europe, its main trading partner being India.

(The article is based on desk research and interviews from economists in Bhutan).

Tshering Pelden from Thimphu