While the South Asian region is projected to emerge as the fastest growing region in the world, Bhutan’s economic growth projection is trailing behind the regional average.

The country’s economic growth slipped for the second time as the construction of hydropower projects slowed and electric power production declined, according to the Asian Development Bank’s (ADB) outlook.

Provisional estimates, as per the outlook, indicate that the GDP growth in 2017-2018, slowed further from 6.3 percent in 2016-2017 to 5.5 percent on the back of weaker performance in industry, slowdown in construction of hydropower projects and weak water flows affecting power generation.

However, growth is likely to slightly increase to 5.7 percent in 2018-19 fiscal year with the commissioning of Mangdechhu. “Barring further delays to the commissioning of the Mangdechhu Hydropower Plant, a full year of operation in FY2020 will help lift growth to 6 percent in that year,” the report stated.

The report also stated that growth in the region would be driven by strong performance of India and Bangladesh, whose growth is projected to be between 7 and 8 percent.

Bhutan, the Maldives and Nepal are expected to experience a moderate growth over the next two years, while the growth in Pakistan and Afghanistan is projected to be below 4 percent.

“Further delay in commissioning of Mangdechhu can affect the growth,” said the country director of ADB, Kanokpan Lao-Araya.

ADB stated that the service sector grew at a rapid 8 percent because of expansion in wholesale and retail trade, hotels and restaurants, and transportation and communications. Revenue from international tourism also rose by 5 percent.

Government spending is expected to increase significantly only in the fiscal year 2019-2020, if the new government begins implementing programmes and projects under the 12th Plan.

While the interim budget in 2018-19 has hampered the capital expenditure,  the ADB projects a drop in government revenue with the discontinuation of excise tax refunds from India under the GST, loss of revenue from a delay in commissioning of the Mangdechhu plant, and declining grants.

With India’s GST affecting competitiveness of Bhutan exports, a Nu 4 billion grant over five years has been committed by India to make Bhutanese products more competitive in the market.

As Bhutan begins to introduce its own GST replacing most indirect taxes, a sharp increase in domestic revenue is expected. This will be complemented by full operation of Mangdechhu project. Expenditure, on the other hand is expected to surge on large capital spending to implement new projects under the plan and current expenditure fueled by salary raise for civil servants.

The pay raise, Kanokpan Lao-Araya said, could also exert pressure on inflationary trend.

The lead author for Bhutan chapter, Lei Lei Sung said that delay in commissioning of Punatshangchhu projects has already resulted in drop of two to three percentage points of the GDP growth in 2018-19 fiscal year.

She said the agriculture sector expanded by 4.5 percent, partly on greater access to credit under the priority sector lending policy, which requires banks to increase the share of credit granted for qualifying loan proposals from cottage and small industries, including agriculture.

However, Kanokpan Lao-Arya said that the CSI sector is also risky because the non-performing loans are higher in this sector.

ADB recommends reducing tax holiday

“Bhutan’s economy is not only small but also has a narrow tax base with numerous tax incentives,” Kanokpan Lao-Araya said. As Bhutan envisages graduating from LDC, she said, fiscal pressures are building because foreign aid and access to concessional loan would decline.

Tax revenue, amounting to of 15.6 percent of GDP in FY2018, depends mainly on hydropower sales, which provide the bulk of corporate taxes. The ratio of tax to GDP is expected to decline for several years owing to major delays in commissioning two large hydropower projects.

Hydropower development entails large fiscal swings, from heavy expenses during construction to robust revenue flows upon commissioning. To accommodate such swings, a stabilisation fund was established in November 2017 to set aside at least 5 percent of hydropower revenue annually to smoothen budgetary volatility.

In addition to GST, ADB also stated that a standard value-added tax system is being considered, with tax crediting. “Such reform would be a major step forward for Bhutan, as it is one of only six economies in Asia and the Pacific that has not yet adopted a value-added tax,” the report stated.

Although fiscal incentives may encourage investors and stimulate private sector growth, the ADB stated that it has been costly for the government. In 2017, foregone revenue amounted to about 17 percent of tax collected, mainly from sales tax and from customs duty. The Fiscal Incentives Act, 2017 removed the finance ministry’s authority to grant exemptions and tax holidays and subjected its approval to parliament’s resolution. ”Parliament would benefit from the establishment of a technical group to make assessments of requests to evaluate their net benefit to the country,” it stated.

The ADB also stated that a large number of existing exemptions should be reduced to enhance revenue. Despite the ease of implementing tax holidays, the report stated that it invited tax avoidance and lacked transparency. “Removing tax holidays would not deter investors, who see solid business opportunities but would discourage the entry of footloose opportunists ready to exit the market when the holiday ends.”

Tshering Dorji