MACROECONOMICS, TRADE, AND INVESTMENT GLOBAL PRACTICE Bhutan Development Update SPECIAL SECTION: PATHWAYS TO ENHANCING SUSTAINABLE FOREST MANAGEMENT AND EQUITABLE SOCIO-ECONOMIC DEVELOPMENT IN BHUTAN AUGUST 2020 2  BHUTAN DEVELOPMENT UPDATE BHUTAN DEVELOPMENT UPDATE Abbreviations and Acronyms 3 Abbreviations and Acronyms AAC Annual Allowable Cut MoH Ministry of Health ABI Association of Bhutanese Industries MoLHR Ministry of Labor and Human BC Biological Corridors Resources BIT Business Income Tax NBFIs Non-bank Financial Institutions BLSS Bhutan Living Standard Survey NDA Net Domestic Assets CAB Construction Association of Bhutan NDC Nationally Determined Contribution CAD Current Account Deficit NFAs Net Foreign Assets UNCBD United Nations Convention on NFSR National Food Security Reserve Biological Diversity NKRA National Key Result Areas CFMG Community Forest Management NPL Non-Performing Loan Groups NPRP National Preparedness and Response CFs Community Forests Plan CIT Corporate Income Tax NRDCL Natural Resources Development COP Conference of The Parties Corporation Limited CRR Cash Reserve Ratio NRF National Resilience Fund CSIs Cottage and Small Industries Nu Ngultrum DoFPS Department of Forest and Park NWFPs Non-Wood Forest Products Services OP Operational Plans DSA Debt Sustainability Analysis PA Protected Area ECP Economic Contingency Plan RGoB Royal Government of Bhutan FMUs Forest Management Units RHBT Rural House Building Timber FRMD Forest Resources Management RMA Royal Monetary Authority Division RNR Renewable Natural Resources FRPA Forest Resources Potential RWCAT Risk Weighted Capital Adequacy Assessment for Bhutan Ratio FYP Five Year Plan SAR South Asia Region GHG Greenhouse Gas SFM Sustainable Forest Management GNH Gross National Happiness SLR Statutory Liquidity Ratio GST Goods and Services Tax SMEs Small and Medium Enterprises HFLD High Forest Cover, Low SRF State Reserve Forests Deforestation UNCCD United Nations Convention to INR Indian Rupee Combat Desertification LFMP Local Forest Management Plans UNFCCC United Nations Framework MDRP Minimum Daily Package Rate Convention on Climate Change MIP Market Price Information YELP Youth Engagement and Livelihood MoAF Ministry of Agriculture and Forestry Program 4 Table of Contents BHUTAN DEVELOPMENT UPDATE Table of Contents Abbreviations and Acronyms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Acknowledgments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1 Recent Economic Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 a. Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 b. Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 c. Monetary Policy and Financial Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 d. External Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 e. Fiscal Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 2 Outlook and Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 a. Outlook. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 b. Risks and Challenges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 3 SPECIAL SECTION:Pathways to Enhancing Sustainable Forest Management and Equitable Socio-economic Development in Bhutan. . . . . . . . . . . . 38 a. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 b. Bhutan’s Forests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 c. Role of Forests in the National Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 d. Policy and Institutional Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 e. Forest Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 f. National Forest Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 g. Opportunities for Bhutan’s Forestry Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 BHUTAN DEVELOPMENT UPDATE Table of Contents 5 List of Boxes Box 1. Government Response to Contain COVID-19 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Box 2. COVID-19 and Food Security in Bhutan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Box 3. Unpacking the Comprehensive National Response to COVID-19. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 List of Figures Figure 1. COVID-19 confirmed cases and number of people in quarantine, and policy actions. . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Figure 2. Tourist arrivals and gross tourism receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 3. Hydropower production and export revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 4. Contribution to GDP growth (percentage points). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Figure 5. Employment share by sector (percent), 2019. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 6. Unemployment rate (percent), 2010-19. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 7. Inflation, Bhutan and India (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 8. Food inflation, imported and local (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 9. CPI categories and inflation drivers in FY2019/20 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 10. Share of households that previously experienced food shortage. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Figure 11. Money supply (y-o-y growth, percent, 3-month moving average). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 13. Financial sector soundness indicators (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Figure 14. Current account components (percent of GDP). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Figure 15. Non-hydro exports of selected goods, excl. electricity, 2019 and 2020 (Nu billion). . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Figure 16. Tourism receipts and services exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Figure 17. Gross international reserves and percent share of Rupee reserves in total reserves. . . . . . . . . . . . . . . . . . . . . . . . . . 26 Figure 18. Fiscal accounts components (percent of GDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Figure 19. Contribution to revenue growth by type (percentage points) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Figure 20. Contribution to expenditure growth by type (percentage points). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Figure 21. Public debt (percent of GDP). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Figure 22. Hydropower production, estimated capacity and production growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 23. Land Use: Land Cover Map of Bhutan, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 Figure 25. Main Forest-Relevant Government Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 List of Tables Table 1. External accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Table 2. Fiscal accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Table 3. Main macroeconomic indicators. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Table 4. Drivers of Deforestation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Table 5. Drivers of Forest Degradation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 6  BHUTAN DEVELOPMENT UPDATE BHUTAN DEVELOPMENT UPDATEAcknowledgments 7 Acknowledgments T he Bhutan Development Update is published Bangladesh and Bhutan), Tenzin Lhaden (Act- semiannually. It assesses recent econom- ing Country Representative for Bhutan), Yutaka ic and social developments, prospects, and Yoshino (Program Leader Equitable Growth, Fi- policies in Bhutan. The report is intended for a wide nance & Institutions), Mona Prasad (Lead Econ- audience, including policy makers, business leaders, omist) and Manuela Francisco (Practice Manag- researchers and academics, the community of ana- er for Macroeconomics, Trade, and Investment). lysts monitoring Bhutan’s economy, and the general The team would like to thank Nora Carina Dihel public. The update was prepared jointly by the Mac- (Senior Trade Economist), Felipe Dizon (Econo- roeconomics, Trade, and Investment (MTI) and the Envi- mist), Yeon Soo Kim (Senior Economist), Sabin Raj ronment and Natural Resources (ENR) Global Practices Shrestha (Senior Financial Sector Specialist) and of the World Bank by a team consisting of Melanie Aurélien Kruse (Senior Economist) for their inputs Trost ( Junior Professional Officer) and Andrea Kutter and comments. The team is grateful to the Minis- (Senior Natural Resources Management Specialist). try of Finance, Royal Monetary Authority, National Statistics Bureau, and the Ministry of Agriculture The report was prepared under the overall su- and Forests for their collaboration and valuable pervision of Mercy Tembon (Country Director, discussions. 8  BHUTAN DEVELOPMENT UPDATE Overview 9 Overview Recent Developments Bhutan’s economy has been severely affected by COVID-19 and the subsequent border closure to contain a domestic outbreak of the pandemic. The pandemic has been contained in Bhutan, with 150 confirmed cases and no deaths as of August 20. The government closed the country for inbound tourists in early March after the first “imported case” was con- firmed and subsequently shut borders, on March 22, as a precautionary measure to prevent the spread of COVID-19. On August 11, the government announced a first nationwide lockdown, to curb community transmission after the first case outside of managed quarantine facilities was confirmed.1 The economic impact of these measures has been primarily trans- mitted through two channels. Tourism-related and transport services have declined as tourist arrivals dried-up; the lockdown in India and domestic con- tainment measures are expected to adversely affect other service activities that require close human in- teractions. Industrial production has also been se- verely disrupted by reduced foreign demand for 1 Following the first COVID-19 cases outside of managed quarantine facilities, lo- cal transmission has been officially declared in Bhutan on August 16. 10 Overview BHUTAN DEVELOPMENT UPDATE Bhutanese products, especially from India, disrup- indicators improved by end-2019, with the Non Per- tions to trade, and labor shortages. forming Loan (NPL) ratio decreasing from 18.4 per- cent in September 2019 to 10.9 percent in December, In this context, economic growth is estimated to the NPL ratio rose back to 19.5 percent as of March have decelerated from 3.8 percent in FY2018/192 2020, reflecting mid-year cyclical factors. The deteri- to 1.5 percent3 in FY2019/20. This is significant- oration in asset quality reflects the poor performance ly lower than the pre-COVID-19 forecast of 5.5 per- of the tourism/service and retail/wholesale trade sec- cent. The services sector, which has been support- 4 tors, which account for more than 50 percent of the ing growth in the past, is believed to have contracted NPLs. While the financial sector has adequate cush- by 0.6 percent in FY2019/20, due to the decrease in ions to absorb potential losses, given its capital ade- tourism arrivals in the second half of FY2019/20 and quacy6, further disruptions to households and busi- domestic containment measures. Manufacturing, nesses could add further stress to the financial sector. construction and other non-hydro exporting indus- The Royal Monetary Authority (RMA) has introduced tries have been adversely affected in the second half a set of monetary relief measures to address the im- of FY2019/20 through disruptions to critical inputs, pact of COVID-19, including a debt moratorium and temporary export restrictions, foreign labor shortag- an interest waiver (including for NPLs), the provision es and lower external demand. Hydropower produc- of working capital and loans for the tourism, manu- tion and exports, on the other hand, increased with facturing and wholesale trade sectors at concessional the on-streaming of the Mangdechhu hydropower terms, and micro loans for the cottage and small in- project (720MW). The agriculture sector is believed dustries (CSI) sector. It will be important to ensure to have been relatively resilient to the pandemic, sup- strong macro-prudential measures and close surveil- ported by government measures to increase domes- lance and supervision to maintain the stability of the tic production. financial sector. Headline inflation has accelerated in the second half Exports and imports have decreased significant- of FY2019/20, driven by an increase in imported ly, in line with weak foreign and domestic demand and domestic food prices. While inflation remained and disruptions to trade. The current account deficit modest in the first half of FY2019/20, averaging 2.5 (CAD) is believed to have narrowed from 22.5 per- percent (year-on-year), it accelerated to 4.2 percent cent of GDP in FY2018/19 to 14 percent of GDP in in May 2020. This was primarily due to an increase FY2019/20, with the reduction in imports having a in local and imported food prices from India, with greater overall impact on the trade balance. While food price inflation accelerating to 9.2 percent (year- hydropower exports increased in line with higher on-year) in April 2020, before slowing to 8.8 percent production, exports of non-hydro goods and services in May. Food prices have been increasing since mid- have been severely impacted by the border closure 2019 in line with food prices in India – 85 percent of and lower external demand. Meanwhile, goods im- Bhutan’s imports are from India and the Ngultrum is ports declined as the pandemic curbed public in- pegged to the Indian Rupee (INR) at par value – food vestment projects and further delayed hydropower inflation in India has since moderated to 7.3 percent construction. in June 2020.5 The fiscal balance has deteriorated in FY2019/20 The economic downturn and heightened uncer- due to the salary increases and higher government tainty have increased financial sector vulnerabili- spending. The fiscal balance is estimated to have ties. After robust growth in the first half of FY2019/20, deteriorated from a surplus of 0.7 percent of GDP credit growth decelerated to 13 percent (year-on- in FY2018/19 to a deficit of 3.1 percent of GDP in year) in April 2020. While financial soundness FY2019/20. This was due to a large increase in current 2 The fiscal year runs from June 1 through July 31 in Bhutan. 3 WB staff projection. The FY2020/21 budget projects real GDP growth to decrease from 3.8 percent in FY2018/19 to 2.7 percent in FY2019/20. 4 Bhutan Development Update, January 2020. 5 The majority of food imports in 2019 was from India (91 percent). 6 Risk weighted capital adequacy ratio RWCAR at 14.2 percent by end-2019 BHUTAN DEVELOPMENT UPDATEOverview 11 spending, while total revenues also rose but to a less- depress services sector growth. The recovery of man- er extent. Current spending has been driven by salary ufacturing and other exporting industries is likely to increases in the public sector, as well as higher gov- be gradual, because of the slowdown in India, Bhu- ernment spending to fund public health measures tan´s main export market. Similarly, the construction (including stocking essential goods). Hydropower sector is expected to recover slowly reflecting a lim- revenues increased thanks to a one-off profit transfer ited pipeline of public sector infrastructure projects. from the commissioning of the Mangdechhu hydro- Finally, the hydropower sector is expected to reach power plant. This was partly offset by a decrease in its capacity in FY2020/21 and to stabilize after that, non-hydro revenues as a result of the discontinuation which means that industry sector growth will likely of excise duty refunds from India and lower tourism be moderate, on average8, in the medium term. The receipts. Public debt is estimated to have increased to CAD is projected to remain narrow in the medium 109.1 percent of GDP by the end of FY2019/20, but term, as weak non-hydro exports coincide with sub- risks of debt distress are moderate as most of the debt dued imports for public investment and hydropow- is linked to hydropower projects financed by India.7 er projects. With elevated expenditure requirements, to implement the COVID-19 recovery package, and The government has outlined a Comprehensive downward pressures on non-hydro revenues, the fis- National Response to COVID-19 to protect vulner- cal deficit is projected to increase to 6.7 percent of able households and minimize the impact on em- GDP in FY2021/22 before gradually decreasing to 4.3 ployment, growth, and financial stability. Health percent in FY2022/23. Total public debt as a share of measures are aimed at containing the pandemic and GDP is expected to remain elevated due to low eco- strengthening healthcare system resilience. Social nomic growth, and to decline only gradually over the protection measures include a cash transfer program medium term. targeted at vulnerable populations and measures to increase food security. The government has also im- The COVID-19 pandemic has exacerbated down- plemented a set of fiscal and monetary policy mea- side risks to growth. Given the unpredictability of sures in March and June to provide immediate re- the pandemic’s course, there is a high degree of un- lief to affected households and businesses, including certainty over Bhutan’s growth forecast. The most an interest waiver. To support economic recovery acute risk to the outlook is a scenario of large-scale and growth, the government is prioritizing the im- community transmission. This would trigger pro- plementation of the Economic Contingency Plan (ECP) longed mobility restrictions and result in substan- with a focus on agriculture and farm roads, tourism tial societal and economic costs. Other domestic risks and construction, and bringing forward and repriori- include lower-than-expected hydropower produc- tizing the 12th Five Year Plan (FYP) activities. tion and delays in the implementation of the goods and services tax (GST) and other revenue measures, which are critical to offset the decline in excise du- Outlook and risks ties and grant financing in the medium to long term. Another risk is the materialization of financial sector The crisis is expected to have strong and possibly contingent liabilities, which could strain government long-lasting effects on Bhutan’s economy. Econom- finances. On the external front, a protracted outbreak ic growth is expected to slow markedly as a result of globally and in India could reduce economic growth the crisis, averaging around 2.5 percent per year over further and delay the recovery, given significant tour- the medium term – well below the pre-COVID five- ism and trade linkages with India and others. year average of 5.5 percent. The tourism sector is ex- pected to recover only gradually, given that travel re- The COVID-19 pandemic is an unprecedented strictions will likely remain until 2021, and that global shock that calls for rapid unconventional policy tourism flows are expected to remain muted. This will responses. The immediate priority is to prevent a 7 The loans from India are under an intergovernmental agreement in which the Government of India covers both financial and construction risks of the hydropower proj- ects and buys surplus electricity at a price reflecting cost plus a 15 percent net return. This debt is denominated in rupees, electricity export receipts are also in rupees and the Bhutanese currency is pegged to the rupee, thereby reducing exchange rate risks. 8 Even if y-o-y fluctuations will continue to reflect weather related output effects. 12 Overview BHUTAN DEVELOPMENT UPDATE further transmission of the virus, and to implement each year between 2013 and 2017 (NSB 2018a). This the Comprehensive National Response to COVID-19 to does not include the contribution of the forestry sector protect public health, human capital and livelihoods in terms of rural timber subsidies, timber for disaster and to prevent economic damage, while preserving victims, timber for construction and renovation of im- macro-financial stability. However, the unprecedent- portant monuments and other national projects. How- ed situation created by the pandemic also presents an ever, the value of Bhutan’s forest in the form of ecosys- opportunity to undertake key structural reforms, in tem services and ecological functions is worth between line with the forthcoming 21 Century Economic Road- st US$394 million to US$1,269 million per year. While map, that will help build resilience and ensure sus- Bhutan’s forest policies prioritize environmental ben- tainable economic growth in the longer term. Spe- efits there is a clear rationale for a more balanced ap- cifically, the Royal Government of Bhutan (RGoB) proach toward sustainable forest management and for could consider strengthening the economic foun- greater synergies between environmental conserva- dations for social and environmental sustainability, tion and economic development objectives. with a special focus on building resilience in the tour- ism and agriculture sectors (including the forestry Bhutan’s economic growth objectives will require sub-sector). In this regard, the special section of this proactive management of its natural resource en- BDU’s edition illustrates pathways to develop a mod- dowments. Specifically, strengthening rural liveli- ernized and resource-efficient forestry sector, while hoods and eradicating poverty require sustainable supporting the objective of remaining a carbon-neu- and productive use of natural resources. The gov- tral and equitable economy. ernment must continue to protect forest ecosystems, which are home to globally important biodiversity, but studies have shown that an increase in sustain- Special Section: Pathways to Enhancing able forest utilization is feasible without jeopardizing Sustainable Forest Management and protection objectives. This presents an opportunity Equitable Socio-economic Development in for Bhutan to explore sustainable forest management Bhutan (SFM) to the fullest. Bhutan is the only carbon-negative country9 in the Bhutan can remain a global champion for environ- world, whose Constitution mandates it to maintain mental conservation while developing a modern- at least 60 percent of land area under forest cover ized and resource-efficient forestry sector. Trans- for all time. The Kingdom of Bhutan is rich in for- forming the forestry sector has the potential to ests and biodiversity. Conservation and sound man- increase employment opportunities, develop small agement of forests and the environment are key de- and medium forest-based enterprises, reduce for- velopment objectives that are fully mainstreamed in est-based product imports, and trigger a move to- national policies and plans. ward market-based approaches for trading timber and Non-Wood Forest Products (NWFPs). Bhutan’s The forestry sector constitutes an important but un- rich forest resources can contribute more to the derutilized and undervalued sector of the economy. country’s growth and job creation, without jeopardiz- While the total potential area for harvesting is 16 per- ing its carbon-neutrality. Forests provide timber and cent of the total forest area of Bhutan, only 7.3 per- NWFPs that are already a key element for Bhutan’s cent is currently under commercial management ow- carbon-neutral development path. Investing in sus- ing to the difficult terrain and limited wood processing tainable forest management will allow Bhutan to in- technologies. Even within the 7.3 percent, only coni- crease its carbon sequestration potential, if forests are fer areas are harvested and marketed, and operation managed dynamically, creating opportunities for ad- of broad leaf areas are downscaled due to limited de- vance regeneration. More investments in wood-sub- mand and poor processing technologies. According to stitution technology will allow Bhutan to replace national accounts, forestry contributed between 2.4 greenhouse gas emission-intense materials like steel percent and 2.9 percent to value added in the economy and cement with wood. 9 Carbon negative means that Bhutan’s carbon footprint is less than neutral, hence, Bhutan is removing more carbon dioxide from the atmosphere than it adds. BHUTAN DEVELOPMENT UPDATEOverview 13 There are various challenges in the forestry sector. mechanisms that could otherwise provide incentives These challenges relate to four thematic areas: (i) de- for more efficient resource allocation, more training forestation and forest degradation, (ii) vulnerability of skilled labor, and more investments in state-of- to climate change and natural disasters, (iii) a chal- the-art technology and equipment. lenging policy and institutional environment, and (iv) underdeveloped wood and non-wood industries. There are five opportunities to transform Bhutan’s While deforestation and forest degradation rates are forestry sector into a modern and effective eco- low overall, there are local hotspots and future de- nomic sector. These include: (i) supporting sustain- velopment activities will put more pressure on forest able forestry management in Forest Management resources. The two main drivers of deforestation in- Units (FMUs) and Community Forests (CFs), (ii) in- clude (i) the allotment of state reserve forest land for vesting in modern forest technology and infrastruc- various purposes and (ii) infrastructure development ture in FMUs and CFs; (iii) exploring a market-based related to the construction of hydropower projects approach for timber and NWFP sales; (iv) establish- (including transmission lines). Timber and fuelwood ing SMEs for timber and NWFPs and value addition; harvesting, as well as forest fires are the main drivers (v) supporting the development of a curriculum for of forest degradation. Bhutan’s 2011 Climate Change wood engineering and wood architecture. Imple- Vulnerability Assessment predicts a warming trend in menting the proposed actions could improve the annual temperature and high levels of variability and productivity of Bhutan’s forestry sector, increase in- uncertainty in annual precipitation. As a result, vul- vestments in forest-based SMEs, and build local ca- nerability is high at a community level, particularly pacity for forest-based industries, while sustaining among subsistence farmers, (Lhendup, Wikramanay- the environmental benefits that forests provide. Fi- ake, and Freeman 2011). Finally, there is a challenging nally, forest-dependent jobs and the development of policy and institutional environment, which inhib- NWFPs hold promising economic opportunities for its the development of the forest-based private sec- rural communities and could provide an attractive tor. For instance, current regulations impede market source of livelihood. 14  BHUTAN DEVELOPMENT UPDATE 1 Recent Economic Developments BHUTAN DEVELOPMENT UPDATERecent Economic Developments 15 a. Growth daily package rate (MDRP) applicable to internation- al tourists and out-of-pocket spending, are estimat- Bhutan’s economy has been affected significantly by ed to have decreased by 42.4 percent, an amount the COVID-19 induced crisis. Even though Bhutan equivalent to 5.5 percent of GDP. In addition, domes- has had a limited number of cases, thanks to stringent tic containment measures, including school closures containment measures (Box 1), the pandemic has af- and social distancing, have significantly depressed fected the economy through two primary channels: consumption and services activities that require (i) a decline in the services sector as tourist arrivals close human interaction. As a result, services sector dried up, and (ii) disruptions to industrial activities, growth is expected to have contracted by 0.6 percent mainly through reduced foreign demand for goods in FY2019/20. exports and disrupted access to critical inputs, in- cluding foreign labor. Meanwhile, hydropower pro- Manufacturing, construction and non-hydro ex- duction and exports increased in FY2019/20 with porting sectors have been adversely affected by the on-streaming of the Mangdechhu hydropower trade disruptions, foreign labor shortages, and de- project. Overall GDP growth has decelerated from pressed external demand, especially from India. an estimated 3.8 percent in FY2018/19 to 1.5 percent While goods are still allowed to be shipped across in FY2019/20.10 The revised FY2019/20 estimate is the Indian border, elevated border controls and de- 4 percentage points lower than the pre-COVID-19 pressed shipment volume have raised transport and forecast of 5.5 percent.11 logistics costs. Restrictions on cross-border move- ment of persons have led to foreign labor shortages. The tourism industry has come to a standstill since Reports from the Association of Bhutanese Industries the government closed the country for inbound (ABI) and Construction Association of Bhutan (CAB) tourists on March 6. Growth had been driven by indicate a sharp decline in non-hydro exports to In- the services sector until FY2018/19, supported by the dia, while shortages in labor and raw material from tourism-related activities (including transport and India have impeded manufacturing and construction communication, retail, and hotels and restaurants). activities. While tourist arrivals increased by 12.2 percent (year- on-year) in the first half of FY2019/20,12 internation- Hydropower production and exports increased in al tourist arrivals decreased by 37.3 percent (year- FY2019/20, supporting industry sector growth, but on-year) in the third quarter of FY2019/20.13 Overall largely reflecting a one-off boost. The state-led hy- in FY2019/20 total tourist arrivals decreased by 41.8 dropower sector accounts for about 26 percent of percent (Figure 2). As a result, gross receipts from GDP14, 28 percent of exports and 22 percent of domes- tourism, which include receipts from the minimum tic revenues.15 Hydropower production is estimated 10 The growth forecast for FY2018/19 and FY2019/20 is based on World Bank staff projections since no quarterly GDP estimates are available for Bhutan. The latest national accounts estimates are available for calendar year 2018. 11 Bhutan Development Update, January 2020. 12 Bhutan Tourism Monitor 2018 and 2019. 13 There are no monthly tourist arrival statistics available for regional tourists. 14 This includes electricity (12 percent) and construction (14 percent) sector activities, which are mainly related to hydropower production and construction (NSB 2019). Hy- dro exports and revenue shares are provided for 2018/19 (actuals). 15 The government receives hydro-related revenues in the form of royalties, a one-time profit transfer when a project is handed over to the government of Bhutan, and corporate income taxes and dividends from the Druk Green Power Corporation Limited (DGPC), a state-owned enterprise. 16 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE Box 1. Government Response to Contain COVID-19 To date, Bhutan has been able to contain a large-scale domestic outbreak of COVID-19 thanks to domestic pandemic mitigation measures. As of August 20, there were a total 150 confirmed cases (of which 105 have fully recovered) and no deaths. The government has ordered a three-week mandatory quarantine for everyone returning from abroad at dedicated government facilities. On August 11, the country recorded its first case outside of managed quarantine, and community transmission was confirmed shortly thereafter. Prior to this, all confirmed cases were “imported” and detected while under mandatory quarantine. Around 9,000 people have undergone quarantine since early March. Bhutan has conducted around 57,000 tests by August 12, which translates to 87,000 tests per million people. The government introduced travel restrictions and health-related measures in early March to slow the spread of COVID-19. The first imported case of COVID-19 was confirmed on March 5, 2020. The government imposed a two weeks restriction on all incoming tourists as of the following day. On March 22, Bhutan further sealed off its land borders as a precautionary measure, except for movement of goods (the Bhutan-India border remained open for trade). As per the National Preparedness and Response Plan (NPRP), the country remains in code orange (moderate disruption), whereby isolation is triggered for confirmed cases and suspected cases are quarantined. All schools and educational institutes were closed on March 18. Additional preventive measures were taken. On March 30, the mandatory quarantine period was extended from two to three weeks. On April 14, business hours for shops were reduced and gatherings in groups of three or more were discouraged. Public and private institutions were advised to implement home-based work. On May 15, the government encouraged facemasks in public places and hospitals, and restricted movement in the southern borders after 7 pm. On June 19, the government announced reopening plans for Phase I, including new health-related measures and a limited reopening of schools. Business hours were extended from July 1. Sports centers, public parks and places reopened on June 22. Facemasks are mandatory in hospitals, schools, markets, and public transport. Home-based work for public and private sector institutions was discontinued from June 22. A tracing system is in place and the Ministry of Health (MoH) is conducting regular testing of high-risk communities and frontline responders. Selected school classes have reopened from July 1. On August 11, the government has announced the first nationwide lockdown. The lockdown was ordered after a returning resident tested positive for COVID-19 after being discharged from mandatory quarantine and coming into close contact with people in the community. The government has asked people to stay home and restricted intra- and inter-district movements of individuals and vehicles. All schools, institutions, offices and commercial establishments will remain closed. The government has issued lockdown guidelines and is coordinating the distribution of essential food supplies in all districts. Essential and emergency medical services are being facilitated. Boarders are expected to remain closed in 2020. The re-entry of all foreigners holding valid visas and work permits is suspended until further notice. Figure 1. COVID-19 confirmed cases and number of people in quarantine, and policy actions 12000 200 10000 150 8000 6000 100 4000 50 2000 0 0 6 Mar 11 Mar 16 Mar 28 Mar 3 Apr 9 Apr 14 Apr 19 Apr 24 Apr 29 Apr 4 May 9 MAy 14 May 19 May 24 May 29 May 3 June 8 June 13 June 18 June 23 June 28 June 3 July 8 July 13 July 18 July 23 July 28 July 2 Aug 7 Aug 12 Aug 17 Aug Borders closed, schools closed Businesses close at 7pm Limited school reopening Nationawide lockdown Travel for incoming tourists suspended Reopening Phase I starts announced People in quarantine (LHS) People discharged from quarantine (LHS) Confirmed cases (RHS) Recovered cases (RHS) Source: MoH BHUTAN DEVELOPMENT UPDATERecent Economic Developments 17 Figure 2. Tourist arrivals and gross tourism Figure 3. Hydropower production and export receipts revenue 400 400 7575 12000 12000 6060 5050 10000 10000 300 300 4040 2525 8000 8000 3030 200 200 6000 6000 2020 -25 4000 -25 4000 1010 100 100 2000 2000 00 00 -75 -75 00 -10 -10 11/ 2 12 12 13 /13 13 14 /14 14 15 /15 15 16 /16 16 17 /17 17 18 /18 18 19 /19 /2 (f) f) 11/ 2 FY 2 12 13 FY 3 13 14 FY 4 14 15 FY 5 15 16 FY 6 16 17 FY 7 17 18 FY 8 18 19 FY /19 /2 (f) f) /1 /1 /1 FY11/1 FY11/1 1 /1 /1 /1 0( 0( FY16/ FY16/ 19 20 19 20 FY13/ FY13/ FY12/ FY 2/ FY17/ FY17/ FY 4/ FY15/ FY18/ FY 4/ FY 5/ FY18/ 1 1 1 1 FY FY FY19/ FY 9/ FY FY FY FY FY FY FY 1 FY Regional Regional arrivals arrivals (thousends, (thousends, LHS) LHS) International International arrivals arrivals (thousends, (thousends, LHS) LHS) Hydropower Hydropower productions productions (GWh, (GWh, LHS) LHS) Gross Grossreceipsts receipsts(y-o-y (y-o-ygrowth, growth,percent, RHS) percent, RHS) Hydropower Hydropower sales (y-o-y sales growth, (y-o-y percent, growth, RHS) percent, RHS) Total Total tourist tourist arrivals arrivals (y-o-y (y-o-y growth, growth, percent, percent, RHS) RHS) Export Export revenue(y-o-y revenue(y-o-y growth, growth, percent, percent, RHS) RHS) Source: MOF Source: MOF to have increased by 22 percent16 in FY2019/20 (Fig- years. As a result, the industry sector is estimated to ure 3). The significant increase in production was pri- have grown by 4.4 percent in FY2019/20 (Figure 4). marily driven by the on-streaming of the Mangde- chhu hydropower project (720MW), inaugurated in The agriculture sector is expected to have grown August 2019. Production also increased in the largest moderately at 2.5 percent in FY2019/20. Reduced hydro project Tala (1,020MW), which had been un- external demand for agricultural products appears to dergoing maintenance work in the previous two fiscal have hurt agribusinesses. Anecdotal evidence suggests that exports of agricultural goods was hampered by Figure 4. Contribution to GDP growth (percentage points) 8 7.4 6.5 7 6.3 6.2 6 5 4.0 3.8 3.8 3.6 4 3 1.5 2 1 0 -1 -2 FY11/12 FY12/13 FY13/14 FY14/15 FY15/16 FY16/17 FY17/18 FY18/19 FY19/20(f) Non-manufacturing (incl. hydro) Manufacturing Agriculture Services Taxes/subsidies GDP growth Source: NBS, WB staff estimates 16 from 8,189 GWh in FY2018/19 to 9,993 GWh 18 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE Figure 5. Employment share by sector Figure 6. Unemployment rate (percent), (percent), 2019 2010-19 100% 8 11.4 7.1 90% 1.3 1.7 21.6 7 4.3 80% 6.3 45.4 3.1 10.1 2.7 6 70% 5.6 7.5 5.3 5.1 60% 5 14 50% 7.6 3.9 4.9 4 40% 3.3 3.4 15.0 71.2 3.1 2.7 30% 3 2.5 51.1 2.1 20% 23.3 2 10% 3.8 1 0% Urban Rural Both 2.6 1 1.5 1.7 1.8 1.6 Agriculture Industry Other services 0 Transportation Accomodation Wholesale 2010 2015 2016 2017 2018 2019 and Storage and Food & Retail Trade Urban Rural National unemployment rate Source: NSB. 2019 Labor Force Survey elevated border controls and the lockdown in India about 30 percent of households depend on tourism (the main market for Bhutan’s food exports account- and trade-related activities (Figure 5).20 ing for 67 percent of total food exports in 2019). As part of the Economic Contingency Plan (ECP), the gov- While jobs were lost in the tourism and related sec- ernment has implemented measures to support do- tors, the border closure and lockdown in India have mestic agricultural and livestock production, includ- resulted in a shortage of foreign workers, mainly in ing input support during the current and upcoming construction. Pre-COVID-19, the overall unemploy- agricultural seasons.17 Other measures include a lend- ment rate decreased from 3.4 percent in 2018 – the ing program for the rural and agricultural sector and highest rate since 2011 – to 2.7 percent in 2019 (Fig- an urban agriculture initiative. 18 ure 6). The youth unemployment rate also dropped from 15.7 percent in 2018 to 11.9 percent in 2019.21 The employment impact of COVID-19 is expected According to the Ministry of Labor and Human Re- to be felt broadly across the country but particu- sources (MoLHR), around 11,000 people (3.5 percent larly in urban areas. Bhutan remains a largely rural of total 2019 employment) have lost their jobs due to and agrarian economy with a large informal sector. 19 COVID-19 by May 2020, mostly in tourism and al- While the agriculture sector may absorb some un- lied sectors.22 In turn, there was a shortage of 20,000 deremployment from other sectors, the impact of foreign workers as of June and half of the remain- the pandemic is likely to be felt in urban areas, where ing 28,000 workers (equivalent to 9 percent of total 17 As part of the Economic Contingency Plan (ECP), the Ministry of Agriculture and Forestry (MoAF) has put forward a 15-month agriculture stimulus plan to strengthen food security through increased domestic production and create employment opportunities. 18 The MoAF has initiated an urban and peri-urban agriculture program in Thimphu to address the current unemployment challenges while achieving food security goals. See http://www.moaf.gov.bt/ministry-launched-urban-and-peri-urban-agriculture-program-in-thimphu/ 19 The informal sector accounted for about 80 percent of total employment in 2014 (WB 2016. Bhutan’s Labor Market. Toward Gainful Quality Employment for All). The share of self-employment, a proxy measure of the degree of informality in employment, was 33.7 percent of total employment in 2019, of which agriculture self-employment accounts for 21.7 percent and services for 7.9 percent. Family worker, agriculture and non-agriculture account for 32.1 percent of total employment. 20 LFS 2019. These sectors include commerce, transport and accommodation and food services. 21 LFS 219. Reasons for the decline include a decrease in the youth population as per population projection, leading to a decline in youth labor force entering the labor market; and youth staying in the school system, thus reducing the number of unemployed youths who are seeking jobs. 22 NSB (2020). According to a rapid socio-economic impact assessment (RSEIA) of COVID-19 on Bhutan’s tourism sector almost one third of respondents have lost their jobs or been placed on leave without pay. http://www.nsb.gov.bt/publication/files/pub1ip5024jn.pdf Also see here https://kuenselonline.com/covid-19-forces-11235-people- out-of-jobs/ BHUTAN DEVELOPMENT UPDATERecent Economic Developments 19 employment) were expected to return to India once percent in May 2020, mainly due to an increase in the lockdown was over.23 A government initiative to local and imported food prices (Figure 7). Price in- facilitate the entry of foreign workers in priority sec- creases of food items, which together carry a 46 per- tor from early June was put on hold when COVID-19 cent weight in the CPI basket, accelerated to 9.2 per- infections in Indian border towns increased.24 cent (year-on-year) in April 2020, before slowing to MoLHR estimates that COVID-19 caused the return 8.8 percent in May (Figure 8, Figure 9). By contrast, of about 3,500 of migrant laborers to Bhutan. non-food inflation decelerated from an average of 2.4 percent in FY2018/19 to 0.4 percent (year-on-year) as of May 2020, driven by lower fuel prices, which also b. Inflation lowered prices for transport services (mainly opera- tion of personal transport equipment) in the second half of FY2019/20. Inflation accelerated in the wake of the COVID-19 pandemic, driven by food price inflation. Since 85 The government has taken measures to monitor percent of Bhutan’s imports are coming from In- and contain rising prices to mitigate risks to food dia and its currency is pegged to the Indian Rupee security. While there have been limited formal re- (INR), Bhutan’s inflation rate co-moves with that of strictions on the movement of goods across the In- India with a time lag.25 Average inflation was low in dian border,26 supply side disruptions have been re- FY2018/19, standing at 2.8 percent, reflecting a de- ported, due to high transport and logistics costs and crease in food prices. While headline inflation re- labor shortages, particularly for perishables. Anec- mained modest in the first half of FY2019/20, aver- dotal evidence suggests that a combination of sup- aging 2.5 percent (year-on-year), it accelerated to 4.2 ply shortages (due to the lockdown in India) and Figure 7. Inflation, Bhutan and India Figure 8. Food inflation, imported and local (percent) (percent) 10% 10% 20% 20% 9%9% 8%8% 15% 15% 7% 7% 6%6% 10% 10% 5%5% 4%4% 5%5% 3%3% 2%2% 0%0% 1% 1% 0%0% -5%-5% Jan-16 Jan-16 May-16 May-16 Sep-16 Sep-16 Jan-17 Jan-17 May-17 May-17 Sep-17 Sep-17 Jan-18 Jan-18 May-18 May-18 Sep-18 Sep-18 Jan-19 Jan-19 May-19 May-19 Sep-19 Sep-19 Jan-20 Jan-20 May-20 May-20 Jan-18 Jan-18 Mar-18 Mar-18 May-18 May-18 Jul-18 Jul-18 Sep-18 Sep-18 Nov-18 Nov-18 Jan-19 Jan-19 Mar-19 Mar-19 May-19 May-19 Jul-19 Jul-19 Sep-19 Sep-19 Nov-19 Nov-19 Jan-20 Jan-20 Mar-20 Mar-20 May-20 May-20 Milk, Milk, eggs eggs Fruits Fruits Vegetables Vegetables Bhutan, Bhutan, overal overal Bhutan, Bhutan, food food India, India, overal overal CPI, CPI, imported imported food food CPI, CPI, local local food food Source: NSB, MoSPI Inida. Note: The all-India general CPI has not been compiled for Source: NSB the months of April and May 2020 and have been imputed by MoSPI. 23 https://thebhutanese.bt/bhutan-short-of-20000-construction-labourers-and-half-of-remaining-28000-set-to-go-back-covid-19-impact/ 24 https://thebhutanese.bt/cabinets-clearance-for-260-plus-foreign-workers-put-on-hold-after-covid-scare-in-jaigaon/ 25 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. 26 Following COVID-19, there is a standing ban on imports of meat and meat products. On March 25, the MoAF initially announced a ban on import of fruits, vegetables, Doma, and Pani. The ban on imports of fruits and vegetables was recalled on March 27. 20 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE Figure 9. CPI categories and inflation drivers in FY2019/20 18% 16% Transport 14% Weight in CPI basket 12% Housing/utilities 10% Bread/cereals Clothing and footwear Vegetables 8% Milk, eggs 6% Furnishing Meat 4% Communication Fruits Restaurants and hotels 2% Recreation and culture Miscellaneous Education 0% Healt -0.01% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Inflation, FY2019/20 (11-months) Source: NSB increased demand for domestic produce led to lo- largest trading partner. The peg remains an appro- calized price increases of selected food products.27 priate nominal anchor even though the real effective Since the onset of the pandemic, the government exchange rate has recently been moderately over- has increased the frequency of data collection on valued.29 The RMA does not have an explicit infla- market price information (MPI) of essential com- tion target and uses the cash reserve ratio (CRR) and modities and published aggregated monthly results the statutory liquidity ratio (SLR) to manage cred- for 20 Dzongkhags.28 In an effort to contain upward it growth and interventions in the foreign exchange pressures on prices, payments for the sales tax and markets targeted at maintaining the exchange rate customs duty on essential items have been deferred peg. from March to June 2020. Box 2 looks at food securi- ty implications from COVID-19 disruptions in Bhu- The growth of money supply accelerated in tan and outlines policy recommendations to ensure FY2019/20, mainly due to an increase in net for- food availability and the proper functioning of food eign assets (NFAs). Broad money growth accelerat- markets and value chains, while supporting vulnera- ed from an average annualized rate of 7.8 percent in ble households. the first half of FY2019/20 to 16.8 percent in April 2020. This was mainly due to an increase in NFAs, reflecting higher capital and financial inflows includ- c. Monetary Policy and ing grants (Figure 11). Growth in net domestic as- Financial Sector sets (NDAs), which is driven by private sector credit growth, slowed in FY2019/20. Monetary policy is anchored by the currency peg to Credit growth slowed somewhat in the second half the INR. The peg, introduced in 1974, served Bhutan of FY2019/20. While credit provision to the pri- well for macroeconomic stability, as India is Bhutan’s vate sector grew at an average annualized rate of 27 Various news reports, eKuensel. In March, the Office of Consumer Protection (OCP) had received 36 complaints on price escalation in two days. Wholesalers indicated that the price for the rice has increased because transport costs doubled given the risk and illegal tax collection along Indian highways. 28 The monthly national Consumer Price Index (CPI) is disseminated with a two-month lag, and hence does not provide a real time price monitoring system to track develop- ments at the subnational level. Complementary data is being collected by the Office of Consumer Protection (OCP) under the Ministry of Economic Affairs (MoEA), which publishes quarterly market price information of essential commodities in 20 Dzongkhags. 29 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. BHUTAN DEVELOPMENT UPDATERecent Economic Developments 21 Box 2. COVID-19 and Food Security in Bhutan The COVID-19 crisis could impact food security in Bhutan. As a small landlocked country, Bhutan relies heavily on food imports – which account for almost half of households’ food expenditure and about 17 percent of total imports. While households in Bhutan have been generally food secure before the COVID-19 crisis, there are uncertainties related to food supply in the future. The global pandemic may disrupt food supply chains resulting in shortages and prices spikes in a broad range of countries with possible impacts on Bhutan. Bhutan relies on imports from India for a significant share of its food supplies. The country produces much of what its needs in terms of non-rice staple cereals and vegetables; however, it needs to import rice and meat products mostly from India. Imported food accounts for roughly half of Bhutanese households’ food expenditure. In comparison, purchases of domestic food account for 33.9 percent and home-produced food for 16.6 percent of overall food expenditure. There was already wide variation in food security across districts before the COVID-19 crisis. According to the latest household survey (2017), only 2.9 percent of Bhutanese reported having experienced food shortage in the preceding 12 months. But the share of such households exceeded 10 percent in Tsirang, while it was low in the districts of Dagana and Zhemgang which have the highest poverty rates of all. The highest incidence of food shortage was reported in the months of June and July. More than 60 percent of residents in Dagana are undernourished, followed by Sarpang (38.8 percent), Gasa (27.8 percent) and Zhemgang (24.5 percent). Food shortages can exacerbate pre-existing malnutrition trends. It appears that poverty and undernourishment are relatively closely related, whereas the high level of food insecurity in Tsirang may be due to other factors and warrants further investigation. Figure 10. Share of households that previously experienced food shortage 0 25 50 100 Kilometers Gasa N Trashiyangtse Lhuntse Punakha Bumthang Paro Thimphu Wangdue Phodrang Trongsa Haa Percent of IIIIs Mongar Trashigang experiencing food 0-2 percent g 2-4 percent el n Dagana Sarpang Zhemgang sh Tsira 4-6 percent at Samtse Chukha Samdrup Jongkhar ag 6-8 percent m Pe 8-11 percent 22 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE The RGoB has responded to the potential threat COVID-19 poses to food security. Efforts have been deployed to secure food stocks (including through a National Food Security Reserve (NFSR) emergency action plan), to boost domestic production and distribution, and to keep trade flows open. Stockpiling of three essential non-perishable commodities is under way, and private wholesalers are procuring and distributing other essential commodities to complement the NFSR. As part of the ECP, the Ministry of Agriculture and Forestry (MoAF) has put forward a 15-month agriculture stimulus plan to strengthen food security through increased domestic production. Safety measures have been put in place to facilitate safe cross-border trade and ensure the continuous supply of essential goods. Vulnerable households have been supported through cash transfer programs (Druk Gyalpo’s Relief Kidu) and efforts to monitor and contain rising prices. To further strengthen food security, the RGoB could consider the following policy recommendations: (i) ensuring food availability and securing production in the ongoing and upcoming agricultural seasons, (ii) ensuring the proper functioning of food markets, value chains, and agri-food systems, and (iii) supporting vulnerable households. (i) Ensuring food availability and securing production in the ongoing and upcoming agricultural seasons. • Data collection tools and modalities could be further adapted and strengthened to monitor food and agricultural supply chains, domestic food production and availability, and agricultural input prices; • Provisions could be made to ensure access to inputs and labor in farms for the ongoing and upcoming agricultural season, including through ongoing and scaled up support to food processing, transport, and marketing; • Recently introduced domestic price controls on vegetables and fruits could be reconsidered; • Climate-resilient agriculture practices and nutrition-sensitive production could be promoted. (ii) Ensuring proper functioning of food markets and domestic and international value chains. • Continued commitment to free trade could be emphasized. The temporary import restrictions on fruits and vegetables could be reconsidered. Other trade restrictions could be avoided to prevent further market distortions. • Automation and electronic procedures to facilitate safe cross-border trade and to improve logistics efficiency could be prioritized. • A cooperative trade initiative could be developed with neighboring countries to refrain from imposing trade restrictions or taxes on critical food staples. (iii) Supporting vulnerable households. • Strengthened data collection efforts, including impact assessments and surveys, could shed further light on the impact of the COVID-19 pandemic on food security. • Regular and frequent price monitoring at the subnational level could provide valuable and timely information that could help detect and mitigate localized food shortages. • Nutritionally vulnerable populations, especially women and children, could be helped through alternative delivery mechanisms to ensure sufficiency in nutrient intake. • A social registry could be established to promote a systematic approach to support the poor and vulnerable. Source: WB (2020). COVID-19 and Food Security in Bhutan: How to Respond? Integrated Agriculture, Macro, Trade, and Social Protection Policy Actions. 16.4 percent (year-on-year) in the first ten months of of 23.2 percent in FY2018/19 to 29.1 percent in the FY2019/20, similar to the FY2018/19 growth rate, it first ten months of FY2019/20. decelerated to 13 percent in April 2020 (Figure 12). Lending remains concentrated in the construction/ Asset quality was weak before COVID-19, and has housing sector (27 percent of total loan exposure) further deteriorated since the onset of the pandem- and service/tourism sector (27 percent). Both sector ic. Bhutan’s financial sector asset quality is the weak- shares in total loans increased in FY2019/20, which est in the South Asia Region (SAR). Owing to poor reflects a pick-up in tourism projects in the first half underwriting standards and ineffective supervision, of FY2019/20, and to some extent, public infrastruc- the NPL ratio deteriorated from 6.5 percent in 2016 ture projects. Credit growth to the construction sec- to 10.9 percent in December 2019. It deteriorated tor has accelerated from an average annualized rate further to 19.5 percent as of March 2020, reflecting BHUTAN DEVELOPMENT UPDATERecent Economic Developments 23 Figure 11. Money supply (y-o-y growth, percent, 3-month moving average) 40% 40% 30% 30% 20% 20% 10% 10% 0 0 -10% Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 -10% Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 NFA net (y-o-y growth, percent) NDA net (y-o-y growth, percent) Broad money (y-o-y growth, percent) NFA net (y-o-y growth, percent) NDA net (y-o-y growth, percent) Broad money (y-o-y growth, percent) Figure 12. Credit growth and sectoral contribution (y-o-y growth, percent, 3-month moving average) 30.0 30.0 25.0 25.0 20.0 20.0 15.0 15.0 10.0 10.0 5.0 5.0 – – (5.0) (5.0) (10.0) Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 (10.0) Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Sevice, tourism Construction Personal loans Trade and commerce Other Credit growth (y-o-y) Sevice, tourism Construction Personal loans Trade and commerce Other Credit growth (y-o-y) Source: RMA Source: RMA mid-year cyclical factors.30 The capital adequacy ra- percent of Bhutan’s total financial sector assets, ca- tio (CAR) also fell from 19 percent in 2016 to 14.2 ter to 24 percent of the country’s borrowing needs percent in December 2019. There are concerns with and account for 41 percent of total NPLs.31 Service/ regards to the non-banking sector. Given limited in- tourism and trade sectors account for the largest NPL vestment opportunities in Bhutan, the non-banking portfolio. However, as a percent of loans extended sector is permitted to undertake retail lending activ- under each sector, the trade and agriculture sectors ities. It is, however, subject to more pronounced ma- have the highest loan impairment (28 percent each). turity mismatches and weaker supervision, and has Provisions for NPLs are high, standing at 68.6 per- a lower loss absorption tolerance. The non-bank fi- cent in December 2019, and required provisions are nancial institutions (NBFIs), which account for 15 calculated on a (conservative) gross basis. 30 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. 31 A systemic insurance company, in particular, is experiencing significant balance sheet pressures. 24 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE Figure 13. Financial sector soundness indicators (percent) 35.0% 30.0% 25.0% 19.5% 20.0% 15.0% 10.0% 0.5% 8.0% 9.7% 10.9% 0.0% 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 2018Q2 2018Q3 2018Q4 2019Q1 2019Q2 2019Q3 2019Q4 2020Q1 (P) Gross non-performing loan (NPL) ratio Risk weighted capital adequacy ratio (RWCAR) Minimum regulatory requirement (12.5%) Statutory Liquidity Requirement (SLR) ratio Source: RMA The RMA has introduced monetary relief mea- d. External Sector sures to address the impact of COVID-19. Mone- tary policy measures (Box 3) have included a debt moratorium and an interest waiver (including for The CAD narrowed in FY2019/20 as a result of NPLs). The cost of the interest waiver was shared muted export and import demand amid COVID-19. equally by the government, funded through the Bhutan has large structural trade deficits, as hydro- National Resilience Fund (NRF), and the financial power investments require significant imports of cap- sector institutions. As the first phase of these mea- ital goods along with other equipment and fuel. In- sures came to a close on June 30, 2020, the gov- dia is Bhutan’s largest trading partner, accounting for ernment announced an extension of the measures around 95 percent of its exports (including electricity with a phased approach (effective from July 1, exports) and 82 percent of imports in 2019. Exports 2020), including: (i) an interest waiver for another and imports of non-hydro goods and services are be- 3 months followed by partial (50 percent) waiver lieved to have decreased significantly in FY2019/20 for 6 months; (ii) a debt moratorium by one year; in line with weak foreign and domestic demand and (iii) new short-term bridge loans at concessional trade disruptions. However the reduction in imports interest rate of up to four years for tourism, man- had a greater overall impact on the trade balance and ufacturing and wholesale trade sector firms; (iv) the CAD is estimated to have narrowed from 22.5 a conversion of working capital loans (including percent of GDP in FY2018/19 to 14 percent of GDP capitalized interest) to term loans repayable over in FY2019/2020 (Figure 14). The CAD is mainly fi- 2-4 years; (v) micro-loans to cottage and small in- nanced by capital flows from India for hydropower dustries (CSI) at 2 percent interest for agriculture projects through a combination of grants and loans.32 and rural activities; and (vi) the easing of pruden- tial norms to provide liquidity support. Finally, Total goods exports have remained stable as a the RMA has cut the CRR by 200 basis point in share of GDP in FY2019/20, thanks to hydropow- April 2020 to improve liquidity in the banking er exports. Goods exports primarily comprise hy- system and facilitate the implementation of other droelectricity (25.3 percent of total exports in 2019) monetary relief measures. and non-hydro commodity exports such as min- eral products (31.4 percent) and base metals (28.8 32 The CA has been financed by surpluses in capital and financial accounts. BHUTAN DEVELOPMENT UPDATERecent Economic Developments 25 Figure 14. Current account components Figure 15. Non-hydro exports of selected goods, (percent of GDP) excl. electricity, 2019 and 2020 (Nu billion) 50.0 50.0 18.0 18.0 16.0 16.0 30.0 30.0 14.0 14.0 10.0 10.0 5.6 5.6 12.0 12.0 10.0 10.0 (10.0) (10.0) 8.0 8.0 (14.0) (14.0) (30.0) (30.0) 4.6 4.6 (19.1) (19.1) (22.5) (22.5) 6.0 6.0 (23.9) (23.9) 8.0 8.0 (27.9) (27.9) (30.3) (30.3) (50.0) (50.0) 4.0 4.0 3.1 3.1 2.0 2.0 (70.0) (70.0) 1.9 1.9 1.3 1.3 FY14/15 FY14/15 FY15/16 FY15/16 FY16/17 FY16/17 FY17/18 FY17/18 FY18/19 FY18/19 FY19/20(f) FY19/20(f) 0.0 0.0 Jan-Jun Jan-Jun 2019 2019 Jan-Jun Jan-Jun 2020 2020 Exportgoods Export goods Export Exportservices services Secondary income Secondary income goods Importgoods Import Importservices Import services Primaryincome Primary income Foodand Food andbeverages beverages Mineralproducts Mineral products CAB CAB Exportsgoods, Exports goods,hydro hydro Basemetals Base metals Others Others Source: RMA Source: MoF, WB staff estimates percent).33 Hydro exports are projected to have in- expected to have decreased from 5 percent of GDP in creased by 3.3 percentage points of GDP to 9.5 per- FY2018/19 to 3.7 percent of GDP in FY2019/20. cent of GDP in FY2019/20 in line with higher pro- duction. However, domestic production of, and Import growth decelerated in FY2019/20 as the external demand for non-hydro goods from Bhutan COVID-19 outbreak slowed public investment proj- have been affected by supply-side disruptions for ects and construction works. Goods imports de- critical inputs, labor shortages and the growth slow- creased by 4.8 percent (year-on-year) in the first half down in India. The border closure and measures to of FY2019/20. Construction works, including on on- facilitate safe cross-border trade resulted in tem- going hydropower projects Puna II and I, were ad- porary restrictions for exporting industries, includ- versely impacted by the crisis through shortages in ing for mineral products. 34 Preliminary estimates skilled labor and raw materials. Preliminary estimates indicate that total non-hydro exports decreased indicate that goods imports decreased by 15 per- by 43 percent (year-on-year) in the second half of cent (year-on-year) in the second half of FY2019/20. FY2019/20 (Figure 15).35 While food imports increased by 20 percent, imports of other goods including raw materials and fuel de- Services exports fell sharply due to the halt in tour- creased by 24 percent and 16 percent, respectively. ism in the second half of FY2019/20. Services ex- On balance, total goods imports are estimated to have ports mainly comprise tourism and transport ser- decreased from 38.6 percent of GDP in FY2018/19 to vices. While they increased by 8.2 percent in the first 30.5 percent in FY2019/20. half of FY2019/20, in line with an increase in tour- ist arrivals, preliminary estimates suggest they fell by International reserves remain at comfortable levels. 35 percent in the third quarter of FY2019/20 (year- Gross international reserves increased in the first ten on-year) (Figure 16). As a result, services exports are months of FY2019/20 by 30 percent (year-on-year), 33 MoF Annual Trade Report 2019. 34 Export of boulders to Bangladesh and India from Samtse is expected to resume in August after three months. A dry port has been developed to facilitate boulder exports, with costs shared between the private sector and the government. See https://kuenselonline.com/boulder-export-to-resume-in-samtse/ and http://www.bbs.bt/bbsweb/ public/News/View/storypage/101 35 Since no official trade data is available for 2020, the system on India’s monthly trade was used to conduct a mirror trade analysis for Bhutan. India accounted for 75 per- cent of Bhutan’s exports in 2019 (excl. electricity). 26 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE Figure 16. Tourism receipts and services Figure 17. Gross international reserves and exports percent share of Rupee reserves in total reserves 45 45 20 20 1400 1400 40% 40% 40 40 35% 35% 10 10 1200 1200 35 35 30% 30% 00 1000 1000 30 30 25% 25% 25 25 -10 -10 800 800 20% 20% 20 20 -20 -20 600 600 15% 15% 15 15 -30 -30 400 400 10% 10% 10 10 -40 -40 200 200 5% 5% 55 00 -50 -50 00 0% 0% Jan-12 Jan-12 Oct-12 Oct-12 Jul-13 Jul-13 Apr-14 Apr-14 Jan-15 Jan-15 Oct-15 Oct-15 Jul-16 Jul-16 Apr-17 Apr-17 Jan-18 Jan-18 Oct-18 Oct-18 Jul-19 Jul-19 Apr-20 Apr-20 : Q1 1 Q22 Q33 1 Q1 : Q2 2 : Q3 3 : Q4 4 19: Q :Q 0: Q 0: Q 19: Q 19: Q 19: Q 20: /20: 8//19 /20: 9//20 8//19 8/19 8//19 19/2 19/2 18 / 18 19 Y18 18 FY19 9 Y1 Y1 Y1 1 FY Y1 Y1 FY FY FY FY Y FY F F F F F F F Tourismreceipts Tourism (US$million, receipts(US$ LHS) million,LHS) Gross Grossinternational reserveces(US$ internationalreserveces million,LHS) (US$million, LHS) Servicesexports Services (y-o-ygrowth, exports(y-o-y growth,percent,RHS) percent,RHS) Rupeeshare Rupee inGIR sharein (percent,RHS) GIR(percent, RHS) Source: RMA Source: RMA to reach US$1.29 billion in April 2020. This is equiv- e. Fiscal Performance alent to 13.6 months of imports of goods and services (Figure 17). International reserves have grown steadi- ly over the recent years and reserve adequacy mea- The fiscal balance deteriorated in FY2019/20, as the sures are met by a wide margin. The composition of government implemented economic stimulus mea- reserves also improved after the rupee crisis in 2012- sures to lift the economy. Total expenditure is esti- 13, when Bhutan experienced a shortage of INR re- mated to have grown by 27.4 percent in FY2019/20 in serves. The share of INR has increased since and is nominal terms (year-on-year), to reach 30.8 percent better aligned with the country’s external liabilities of GDP. The increase in spending was primarily driv- and trade structure. en by the increase in salaries and wages, and a pick- up in current spending. Total revenues and grants are Table 1. External accounts FY14/15 (act) FY15/16 (act) FY16/17 (act) FY17/18 (act) FY18/19 (act) FY19/20 (est) Change Export 35.7 31.0 31.1 31.5 26.7 25.6 (1.1) Goods 29.4 24.0 24.2 24.0 21.6 21.9 0.3 Hydro 9.2 7.7 8.5 6.8 6.2 9.5 3.3 Non-hydro 20.2 16.2 15.7 17.2 15.5 12.4 (3.0) Services 6.4 7.1 6.9 7.5 5.0 3.7 (1.4) Import (61.0) (60.0) (54.0) (50.2) (47.0) (37.4) 9.6 Goods (51.2) (49.9) (44.8) (41.1) (38.6) (30.5) 8.1 Services (9.9) (10.0) (9.2) (9.1) (8.5) (6.9) 1.5 Primary income (6.7) (8.3) (8.6) (8.4) (8.8) (7.2) 1.7 Secondary income 4.1 7.0 7.6 8.1 6.7 5.0 (1.7) Current Account (27.9) (30.3) (23.9) (19.1) (22.5) (14.0) 8.5 Source: RMA, WB staff estimates BHUTAN DEVELOPMENT UPDATERecent Economic Developments 27 believed to have increased by 11.6 percent (year-on- percent of GDP in FY2018/19 to 0.5 percent of GDP year) to 27.7 percent of GDP in FY2019/20. As a result, in FY2019/20.36 This was somewhat offset by an in- the fiscal balance is expected to have deteriorated crease in profit transfers from RMA (0.8 percentage from a surplus of 0.7 percent of GDP in FY2018/19 to points). The tax-to-GDP ratio is projected to have a deficit of 3.1 percent of GDP in FY2019/20 (Figure decreased from 15.4 percent of GDP in FY2018/19 18). Financing needs in FY2019/20 have been main- to 13.4 percent of GDP in FY2019/20, its lowest level ly covered by external borrowing from multilateral since 2008/09.37 Tax collection was low by interna- and bilateral partners at concessional terms, while tional standards before the COVID-19 crisis, primar- domestic borrowing has been limited. ily because of a narrow tax base, widespread exemp- tions, and a limited share of the private sector in the Total revenue has increased thanks to hydropow- economy. External grants, which mainly cover cap- er-related revenues and external grants (Figure ital expenditures under the FYPs, are projected to 19). Hydropower revenues are estimated to have in- have increased from 6 percent of GDP in FY2018/19 creased from 4.3 percent of GDP in FY2018/19 to 7 to 6.9 percent of GDP in FY2019/20, in line with the percent of GDP in FY2019/20 thanks to a one-off increase in capital expenditure. profit transfer from the commissioning of the Mang- dechhu hydro power plant (2.1 percent of GDP) and Expenditure growth has been driven by an increase higher production. By contrast, non-hydropow- in current spending in response to the pandemic er revenues are believed to have decreased from induced crisis and the salary increase (Figure 20). 15.4 percent of GDP in FY2018/19 to 13.9 percent in Total spending is projected to have increased from 25 FY2019/20, mostly reflecting the discontinuation of percent of GDP in FY2018/19 to 30.8 percent of GDP excise duty refunds from India and the closure of in FY2019/20. The government has increased cur- tourism due to COVID-19. Direct tourism-related rent spending toward measures to contain the pan- revenues are estimated to have decreased from 1.1 demic and ensure public health, stock essential goods 36 Government revenues directly related to tourism include the Sustainable Development Fee (SDF), visa fees and Tax Deduction at Source (TDS) from tour income. 37 The tax-to-GDP ratio is low by international standards, primarily because of a narrow tax base, widespread exemptions and a nascent private sector. 28 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE Figure 18. Fiscal accounts components Figure 19. Contribution to revenue growth by (percent of GDP) type (percentage points) 40.0 25.0 22.3 21.1 20.0 30.0 15.0 11.6 10.0 20.0 5.0 0.0 (0.5) 10.0 (5.0) (6.4) (10.0) 0.0 (12.6) (0.7) (15.0) (1.1) (1.3) (4.8) (2.8) /15 f) /16 /17 /18 /19 0( 16 14 15 17 18 /2 FY FY FY FY FY 19 (10.0) FY FY14/15 FY15/16 FY16/17 FY17/18 FY18/19 FY19/20(f) Hydro revenue Non-hydro revenue Total revenues and grants Total expenditure Overall balance Grants Total revenues and grants and fuel, and other activities to ensure public safe- increased significantly over the past two decades, ty. It also implemented fiscal and monetary measures driven by borrowing for hydropower projects. Pub- in the fourth quarter of FY2019/20 to provide im- lic debt as a share of GDP is high, estimated at 109.1 mediate relief to affected individuals and business- percent of GDP at the end of FY2019/20 (Figure 21). es as part of its Comprehensive Response to COVID-19 Hydropower debt accounts for 75.5 percent of the to- (see Box 3). To limit the impact on spending the re- tal debt stock. However, the 2018 Debt Sustainability sponse measures were partially financed through in- Analysis (DSA) carried out jointly by the International ternal reprioritization and technical adjustments. Monetary Fund and the World Bank assessed Bhu- The government has also set up the NRF38 to imple- tan to be at moderate risk of debt distress.40 This is ment additional COVID-19 related policy measures, because, around 95 percent of total debt has long- including an interest waiver (50 percent was cov- term maturities, and 74.3 percent is linked to hydro- ered through the NRF) and a cash-transfer program. power project loans from the Government of India Salaries and wages are estimated to have increased (74.3 percent of GDP). These loans are governed by by 2.8 percentage points to 10.4 percent of GDP in an intergovernmental agreement in which the Gov- FY2019/20 due to salary increases, which is mainly fi- ernment of India covers both financial and con- nanced by the one-off profit transfer from the Mang- struction risks of the hydropower projects and buys dechhu hydropower project. 39 Capital expenditures surplus electricity at a price reflecting cost plus a 15 are believed to have remained subdued at 10.3 per- percent net return. This debt is denominated in ru- cent of GDP in FY2019/20 as the government strove pees, electricity export receipts are also in rupees to reduce non-priority spending. and the Bhutanese currency is pegged to the rupee, which means there are no exchange rate risks. In ad- Public debt levels have increased, but risks are mod- dition, debt service begins only after the projects are erate as most of the external debt is linked to hy- on-streamed. Domestic debt remains a small share of dropower project loans from India. External debt GDP (2.2 percent). 38 The NRF with a size of Nu30 billion (15.6 percent of 2019/20 GDP) will be managed by the Ministry of Finance, and all spending will be routed through the budget. The fund will receive both domestic and external funds, which will cover additional spending on COVID-19 related measures. 39 The government formulated the Fourth Pay Commission in January 2019. The report was prepared based on three principles: (a) protecting erosion 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 rec- ommends introducing performance-based incentives (PBI). 40 The next joint IMF-World Bank DSA for Bhutan is scheduled for 2020. BHUTAN DEVELOPMENT UPDATERecent Economic Developments 29 Figure 20. Contribution to expenditure growth Figure 21. Public debt (percent of GDP) by type (percentage points) 40 120 112.5 111.8 110.5 109.1 27.4 104.4 30 22.5 98.6 100 25.9 23.8 24.9 24.6 23.9 20 11.8 12.7 27.5 80 5.4 10 60 0 81.3 80.6 83.2 77.7 82.4 40 69.4 -10 (21.8) -20 20 1.7 3.4 6.6 5.0 2.9 2.2 -30 0 f) /15 f) /15 /16 /17 /16 /18 /19 /17 /19 /18 0( 0( 16 14 15 17 18 16 14 15 17 18 /2 /2 FY FY FY FY FY 19 FY FY FY FY FY 19 FY FY Capital expenditure Salary and wages Goods and services Interest payments Other Subsidies and transfers Domestic debt External debt, hydro Total expenditure External debt, non hydro Total Public Debt Source: MoF Table 2. Fiscal accounts FY14/15 (act) FY15/16 (act) FY16/17 (act) FY17/18 (act) FY18/19 (act) FY19/20 (est) Overall balance (1.1) (1.3) (4.8) (2.8) 0.7 (3.1) Primary balance 0.5 0.3 (3.5) (1.5) 1.6 (2.1) Revenue 29.6 30.7 28.0 31.9 23.8 28.0 Hydropower revenue 3.3 3.5 4.4 5.1 4.3 7.0 CIT 1.7 1.9 1.6 1.4 1.1 1.2 Royalties 0.0 0.1 0.1 1.2 1.3 1.4 Dividend 1.5 1.4 2.7 2.5 1.9 2.3 Transfer of profit - - - - - 2.1 Non-hydro revenue 18.2 16.5 15.1 17.7 13.6 14.2 Direct 6.1 5.6 5.2 5.9 5.7 6.2 Indirect 7.2 6.9 7.3 8.1 7.3 4.7 Non-tax 5.0 4.0 2.6 3.8 0.6 3.3 Grants 8.1 10.9 8.5 9.1 6.0 6.9 Other 0.9 (0.6) (0.0) 0.2 (1.8) 0.3 Expenditure 29.8 32.7 32.8 34.5 25.0 30.8 Current expenditure 17.2 16.7 15.8 16.8 15.7 20.5 Compensation of employees 8.7 8.0 7.2 7.0 7.6 10.4 G/S 4.7 4.5 4.3 4.2 4.1 4.6 Interest payments 1.7 1.5 1.3 1.3 0.9 1.0 Transfers and subsidies 1.6 2.3 2.7 4.0 2.6 3.9 Other 0.5 0.4 0.4 0.4 0.5 0.6 Capital expenditure 12.6 15.9 17.0 17.6 9.2 10.3 Source: MoF, WB staff estimates 30 Recent Economic Developments BHUTAN DEVELOPMENT UPDATE Box 3. Unpacking the Comprehensive National Response to COVID-19 The budget FY2020/21 outlines the government’s Comprehensive National Response to COVID-19. Short- to medium term policy actions to ensure public health and safety, maintain public confidence, macroeconomic stability and economic transformation are outlined below. The government has announced policy measures in Phase II of the National Response to COVID-19 at the end of June, which are also included below. Health measures are aimed at containing the pandemic and protecting health, and strengthening healthcare system resilience. The NPRP has been developed to strengthen disease surveillance, detection and prevention and ensure effective treatment. The government has reprioritized FY2019/20 budget for the procurement of protective material, drugs and medical equipment, and provisions for quarantine facilities. Budget allocations to the health sector in FY2020/21 focus on ensuring adequate medical supplies for all hospitals and health units, increasing public hospital capacity, and advancing the health flagship programs of the 12th FYP (gastric cancer, cervical cancer and breast cancer programs). A cash transfer program and measures to increase food security were included to protect vulnerable households. Vulnerable households have been supported through His Majesty’s cash transfer program (Druk Gyalpo’s Relief Kidu, funded through the NRF), which provides immediate financial support for individuals who have been laid off, placed on unpaid leave or on reduced pay from businesses, as well as self-employed individuals who have lost their earnings either partially or completely.1 The program was scheduled to last for three months initially (April-June 2020), and has been extended until September 2020 under Phase II. The government has also taken policy actions to increase food and nutrition security, through securing food stocks, and incentives to boost domestic food production and distribution. Nutritious food will be provided to more than 12,000 vulnerable children in the absence of the school feeding program, and the government has increased efforts to monitor and contain rising prices. 2 Economic measures to stabilize the economy and stimulate growth focus on the agriculture, tourism and construction sectors. The government has implemented a set of fiscal and monetary policy measures to provide immediate relief to affected individuals and businesses (initially for the period April-June 2020). Most of these initial measures were extended in Phase II of the Comprehensive National Response to COVID-19. In addition, the government aims to revitalize the rural economy and create employment opportunities through the frontloading/re-prioritization of 12th FYP activities and the implementation of the ECP with particular emphasis on the agriculture, tourism and construction sectors. • Fiscal measures include (i) interest waiver on loans for six months until September 2020, followed by a partial interest waiver (50 percent) for six months until March 2021;3 (ii) deferment of Corporate Income Tax (CIT) and Business Income Tax (BIT) filing until June 2020, and further deferment until December 2020 for tourism and allied sectors; (iii) deferment of sales tax and customs duty on essential items to facilitate import of essential items until June 2020; (iv) monthly rent waiver on leased government property for the tourism sector; (v) deferment of electricity bills for industries, (vi) simplified procurement rules and regulations to implement the ECP. • Monetary measures include (i) working capital at concessional rates to wholesalers, tourism sector, and manufacturing industries to import raw materials, as well as bridging loans for business entities to ensure business continuity; (ii) micro loans at concessional interest rates for the agriculture and CSI sectors through the National CSI Development Bank. In Phase II, all monetary measures have been extended until June 2021. In addition, RMA has reduced the CRR to increase liquidity in the banking system.4 • The ECP focuses on three core programs. The Agriculture and Farm Road Improvement Program aims to strengthen food security through increased domestic agricultural and livestock production and new employment opportunities. This includes the improvement of farm roads to increase access to markets and reduce transport costs. Activities under the Tourism Resilience Program include training programs for tourism personnel in tourism and hospitality, as well as re-skilling programs for deployment 1 Affected people can apply online and upon verification, will receive a cash transfer of Nu12,000 (US$160) per person per month for April-June 2020, and a reduced amount of Nu10,000 (US$130) per person per month from July-September 2020. About 23,000 individuals have received the DGRK for the months of April-June for which Nu700 million (US$9.3 million) has been disbursed. 2 For more information, see WB note on COVID-19 and food security in Bhutan, 2020. 3 Of the first 3 months, 50 percent is funded through the NRF. The remaining 9 months are fully funded through the NRF, with an estimated amount of Nu7.5 bil- lion (US$99.3 million). 4 Monetary measures under Phase II also include a liquidity window facility (interbank borrowing system) to meet temporary funding requirements and ease liquidity constraints within the financial system and the revision/easing of prudential regulations, including the Capital Adequacy Ratio (CAR), and Statutory Li- quidity Ratio (SLR). BHUTAN DEVELOPMENT UPDATERecent Economic Developments 31 in the construction sector. The Build Bhutan project aims to increase domestic labor in the construction sector through the Youth Engagement and Livelihood Program (YELP) and skills training. The COVID-19 policy measures are aligned with the 12th FYP and its flagship programs. The 12th FYP is dedicated to creating a “Just, Harmonious and Sustainable Society through enhanced Decentralization”. The government will advance flagship programs under the 12th FYP through the FY2020/21 budget. Programs including Digitalizing Bhutan, increasing the use of digital technologies in schools, Growing Organic, Redefining Tourism, and Managing Waste have been leveraged through the COVID-19 response and could increase future resilience. The RGoB is currently drafting the 21st Century Economic Roadmap, which will outline Bhutan’s long-term vision. The overall objective is to create economic opportunities for the next generation and become a ‘High Income Gross National Happiness (GNH) Society’ by 2030. 32  BHUTAN DEVELOPMENT UPDATE 2 Outlook and Risks BHUTAN DEVELOPMENT UPDATE Outlook and Risks 33 a. Outlook Inflation is expected to remain elevated in the short term, mainly due to food price inflation, before moderating in the medium term. Food prices are The crisis is expected to have significant and possi- expected to gradually decrease in the medium term, bly long-lasting effects on Bhutan’s economy. Eco- in line with food prices in India. Non-food inflation is nomic growth is expected to slow markedly, aver- projected to remain moderate, supported by low oil aging around 2.5 percent per year over the medium prices. As a result, headline inflation is projected to term – well below the pre-COVID five-year average increase to 5 percent in FY2020/21 before moderat- of 5.5 percent. The tourism sector is not expect- ing to around 2.7 percent in the medium term. ed to return to its pre-COVID-19 level in the short term given that travel restrictions in Bhutan will like- The CAD is expected to remain narrow over the me- ly hold until at least early 2021, dampening services dium term as COVID-19 related disruptions weigh sector growth. 41 India’s real GDP is projected to con- on exports and imports. Hydropower exports are tract materially in FY2020/21 and its economy will projected to stabilize, in line with production capaci- rebound only gradually in FY2021/22.42 The slow- ty. Non-hydro goods and services exports are expect- down in India is expected to weigh on the manufac- ed to increase gradually over the medium term, sup- turing and exporting industries, and the construction ported by a slow recovery in demand from India and sector is likely facing a protracted slowdown in the in the tourism industry. Import growth is projected medium term due to a limited pipeline of public sec- to decelerate as the COVID-19 outbreak dampens in- tor infrastructure projects and labor shortages. The vestment projects and hydropower construction. In- COVID-19 induced crisis is expected to further de- ternational reserves are projected to remain adequate lay completion of Puna I and II beyond the projec- at 10.3 months of next year’s imports of goods and tion period. Finally, as hydropower production levels services by end-2022/23. are expected to reach capacity in FY2020/21, indus- try sector growth is expected to be moderate in the The fiscal deficit is projected to remain elevat- medium term (Figure 22). ed in the medium term as non-hydro revenues Figure 22. Hydropower production, estimated capacity and production growth 15,000.0 25 10,000.0 15 5,000.0 5 0 (5) FY18/19 FY19/20(f) FY20/21(f) FY21/22(f) FY22/23(f) FY23/24(f) Mangdechhu (GWh, LHS) Tala (GWh, LHS) Chhukha (GWh, LHS) Other (GWh, LHS) Total production (GWh, LHS) Total production (y-o-y growth, percent, RHS) Source: MoF, WB staff estimates 41 The Tourism Council of Bhutan (TCB) indicates that tourism sector may open up in January 2021. https://kuenselonline.com/convertible-currency-earnings-hit/ 42 India Development Update, August 2020. The fiscal year runs from April 1 through March 31 in India. 34 Outlook and Risks BHUTAN DEVELOPMENT UPDATE Table 3. Main macroeconomic indicators FY14/15 FY15/16 FY16/17 FY17/18 FY18/19 FY19/20 FY20/21 FY21/22 FY22/23 (act) (act) (act) (act) (act) (est) (est) (est) (est) Real GDP growth 6.2 7.4 6.3 3.8 3.8 1.5 1.8 2.0 2.8 Agriculture 3.4 4.4 3.6 3.7 3.8 2.5 3.1 3.5 4.0 Industry 6.0 7.6 4.7 -1.2 -1.6 3.7 2.0 1.5 1.5 Services 8.4 9.2 8.2 7.9 9.9 -0.6 1.3 2.2 3.6 Inflation (CPI) 6.7 3.3 4.3 3.7 2.8 3.2 5.0 2.8 2.7 GDP deflator 4.0 4.7 3.4 2.6 3.0 4.6 2.6 2.4 Current Account Balance (% GDP) -27.9 -30.3 -23.9 -19.1 -22.5 -14.0 -13.8 -12.3 -12.1 Fiscal balance (% GDP) -1.1 -1.3 -4.8 -2.8 0.7 -3.1 -6.7 -5.3 -4.3 Revenue 29.6 30.7 28.0 31.9 23.8 28.0 24.5 24.6 25.0 Hydropower revenue 3.3 3.5 4.4 5.1 4.3 7.0 7.0 5.9 5.9 Non-hydro revenue 17.3 17.1 15.1 17.5 15.4 13.9 10.3 11.8 12.3 Grants 8.1 10.9 8.5 9.1 6.0 6.9 6.9 6.9 6.8 Expenditure 29.8 32.7 32.8 34.5 25.0 30.8 30.9 29.9 29.3 Current expenditure 17.2 16.7 15.8 16.8 15.7 20.5 20.5 20.3 19.8 Interest Payments 1.7 1.5 1.3 1.3 0.9 1.0 1.0 1.6 1.6 Salary and Allowances 8.7 8.0 7.2 7.0 7.6 10.4 10.1 9.6 9.3 Goods and Services 4.7 4.5 4.3 4.2 4.1 4.6 4.6 4.5 4.4 Subsidies and Transfers 1.6 2.3 2.7 4.0 2.6 3.9 4.2 4.1 4.0 Other 0.5 0.4 0.4 0.4 0.5 0.6 0.6 0.6 0.6 Capital expenditure 12.6 15.9 17.0 17.6 9.2 10.3 10.4 9.6 9.5 Debt (% GDP) 98.6 112.5 111.8 110.5 104.4 109.1 108.8 109.1 108.8 Source: MoF, WB staff estimates BHUTAN DEVELOPMENT UPDATE Outlook and Risks 35 remain subdued and the government implements Electricity production strongly depends on water the COVID-19 relief and recovery package. Hydro- availability and weather patterns. Lower than expect- power revenue is projected to increase in the short ed rainfall would negatively impact growth and re- term, boosted by the one-off profit transfer from the duce electricity exports and government revenues. commissioning of the Mangdechhu power plant in Slower than expected implementation of the GST FY2019/20 and FY2020/21, before returning to pre- would affect fiscal outcomes, because of the discon- COVID levels (as a share of GDP).43 Non-hydro reve- tinuation of excise duty refunds and lower levels of nues are expected to remain below pre-COVID lev- grant financing from India. The introduction of the els in the medium term due to subdued economic GST in FY2020/21 and other revenue measures are growth, with some revenue gain from the planned in- critical to offset the decline in excise duties and grant troduction of the GST in 2021/22.44 External grants, financing in the medium to long term. which are based on bilateral agreements with India and mainly cover capital expenditures, are expected The contingent liabilities in the financial sector con- to remain subdued as the government reduces non stitute another source of risk. Asset quality is expect- priority spending. Current expenditure is projected ed to deteriorate further. It is thus crucial to assess to remain elevated over the projection period as the the maximum exposure from contingent liabilities in government implements the COVID-19 relief and the financial sector, through an in-depth assessment recovery package (Box 3). Financing needs are pro- of vulnerable sectors, as well as the possible magni- jected to be covered mainly by external borrowing tude of providing emergency liquidity to banks and from multilateral and bilateral partners, net lending NBFIs. In the medium term, a revised loan classifica- – principal recoveries from the Mangdechu hydro- tion requirement could be considered to reduce sea- power project,45 and domestic financing. sonal fluctuations in NPLs.46 Public debt is expected to remain elevated as a share External risks include a protracted global pandemic of GDP due to low economic growth, before gradu- and a slower recovery of economic activity in India. ally declining over the medium-term. The govern- A protracted global pandemic with precautionary be- ment has decided not to participate in the G20 Debt haviors and restrictive policies remaining in place Service Suspension Initiative (DSSI). for several months could reduce economic growth further and delay the recovery. The slowdown in In- dia and resulting cross-border spillovers could be b. Risks and Challenges more severe than expected, reducing the demand for non-hydro exports further, and possibly even for hy- dro exports. Even if the domestic outbreak remains Risks to the outlook are firmly to the downside, under control and mitigation measures are lifted, a with a domestic COVID-19 outbreak being the most recovery in the tourism sector may be delayed due acute risk. There remains a high degree of uncertain- to international travel restrictions and changing con- ty over Bhutan’s growth trajectory due to the evolv- sumer behavior. ing situation related to the pandemic, including the recently announced nationwide lockdown and mo- The COVID-19 pandemic is an unprecedented sit- bility restrictions. The most acute risk is a large- uation that requires rapid and coordinated policy scale domestic outbreak of COVID-19, which would responses. The immediate challenge for the RGoB have substantial societal and economic costs. Other is to implement the Comprehensive National Response domestic risks include lower hydropower produc- to COVID-19. Overall leadership and coordination tion and delays in the implementation of the GST. in the implementation of the strategy will be critical 43 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. 44 The GST act was enacted in July 2020, and will be implemented in July 2021. The standard GST rate is 7 percent, the minimum turnover threshold is Nu5 million. The GST will replace the sales tax and certain other indirect taxes. 45 Net lending includes on-lending to state-owned enterprises (SOEs) (including the hydropower sector), and principal recoveries from SOEs. 46 For instance, there could be an extended period before an impaired loan can be reclassified as performing, which would also help addressing the sharp seasonal fluc- tuations in NPLs that characterizes Bhutan’s financial sector. 36 Outlook and Risks BHUTAN DEVELOPMENT UPDATE to ensure its effectiveness. Delivering clear and reli- Establishing an enabling environment for the pri- able communication messages and designing health vate sector is critical to create more jobs, partic- and hygiene protocols will also be important to cre- ularly for youth and in rural areas. Bhutan relies ate and maintain consumer trust as the country eases heavily on state-owned enterprises (SOEs) to pro- travel restrictions in the future. 47 vide essential goods and services because the do- mestic market is small and the private sector em- The COVID-19 pandemic has highlighted Bhu- bryonic. Structural reforms are needed to create tan’s vulnerabilities and development challeng- incentives for private sector investments, including es such as a lack of economic diversification and in sectors with high potential for job creation, such job creation. Bhutan relies heavily on hydropower as agriculture/agribusiness, forestry, and tourism. generation for tax revenue and foreign exchange. With the need to reinvigorate growth and cre- The public sector, the largest formal employer, ate jobs, the RGoB has increased its emphasis on employs about 20 percent of the workforce and strengthening the rural economy and elevated the the hydropower sector, which accounts for about importance of addressing financial sector vulnera- 26 percent of GDP, employs less than 1 percent. bilities and economic diversification. 47 WB (2020). COVID-19 and Tourism in South Asia. Opportunities for sustainable regional outcomes. Other recommendations for policy actions include (i) destination up- grades and reinvestment in the environment, in parks, and cultural monuments; (i) providing accessible skills training in digital communication, health operations, and contact-free service, and (iii) regional collaboration. BHUTAN DEVELOPMENT UPDATE Outlook and Risks 37 The recovery phase offers a window of opportu- nutrition-sensitive production, as well as opportu- nity for key structural reforms to address these nities in organic production and value chain devel- weaknesses, accelerate recovery and build resil- opment. The Agriculture Stimulus Plan under the ECP ience. The RGoB could consider focusing on build- could be aligned with the National Organic Flagship ing resilience in the tourism and agriculture sector, Program of the 12th FYP, which highlights Bhutan’s including forestry. For instance, employment and comparative advantage in organic production. The re-skilling programs under the ECP could be aligned special section of the BDU illustrates pathways to with the future requirement of labor and skills as unlock the untapped economic potential of Bhu- outlined in the forthcoming 21st Century Economic tan’s forests by promoting sustainable forest man- Roadmap. In the agriculture sector, the government agement and natural resources while supporting the could leverage technologies and innovation in ag- objective of remaining a carbon-neutral and equita- riculture, climate-resilient agriculture practices and ble economy. 38  BHUTAN DEVELOPMENT UPDATE 3 SPECIAL SECTION:Pathways to Enhancing Sustainable Forest Management and Equitable Socio-economic Development in Bhutan BHUTAN DEVELOPMENT UPDATESPECIAL SECTION 39 a. Introduction timber for construction and renovation of im- portant monuments and other national projects. The Kingdom of Bhutan is a high forest cover, low Meanwhile a lack of rural income sources and em- deforestation (HFLD) country. It is globally known ployment are fueling rural-to-urban migration, for its efforts to conserve biodiversity and its philos- which is perceived as a national challenge. While ophy of Gross National Happiness (GNH). Thanks Bhutan clearly prioritizes environmental benefits to Bhutan’s effective and rigorous forest conserva- through its forest policies, there is a clear rationale tion framework, forest cover has increased over the for a more balanced approach toward SFM allow- past decades and deforestation is well curbed. How- ing for synergies between environmental con- ever, the forestry sector has the potential to contrib- servation and economic development objectives. ute significantly more to the economy and peoples’ Improving the productivity of Bhutan’s forestry livelihoods. sector, building up forest-based small and medi- um enterprises, and developing new job oppor- Bhutan’s economic growth objectives and develop- tunities in the wood-based and construction in- ment aspirations require proactive management dustry would generate private sector jobs, more of its natural resource endowment. Studies have revenue for the government, and higher or new shown that Bhutan can increase its forest utilization, income sources especially for the rural popula- providing much needed rural employment, without tion, as well as non-monetary co-benefits linked jeopardizing its conservation achievements. But the to increased resilience, climate change mitigation, current forest governance system primarily supports and biodiversity conservation. forest conservation, while opportunities for sustain- able forest management (SFM) matching the coun- • The forestry sector will be crucial for contribut- try’s development aspirations are not explored to the ing to the development goals of the RGoB. The fullest. sector has potential to increase its contribution to Bhutan’s economy, create new job opportuni- • While the total potential area for harvesting is 16 ties and improved livelihoods for the population percent of the total forest area of Bhutan, only without compromising forest cover and quality. In 7.3 percent is currently under commercial man- order to realize this potential, however, Bhutan’s agement owing to the difficult terrain and lim- forest sector needs to be sustainably modernized ited wood processing technologies. Even within considering the country’s uniqueness with regard the 7.3 percent, only conifer areas are harvested to size, geography, culture and focus on forest and marketed, and operation of broad leaf areas conservation. are downscaled due to limited demand and poor processing technologies. While in rural areas live- lihoods are largely dependent on the sustainable b. Bhutan’s Forests use of natural resources (agriculture and forestry), forests contributed only about 3 percent (US$73 Bhutan’s forests account for about 71 percent of the million) to GDP in 2018. This does not include the total land area (Figure 23).48 The Constitution man- contribution of the forestry sector in terms of ru- dates to maintain 60 percent forest cover in perpetu- ral timber subsidies, timber for disaster victims, ity (RGoB 2008). Bhutan’s forests consist of broadleaf 48 The definition of forest used in Bhutan: land with trees spanning more than 0.5 hectare with trees higher than 5 meters and a canopy cover of more than 10 percent. 40 SPECIAL SECTION BHUTAN DEVELOPMENT UPDATE Figure 23. Land Use: Land Cover Map of Bhutan, 2016 Source: FRMD 2017. (45.9 percent), mixed conifer (13.5 percent), fir (6.0 wetlands, and a wide net of rivers and streams that percent), chir pine (2.6 percent), and blue pine (2.6 provide water for Bhutan and neighboring coun- percent). Other land uses and land covers include tries (MoAF 2012). The total annual value of eco- shrubs (9.7 percent), snow cover (5.4 percent), rocky system services49 provided by Bhutan’s forests, in- outcrops (4.2 percent), alpine scrub (3.4 percent), cul- cluding food, timber, water and energy, has been tivated agricultural land (2.8 percent), and meadows estimated between US$394 million to US$1,269 (2.5 percent) (FRMD 2017). million (WMD, 2019). Bhutan is a global biodiversity hotspot. Centu- About 51 percent of the total land area is within ries of isolation from the international exchanges, Bhutan’s protected area (PA) network. Bhutan has a small population, topographical extremes, and five national parks, four wildlife sanctuaries, one a conservation-oriented development approach strict nature reserve, and eight biological corri- have all contributed to Bhutan’s enormous bio- dors (BCs) (DoFPS 2016) . The sustainable use of diversity wealth. The country falls within the In- natural resources by local people living in PAs is do-Burma biodiversity hotspot, which is among allowed except in core zones. While PAs are man- the 34 biodiversity hotspots in the world, with Bhu- aged by park offices, the BCs are managed by re- tan having the highest species density and a high spective forest divisions. The estimated expendi- degree of endemic flora and fauna (Banerjee and ture (of US$3–$4) per hectare of PA in Bhutan is at Bandopadhyay 2016; WWF Bhutan 2016). Further- the lower end of the range of expenditure values more, Bhutan has an abundant reservoir of wa- considered as sufficient for PA management (Da- ter resources with over 3,000 lakes, high altitude mania et al. 2008). 49 Ecosystem Services are benefits people derive from ecosystems, such as goods (i.e. wood and other raw materials, plants, animals, fungi and micro-organisms) and services (i.e. pollination of crops, prevention of soil erosion and water purification, and a vast array of cultural services, like recreation). BHUTAN DEVELOPMENT UPDATESPECIAL SECTION 41 Figure 24. Renewable Natural Resources (RNR) Sector Growth (constant prices, percent) 8% 6% 4% 2% 0% -2% -4% -6% -8% 2013 2014 2015 2016 2017 2018 Agriculture, livestock and forestry Crops Livestock Forestry and logging Source: MoAF 2019. Bhutan is internationally recognized as a leader Forest Management Units (FMUs) (NSB 2018a). In in nature conservation and champion for the en- addition, forest area designated as Community For- vironment. The country has ratified international ests (CFs) accounts for 3.3 percent of the total forest conventions such as the United Nations Convention area (DoFPS 2018). The forest area utilized by rural on Biological Diversity (CBD), the United Nations households for subsistence use through formal Lo- Framework Convention on Climate Change (UNFC- cal Forest Management Plans (LFMPs) accounts for CC), the United Nations Convention on International another 4.8 percent of the total forest area (DoFPS Trade in Endangered Species of Wild Flora and Fau- 2018) (Feuerbacher et al. 2019). Hence, approximately na (CITES), the United Nations Convention to Com- 15 percent of Bhutan’s forests are managed through bat Desertification (UNCCD), and the Ramsar Con- approved FMUs, CFs and LFMPs. Forests inside the vention on Wetlands. Bhutan is currently the only protected area networks are currently accessed by ru- carbon-negative country globally. In the Nationally ral communities for subsistence consumption. Wom- Determined Contribution (NDC) submitted to the en are strongly engaged in community forestry and COP21 (Conference of the Parties) of the UNFCCC in contribute to forest conservation. December 2015 in Paris, Bhutan reaffirmed to remain carbon neutral and pursue a low-emission develop- The forestry sector constitutes an important but un- ment path in support of the commitments of the Par- derutilized and undervalued economic sector of the is Agreement (NEC 2015). economy. According to Bhutan’s national accounts, forestry contributed between 2.4 percent and 3 per- cent to gross value added between 2013 and 2018 c. Role of Forests in the (NSB 2019). This does not include the contribution of National Economy the forestry sector in terms of rural timber subsidies, timber for disaster victims, timber for construction and renovation of important monuments and other Current Contribution national projects. From the early 2000s onward, the forestry sector’s contribution to real GDP has expe- Only a small fraction of forests is currently uti- rienced a steady decline, and since 2016, the growth lized. Due to difficult terrain and lack of advanced rate of the sector has been negative (Figure 24). The forest harvesting and processing technologies, only forest sector’s small contribution to GDP is also re- 7.3 percent of Bhutan’s total forest area is current- flected in low employment numbers. In 2012, only ly used for commercial forest production through 0.5 percent of Bhutan’s labor force (1,500 workers) 42 SPECIAL SECTION BHUTAN DEVELOPMENT UPDATE worked in forestry according to the Bhutan Living than 43 percent is attributed to space heating, 41 per- Standard Survey (BLSS) 2012 (NSB and ADB 2012). cent for fodder preparation, and the rest for cook- Different forest resource assessments show that Bhu- ing (Lhendup et al. 2015). Rural entitlements for fuel- tan could substantially increase its forest utilization wood are decreasing as substantial progress has been with the availability of advanced harvesting and pro- made to electrify rural households. In 2017, 97.7 per- cessing technologies (MoAF 2014; Schindele 2004), cent of rural households had electricity access (World hence creating new job opportunities and contribut- Bank 2020). ing to economic growth. Non-wood forest products (NWFPs) provide an Despite a large growing stock in Bhutan’s forests, important source of income for rural households. forest productivity remains low. Bhutan’s latest Na- For example, the collection and trade of Cordyceps tional Forest Inventory (FRMD 2016) assessed the (Ophiocordyceps sinensis), a caterpillar fungus, makes total growing stock of Bhutan’s forests at 1,001 mil- up 50 percent of the income of people living in the lion cubic meters and average growing stock at 261 highlands (MoAF 2016). Other NWFPs include mush- cubic meters/hectare.50 For timber harvesting, an an- rooms, incense, essential oils, fruits, seeds, grass, and nual allowable cut (AAC) is determined to allow sus- bark (FAO 1996). Today, the number of NWFP man- tained yield-based harvesting of timber. In Bhutan, agement groups has risen to 148 in 17 dzongkhags, the AAC is determined by a combination of area, vol- involving more than 5,500 rural households as ume, and rotation age. Current timber harvesting members. levels are below AAC set for FMUs mainly due to the frequent breakdown of old equipment (for example In 2018, there were 781 CFs covering about 92,165 cable cranes), inadequate equipment, lack of skilled hectares (3.3 percent) of forested area and bene- manpower and unexpected weather conditions  (for fiting 33 percent of the rural population (~32,400 example changing rainfall patterns). Even if Bhutan households). About 18,000 hectares (0.6 percent harvests timber within the sustainable levels, demand of total forest area) was used for forest plantations needs to be increased for selected broadleaved spe- (MoAF 2016). With the 2007 Land Act, farmers were cies for which advanced wood processing technolo- given full ownership over the forest produce grow- gies will be required. ing on private registered land. However, lack of in- centives and subsidies discouraged farmers to reg- Rural households receive preferential access to tim- ister trees growing on their lands as private forests, ber. For the construction and renovation of rural thereby resulting in a decline of registered private houses, they are eligible to receive a fixed quantity of forests with just 136 hectares of private forest reg- timber at discounted royalty through the subsidized istered in 2013 compared with 336 hectares in 2011 Rural House Building Timber (RHBT) program (Sears (MoAF 2015). et al. 2017). For the subsistence use of fuelwood, rural households are granted an annual extraction quota of Bhutan’s forests generate indirect benefits for other either 8 or 16 cubic meters of stack volume, depend- economic sectors, such as agriculture, energy, tour- ing on whether they have access to electricity or not ism, and transport. While forests provide such indi- (RGoB 2017). FMU accounts for only 56,641 m3 while rect benefits, these are often not fully understood or the rural house building timber accounts for 2,00,316 accounted for. MoAF recently assessed the economic m3 timber, which solely comes from areas outside the contribution of forest ecosystem services to Bhutan’s FMUs. national economy. The study estimates that forests provide ecosystem services worth between US$394 Fuelwood is the major source of energy for most million to US$1,269 million per year (WMD 2019). Bhutanese and comprises 70 percent of nation- This includes provisioning services (food, timber, al energy consumption (Siebert and Belsky 2015). water and energy), carbon sequestration, and the reg- Ninety-five percent of households rely on trees for ulation of water quality. Such large contribution of lighting, heating, and cooking, out of which more forests to national economy is yet to be internalized 50 including all trees whether they fall under Bhutan’s forest definition. BHUTAN DEVELOPMENT UPDATESPECIAL SECTION 43 in the policy making and planning. Further work source of livelihood. However, a conducive policy needs to be done on natural capital accounting. Sys- environment is needed to encourage forest activities tematic data on the economic contribution of Bhu- on private lands. tan’s forests under different management regimes will be important to further inform forest manage- Applying the principles of SFM to Bhutan’s pro- ment policies. duction forests could significantly increase pro- ductivity and improve ecological resilience. While Economic Potential the AAC focuses on sustaining harvesting levels over a long period of time, SFM goes beyond sus- Despite the challenges constituted by Bhutan’s taining harvesting levels by also addressing the eco- steep terrain, a significant forest area is still avail- logical and economic dimension of forestry. SFM able for utilization. The 2013 Forest Resources Po- promotes silvicultural management practices for tential Assessment for Bhutan (FRPA) (MoAF 2014) harvesting, such as thinning, selected harvesting (for identified that 11.3 percent (equivalent to 16 percent example, of mature trees to support regeneration), of the forest area) of the total geographical area hav- and the removal of dead wood. SFM manages for- ing slope of 35o or less, and excluding the protected ests as dynamic systems sustainably generating im- area network, had the potential to be brought under portant ecosystem goods and services. Concerns SFM. This is in addition to the present share of only that human interventions linked to SFM cause un- 7.3 percent of the forest area managed under FMUs. alterable (negative) changes to natural processes of Given that about 20 percent of agricultural land forests are not well founded—in fact, silviculture in Bhutan is left fallow (MoAF 2013), private forest supports these processes with the objective of har- plantations could provide an attractive alternative vesting timber and non-timber forest products at 44 SPECIAL SECTION BHUTAN DEVELOPMENT UPDATE sustainable levels without affecting the integrity of China account for close to half of all herbal exports the forest ecosystem. to a US$160 billion global market. Bhutan’s herbal exports currently are limited to cross-border trade The RGoB is committed to increasing the produc- (RGoB 2005). As the global herbaceutical industry tivity of its forests. As part of the 12th Five-year has grown into a trillion-dollar industry today, the Plan, the MoAF intends to increase the area un- government has started exploring opportunities for der SFM regime from 357,915 hectares to 425,495 sustainable commercial cultivation and harvesting of hectares ; the forest area under scientific thinning 51 high-value herbal plants. from 381 to 15,000 hectares; and the number of SFM plans from 46 to 96. While the plan focuses on strengthening the existing CFs and NWFPs, the d. Policy and Institutional plan also commits to increasing the number of CFs and NWFPs groups52. To move to implementation Context and achieve these targets, it will be essential to (i) provide targeted capacity development to various Bhutan’s Constitution mandates to maintain at least stakeholder groups; (ii) invest in modern technolo- 60 percent of land area in perpetuity under forest gy and infrastructure; and (iii) invest in value-chain cover. Land stability in a country with mountainous addition activities. geography and seismic activity is a matter of concern. Forest cover not only helps recharging groundwater, Trade data suggest that Bhutan has a substantial but it also maintains land stability and provides oth- trade deficit in wood and wood products, with im- er ecological services. However, despite its high for- ports volumes that are eleven times higher than est cover Bhutan faces with timber shortage. SFM is exports. Bhutan’s Forest and Nature Conservation possible even within a mountainous context, without Rules (RGoB 2017) explicitly state that the “export resulting in degradation and deforestation. Hence, a of timber in either log form, sawn timber form or study is necessary to discuss how Bhutan can make as firewood is banned.” The only forest products better economic use of its forests without jeopardiz- that are currently exported are NWFPs, consisting ing the forest conservation agenda, including lever- mainly of Ophiocordyceps, matsutake mushroom, aging synergies with other objectives such as biodi- lemon grass oil, Rubia, Chirata and Pipla. The most versity conservation. significant wood-based import item is charcoal. In 2019, Bhutan imported charcoal from India worth Policies US$24.5 million, comprising 2.7 percent of total im- ports and 58.8 percent of wood-based imports (MoF Conservation and sound management of forests, 2019). Other wood-based imports include processed natural resources, and the environment are an in- wood (for example, furniture) and bamboo (MoF tegral part of Bhutan’s development objectives and 2019). feature in the Constitution, Bhutan 2020, and other national policies and plans. Bhutan 2020 outlines the Community-based NWFP enterprises have the country’s development goals, objectives, and targets potential to significantly improve rural life be- with a 20-year perspective to maximize gross nation- cause they would generate income and youth em- al happiness. It promotes a development path within ployment opportunities (Cheki 2017). NWFPs hold the limits of environmental sustainability and with- promising economic opportunities for rural com- out impairing ecological productivity and natural di- munities. Bhutan has around 400 medicinal and ar- versity. The recently finalized Reduced Emissions from omatic plant varieties (RGoB 2005). Using these re- Deforestation and Forest Degradation, Sustainable Man- sources to produce high-value products would give agement of Forests, and Enhancement of Forest Carbon Bhutan a distinctive comparative advantage in the Stocks (REDD+) strategy proposes policies and mea- international market. For example, Nepal, India and sures that support the transition to low-emission, 51 This includes all forest management regimes with local forest management plans, including FMUs and CFs. 52 Includes the plans that are to be revised. BHUTAN DEVELOPMENT UPDATESPECIAL SECTION 45 climate-resilient, and sustainable development path- enhanced; (2) poverty eradicated and inequality re- ways in forestry, agriculture, energy, tourism, and duced; (3) healthy ecosystem services maintained; (4) other cross-cutting areas. carbon-neutral, climate- and disaster-resilient de- velopment enhanced; and (5) productive and gainful The National Forest Policy ensures that forest re- employment. sources, watersheds, and biodiversity are managed for sustainable production of economic and envi- ronmental goods and services to meet the long-term e. Forest Governance needs of society (RGoB 2011). Emphasis is on a more decentralized and people-centered approach to imple- mentation, with a strong poverty reduction agenda. A Almost all of Bhutan’s forest area is state-owned key feature of this policy is the application of an inte- and a strict governance system distinguishes be- grated landscape-level approach to sustainable forest tween management of forest resources designated management. for urban (commercial use) and rural areas (sub- sistence use). The State Reserve Forests (SRF) cat- Through the 1995 Forest and Nature Conservation egory encompasses several governance types and Act (“Forest Act”), all forests are declared to be SRF management regimes, including FMUs, local forest (RGoB 1995). The Forest Act “provides for the pro- management areas, and CFs. The MoAF is respon- tection and sustainable use of forests, wildlife and re- sible for resource management, while the commer- lated natural resources of Bhutan for the benefit of cial extraction and sale of timber is done through present and future generations.” The Forest Act au- the Natural Resources Development Corporation thorizes the MoAF to establish CFs on SRF, and to Limited (NRDCL).53 CF groups can sell surplus tim- develop rules regarding the management of CFs. The ber to the commercial market (Feuerbacher et al. ministry can also issue social forestry rules to en- 2019). Rural timbers for individual applicants, dz- courage any person to grow or nurture forest crops ongs, lhakhangs and other constructions in rural areas on his own registered private land, excluding tsam- are allotted by the Department of Forest and Park drog (grazing land) and sokshing (forest for leaf litter Services (DoFPS). collections). In addition to the Forest Act, there is a comprehensive and periodically updated law of reg- Community forestry is a key component of Bhu- ulations and procedures related to the governance tan’s forest policy and is important for generating and conservation of Bhutan’s forest, the Forest and rural income and livelihood opportunities. Com- Nature Conservation Rules and Regulations of Bhu- munity forests are SRF for which rural communi- tan (RGoB 2006, 2017). ties, organized as Community Forest Management Groups (CFMG), receive management and use rights The 12th Five-Year Plan (2018–2023) targets a “Just, under conditions set out in a management plan and Harmonious and Sustainable Society through en- by laws. Following the adoption of a more decen- hanced Decentralization.” The plan emphasizes im- tralized and people-centered approach to forest- proved coordination, consolidation, and collabora- ry in the early 2000, the number of CFMG has in- tion across all national and subnational agencies; the creased rapidly since 2007. By 2018, there were 781 effective and efficient operation and maintenance of CFMG involving 32,402 rural households managing infrastructures already in place, instead of expansion; 92,165 hectares (3.3 percent) of forest land (MoAF and an increase in regional cooperation in trade, tran- 2018a). sit, and energy to give rise to new technologies and opportunities (GNHC 2018). There are five National With this transfer of responsibilities, local com- Key Result Areas (NKRAs) directly relevant to the for- munities again become custodians of their forests. estry sector: (1) economic diversity and productivity Studies show that forests provide safety nets during 53 NRDCL is a state-owned enterprise governed under the Company Act 2000. It is the nation’s main supplier of commercial timber, sand, and stone based on the man- agement plans and approval from the DoFPS, MoAF, and it makes these resources available, affordable, and accessible. The NRDCL, as the only authorized agency, is involved in forest road construction and maintenance, timber harvesting, and reforestation in FMUs and working schemes. 46 SPECIAL SECTION BHUTAN DEVELOPMENT UPDATE Figure 25. Main Forest-Relevant Government Institutions Ministry of Agriculture and Forests (MOAF) Mandate: formulation and implementation of policies and legal frameworks related to biodiversity, forests, livestock, and agriculture chairs National Environment Commission (NEC) Department of Forests and Park Services Mandate: formulates policies and regulation Mandate: Conserving & managing forest resources & related to the natural environment, biodiversity; responsible for providing forestry clearance coordinates inter-sectoral programs, and for all developmental activities including the establish- implements policies and legislation about ment of any enterprises requiring forestry resources. the environment & climate change. Approval of activities Forest Protection and Enforcement Division NRDCL (state-owned enterprise) Social Forestry and Extension Division Mandate: premier supplier of commercial timber, sand, and stone; forest road construction and maintenance, Forest Resources Management Division timber harvesting, and reforestation in FMUs and Watershed Management Division working schemes; Nature Conservation Division Ugyen Wangchuck Institute for Conservation & Environment Research Bhutan Tiger Center Service provision to local communities including supply of Supply of commercial timber, sand, and stone rural timber & other forest products times of hardship and reduce income gaps during evaluation of the management plan is also conduct- lean seasons (Pullanikkatil and Shackleton 2019). Ru- ed by FRMD. For the CFs, the CFMGs prepare the ral households with forestry-related activities were management plans with the technical support from found to have higher income and to be less prone to the field divisions while for the local forest manage- poverty (Rahut, Ali, and Behera 2015). The contribu- ment areas, the management plans are prepared by tion of Bhutan’s forests toward rural livelihoods could the respective field divisions and approved by the thus be strengthened because they provide firewood, department. The plans are used for sustainable sup- timber, fodder, and NWFPs. These high-value forest ply of timber especially for rural timber allotments. resources could emerge as a key growth area and ma- The plans are used to provide a sustainable supply of jor source of revenue for rural communities (UNDP timber especially for rural timber allotment. 2016). All forest areas designated for production have a f. National Forest Challenges management plan with scientific principle-based prescriptions for harvesting timber and NWFPs. For each FMU, a forest management plan (10-year As discussed, Bhutan has one of the highest forest time frame) is prepared by the respective field di- cover in the world (as a proportion) and is a lead- visions with technical support from the Forest Re- er in forest and biodiversity conservation, yet Bhu- sources Management Division (FRMD). Annual tan must deal with various challenges to its forests. operational plans are prepared by the respective di- These challenges are related to (i) drivers of defor- visions based on the management plan, which is then estation and forest degradation, (ii) vulnerability to reviewed and approved by FRMD. There are current- climate change and natural disasters, (iii) underdevel- ly 21 FMUs (RGoB 2018). Besides yearly monitoring oped wood and non-wood industries, and (iv) policy by the field divisions and FRMD, a midterm and final and institutional environment. BHUTAN DEVELOPMENT UPDATESPECIAL SECTION 47 Table 4. Drivers of Deforestation Annual greenhouse gas emissions because of forest Driver Area affected annually (ha) area loss (tCO2e) State reserved forest land allotment for various purposes 1,923 604,852 Hydropower projects 1,880 591,327 Agriculture 778 244,709 Roads 820 257,919 Mines and quarries 633 199,101 Electricity transmission lines 542 170,478 Total 6,714 2,111,791 Source: MoAF 2017b. Drivers of Deforestation and Forest deforestation in Bhutan. Together, these two driv- Degradation ers account for 57 percent of total deforestation. The government allocates SRF land for various purposes, While forest loss has been occurring more prom- including (i) leasing to large projects such as hydro- inently on the southern border and in valleys, the power, private commercial farming, mining, quarry- northern mountains have benefited from forest ing; (ii) compensation for private registered land ac- gains. The results of an analysis of deforestation and quired for developmental purpose; (iii) government forest degradation between 2000 and 2015 (part of agencies and religious institutions; and (iv) land ex- Bhutan’s engagement in REDD+) indicate a net in- change for special situations, such as to compensate crease of forest cover of 12 percent at an annual rate land destroyed by natural disasters. Hydropower in- of 0.8 percent (MoAF 2017b) but also localized degra- vestments require large areas to build various com- dation of some forests.54 The drivers of deforestation ponents, including access roads, transmission lines, and forest degradation are presented below. storage, and tunnels to divert river flows (World Bank 2016). Area deforested for transmission lines and ac- cess roads is included under the SRF land allotment. Drivers of Deforestation On average, about 0.5 hectares of forest are lost for ev- ery megawatt of generation capacity. Currently, there The Ministry of Agriculture and Forests (2017b) has are many plans for hydropower investments in Bhu- identified the following six major drivers of defor- tan. Extrapolating the known development plans, it is estation and ranked them in the order of severity estimated that 18,380 megawatts may impact about (Table 4). In total, the annual rate of deforestation 39,760 hectares of forest (1.5 percent of forest area), equals 6,714 hectares, or 0.2 percent of the total forest or an annual average of 1,880 hectares (MoAF 2017b). cover. This loss in forest cover is overcompensated by gains in forest cover elsewhere. Given the low prev- alence of deforestation in Bhutan, only the top two Drivers of Forest Degradation main drivers of deforestation are discussed below. The MoAF has identified three major drivers of for- Allotment of SRF land for various purposes and est degradation (MoAF 2017b). Table 5 provides an- construction of hydropower projects (including nual degradation data and resulting annual green- transmission lines) are the two main drivers of house gas (GHG) emissions. 54 These figures are currently being updated and validated as part of the Forest Reference Emission Level/Forest Reference Level. 48 SPECIAL SECTION BHUTAN DEVELOPMENT UPDATE Table 5. Drivers of Forest Degradation Annual degradation Annual GHG emissions because of Driver (m3/ha) forest degradation (tCO2e/ha) Timber harvesting 161,008 159,019 Firewood 84,936 83,886 Forest fires 46,397 49,599 Total 369,608 274,103 Source: MoAF 2017b. Timber and fuelwood harvesting accounts for 67 availability of timber/firewood, decrease in wildlife percent of total degradation of forests in Bhutan.55 diversity, decrease in availability of NWFPs, and plant The applied method relies on the assumption that diversity. As a result, vulnerability at a community the total timber harvested, according to national sta- level, particularly among subsistence farmers, is high tistics, is associated with forest degradation. In the (Lhendup, Wikramanayake, and Freeman 2011). forest reference emission level, harvesting is identi- fied as a driver of degradation but is part of sustain- The development of alternative income sources is able forest management. thus important to increase the resilience of rural communities. In 2013, an analysis of Bhutan’s for- Forest fires are another causes of forest degradation. est policy framework to mainstream climate change The number of forest fires have fluctuated over time, adaptation was conducted (Wangdi, Lhendup, and from 34 in 2012–13 to 72 incidences in 2016 and 37 Wangdi 2013). To enhance resilience, the study pro- in 2017–18 (MoAF 2017b). Fires are more prevalent poses the promotion of small-scale cottage indus- in the eastern and western regions, where pine and tries for generating off-farm income opportunities oak forests are more susceptible to fire incidences. In to supplement communities’ livelihoods in the event 2017-18, 73 percent of the fires have unknown caus- of climate disasters. These small-scale industries es. Other causes include agricultural debris burning could include forest-based enterprises such as furni- and electrical short circuits. Data suggest that the ture making, handicrafts, wood turning, and lacquer- area burned has been increasing. Because of climate ing to produce different types of wood products that change, fire incidences are projected to increase. can be sold to tourists, urban consumers, and other communities. Vulnerability to Climate Change and Natural Disasters Challenging Policy and Institutional Environment, including for the Private Bhutan’s 2011 Climate Change Vulnerability Assess- Sector ment predicts a warming trend in annual tempera- ture and high levels of variability and uncertainty in Guided by Article 5 of the Constitution, Bhutan has es- annual precipitation. This will lead to shifts in sea- tablished an extensive legal and regulatory framework sonal stream flow, ecosystems, and distributions of aimed at conserving the environment and mitigating species depending on habitat shifts. The 2016 UNDP adverse environmental impacts. However, effective study identified forest conditions as the most sensitive implementation is lacking. Shortages of law enforce- indicator to be affected by climate change. Forest con- ment personnel, ambiguity in institutional mecha- dition measurements include, in the order of severi- nisms, and lack of technical and financial resources to ty, forest fire incidents, decrease in fodder availabil- implement environment-friendly technology are some ity, decrease in availability of water in streams/lakes, of the key reasons for weak law enforcement. 55 If timber and fuelwood are harvested sustainably based on SFM principles, this activity should not be identified as a driver of forest degradation. BHUTAN DEVELOPMENT UPDATESPECIAL SECTION 49 Bhutan’s policy for access to and pricing of ex- country. Although rules and regulations are framed tracted wood negatively affects the development of to facilitate the smooth provision of services by gov- wood-based industries. As noted earlier, substantial ernment agencies to Bhutan’s citizens, some people quantities of firewood are provided with subsidies. engaged in wood-based industries feel that there is Firewood is regulated by the Forest and Nature Con- overregulation causing inefficiencies and thereby servation Rules of Bhutan 2006 (RGoB 2006). The impeding further development of wood-based in- rules specify that households are allowed 16 cubic dustries. NRDCL is a government authorized agen- meters of fuelwood per year if they lack electrici- cy involved in harvesting and distribution of timber ty or 8 cubic meters per year if they have electrici- (mainly commercial) in the country. The change in ty, irrespective of household size, need, forest type, policy and regulating harvesting and distribution and availability. Households also have entitlements of timber through NRDCL has ensured that natural to 4000 cubic foot of rural timber for construction resources mainly timber, sand and stones are avail- and 700 cubic foot for renovation. The subsidized able, accessible and affordable for all Bhutanese. The provision of wood to individuals impairs the devel- current regulation of the forestry sector (i.e., pric- opment of specialized enterprises to become an eco- ing) seems to impede market mechanisms that could nomically viable source of timber and forest prod- provide incentives for efficient resource allocation, ucts, such as building materials (Narain, Toman, and training of skilled labor, and investments in state- Jiang 2014). of-the-art technology and equipment. In addition, since Bhutan produces timber almost exclusively for The current regulatory framework is impeding the domestic market, the NRDCL and sawmills are the development of wood-based industries in the heavily dependent on national policy decisions. For 50 SPECIAL SECTION BHUTAN DEVELOPMENT UPDATE example, the housing loan restrictions in 2012 badly increase employment opportunities, develop affected sawmill owners’ business and sale of timber small and medium forest-based enterprises, re- and building components slumped by about 50 per- duce forest-based product imports, and move to cent. The NRDCL was also affected and had to deal a market-based approach for trading timber and with a huge unsold timber stock (also due to the lack NWFPs. of market for the less preferred broadleaved species), which it was able to dispose only in 2014. Bhutan’s • Bhutan’s rich forest resources can contribute 2016 Economic Development Policy (RGoB 2016a) more to the country’s growth and job creation makes provisions for subsidies and other fiscal incen- while remaining a carbon-neutral and equita- tives for forest-based industries. However, the lack of ble economy. Forests provide timber and NWFPs implementation and other factors such as outdated that are already a key element for Bhutan’s car- technology and methods, lack of value addition and bon-neutral development path. Investing in SFM product diversification and lack of skilled labor make will allow Bhutan to increase its carbon sequestra- the forestry sector uncompetitive. tion potential as forests are managed dynamically, creating opportunities for advance regeneration. There are several constraints that hamper the de- More investments in wood-substitution technol- velopment of a vibrant forest-based private sector. ogy will allow Bhutan to replace greenhouse gas emission-intense materials like steel and cement • Access to capital (World Bank 2017). Improving with wood (for example, using cross-laminated access to capital for forest-based private enter- timber technology), which stores carbon for the prises includes reducing high banking transaction lifetime of the product. charges; promoting competitive interest rates; and reducing high collateral requirements for loans. • Potential action areas to modernize and improve • Lack of competitiveness (MoEA 2017). Forest-based Bhutan’s forestry sector relate to the most rele- enterprises often deal with locally produced raw vant drivers and principles that define the nex- materials of low quality; increase in raw materi- us between forests, economic development, and al prices, high transportation costs; policy restric- pathways out of poverty. The implementation of tions on employment of foreign workers; and cheap the proposed actions could improve the produc- wood imports (mainly from China and India). tivity of Bhutan’s forestry sector through SFM, • Underdeveloped NWFP industries. The small increase investments in forest-based SMEs, and NWFP industry is hampered by lack of technol- build local capacity for forest-based industries ogy, management skills, markets and capital for while sustaining the environmental benefits for- value addition, market information, and quantity ests provide. and quality requirements. In addition, small and dispersed volumes, irregular supply and demand, • There are five opportunity areas that have a high poor infrastructure, and high transportation costs potential to transform Bhutan’s forestry sector impact business development opportunities (Che- into a modern and effective economic sector in ki 2017). NWFP resources are also threatened by the short and medium term: the impacts of climate change. (i) Supporting sustainable forest management in FMUs and CFs; g. Opportunities for Bhutan’s (ii) Investing in modern forest technology and in- Forestry Sector frastructure in FMUs and CFs (iii) Exploring a market-based approach for tim- ber (rather than price fixing) and NWFP sales; • Bhutan’s forestry sector can be more productive (iv) Establishing SMEs for timber and NWFPs and without jeopardizing the goal of maintaining at value addition including exploring technolo- least 60 percent of Bhutan’s land under forest- gies for utilizing less preferred timber species; ed cover in perpetuity and remaining a global and leader in environmental conservation. Trans- (v) Supporting the development of a curriculum forming the forestry sector has the potential to for wood engineering and wood architecture BHUTAN DEVELOPMENT UPDATESPECIAL SECTION 51 Implementing these activities could lead to the fol- • The resilience of forest ecosystems against the im- lowing illustrative results: pacts of climate change and other natural disasters has increased. • Production forest quality is improved, while forest cover is sustained. In the long-term, the RGoB could explore the fea- • Forest-dependant jobs are created, including in sibility of pursuing additional opportunities to fur- the private sector. ther enhance the role of the forest sector in Bhu- • Institutional and human capacity for SFM has tan’s economy and contribution to Bhutan’s GNH, increased. including (i) a feasibility study for domestic char- • Improved technologies and equipment for timber coal production with improved technologies; (ii) harvesting and processing, product diversification the development of a high-value furniture indus- and value addition to increase roundwood pro- try; and (iii) an online timber and NWFP auctioning duction and reduce wood-based imports. system. There are also opportunities for building • The carbon sequestration potential and carbon regional and local partnerships e.g. for combating stock has increased. forest fires. 52 References BHUTAN DEVELOPMENT UPDATE References Banerjee, A., and R. 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