How much should Bhutan worry about its public debt?

There are heated debates on an accumulation of public debt in Bhutan. One concern is that the accumulation of public debt may lead to a debt crisis. A key question is how much Bhutan should worry about its current level of public debt. This note attempts to address the question with a debt sustainability analysis.

Definition and measurements of debt sustainability. Debt sustainability refers to an ability to pay its debt obligation in the long term without a liquidity problem. A debt to Gross Domestic Product (GDP) ratio is a useful indicator to measure size of debt relative to a country’s economy. Simple debt dynamics is that if interest rate of debt < GDP growth, the debt to GDP ratio tends to decline. The World Bank and the International Monetary Fund (IMF) work together to support their client countries to achieve their development goals without creating future debt problems through the Debt Sustainability Analysis (DSA).

A DSA compares debt services (i.e., the sum of principal and interest payments) and debt stock with various measure of a country’s repayment capacity such as GDP, exports and revenues. To assess debt sustainability, these indicators are compared to indicative debt-burden thresholds and place the country into four categories of risk of debt distress – low, moderate, high and in debt distress. The DSF is a useful framework to consider debt sustainabilidty in Bhutan.

Level and structure of Bhutan’s public debt. Before applying the DSA, let’s get figures right. As of March 2017, the total public debt was Nu. 171 billion, equivalent to 107 percent of GDP. The public debt consists of domestic debt (Nu. 13 billion, 8 percent of GDP) and external debt (Nu. 158 billion, 99 percent of GDP). The external debt is further disaggregated by borrowers and purposes (table 1). Hydropower accounts for about 80 percent of the external debt (77 percent of GDP), while non-hydropower accounts for 20 percent (22 percent of GDP).

The disaggregation is important, as each category has different characteristics. Non-hydropower government debt is borrowing from multilateral and bilateral agencies for socio-economic development including World Bank financing. This financing is highly concessional. For example, the latest World Bank financing term is 1.25 percent interest rate with 25-year repayment period. Non-hydropower debt by the Royal Monetary Authority (RMA) is small and for balance of payment support purpose. The largest external debt category is hydropower debt by state enterprises (including on-lending from the government). 

Applying the DSA to Bhutan. The World Bank-IMF joint DSA in 2016 is still relevant, as the development of debt dynamics until now does not deviate from the DSA. All external debt indicators (e.g., the external debt to GDP ratio) indicate that Bhutan is high risk of debt distress. Despite these indicators, the DSA concludes that Bhutan has a moderate risk of debt distress due to the country’s hydropower debt.

The dominance of hydro external debt means that debt sustainability is closely related to sustainability of hydro external debt. About 90 percent of hydro external debt is financed by India with interest rates at 9-10 percent for Punatsangchhu I and II, and Mangdechhu projects. The first interest and principle payments are expected in 2018. This timing is earlier than the scheduled commissions of Punatsangchhu I and II. Also, construction costs are increasing. The delays and cost escalations raise concerns. However, “the Government of India covers both financial and construction risks of these projects and buys the surplus electricity output at a price reflecting cost plus a 15 percent net return” (World Bank / IMF Joint Debt Sustainability Analysis, June 2016). As long as the 15 percent net return is secured, while the delays affect economic growth, government revenues and repayment capacity of non-hydro debt, hydropower external debt is considered sustainable. Hydro external debt is therefore unlikely to lead to a debt crisis.

Non-hydro external debt low at 22 percent of GDP. Also, the high proportion of concessional financing (low interest rate with long repayment period) and sustainable growth (exceeding 7 percent) in the past few decades suggest that non-hydropower external debt is sustainable.

In addition to the level and structure of public debt, debt management is essential for debt sustainability. Thus, debt policy / management is one of 16 indicators of World Bank Country Policy and Institutional Assessment (CPIA). Among 73 low / lower-middle income IDA countries, Bhutan’s score is 9^th highest in this indicator. The 2016 Public Expenditure and Financial Accountability (PEFA) assessment by the World Bank also shows that debt management is reasonably good, although there is a room to improve a debt management strategy. The adoption of the Public Debt Policy 2016 is an important achievement. The Policy defines the legal framework, institutional arrangement, establishes a mechanism for risk assessment and monitoring, and sets a debt threshold. For example, non-hydro external debt to GDP is set at 35 percent (the current non-hydro external debt to GDP ratio is 22 percent).

Conclusion. While Bhutan should carefully monitor its public debt, the debt sustainability analysis does not suggest an immediate risk of a debt crisis. To maintain debt sustainability, we would like to highlight the following:

• Ensuring hydro external debt sustainability. The current arrangement – a 15 percent net return – ensures sustainability of hydro external debt. Maintaining this arrangement is critical.
• Effective implementation of debt-financed project with maximizing concessional financing. Debt sustainability of non-hydro external debt is subject to economic growth rate and cost of financing. On economic growth, debt has to be used for productive purposes such as infrastructure and investment in health and education. On financing cost, maximizing access to concessional financing (low interest rate) ensures sustainability.
• Maximizing non-debt financing. Financing for development is not limited to debt financing. Maximizing access to non-debt financing such as foreign direct investment (FDI) and remittances ensures stable financing for development and less reliance on debt financing.