Approved by: Prepared by the staff of the International Marcello Estevão and Zoubida Kherous Development Association (IDA) and the Allaoua (IDA), Nada Choueiri and Kevin International Monetary Fund (IMF). Fletcher (IMF) BHUTAN : JOINT BANK-FUND DEBT SUSTAINABILITY ANALYSIS Risk of external debt distress Moderate Overall risk of debt distress Moderate Granularity in the risk rating Limited space to absorb shocks Application of judgment Yes. The risk of debt distress is assessed as moderate due to the FDI nature of hydro-related loans and the projected improvement of medium-term dynamics due to hydro exports and revenues. Bhutan’s risk of overall and external debt distress is assessed as moderate, unchanged from the 2018 DSA.1 While the mechanical results point to a high risk of overall and external debt distress, with breaches in the indicators under the baseline scenario, judgement was applied given the unique mitigating factors. First, the majority of the outstanding public and publicly guaranteed debt is linked to hydropower project loans from the government of India (GoI). These projects are implemented under an intergovernmental agreement in which the GoI covers both financial and construction risks of the projects and commits to buy all surplus electricity at a price reflecting cost plus margin. Second, the debt dynamics are set to improve further over the medium term, driven by a significant increase in electricity exports and a decline in imports associated with hydropower construction. Overall, the analysis shows that external debt sustainability could be vulnerable to export and depreciation shocks, while the overall debt sustainability could be susceptible to contingent liabilities shocks. Within the moderate rating, Bhutan is assessed to have limited space to absorb additional shocks. Going forward, a gradual fiscal consolidation and revenue mobilization, a stable peg with the Indian rupee, and reforms to improve productivity and competitiveness of the non-hydropower sector, could help support debt sustainability. 1 >>> 1. The coverage of public debt in this debt sustainability analysis (DSA) includes public and publicly guaranteed (PPG) debt. PPG debt in Bhutan includes central government debt, central government borrowing on-lent to state-owned enterprises (SOEs) (including for hydropower-related projects), external guaranteed debt contracted by SOEs,2 and central bank debt (standby credit facilities). Bhutan’s local governments, social security fund and e xtra budgetary funds do not have any outstanding debt.3 The coverage of public debt in the 2022 DSA is broadly the same as that in the 2018 DSA. The external debt definition is based on residency. The calibration of the contingent liability shock is based on the default values, which account for domestic non-guaranteed SOE debt (2 percent of GDP), financial market component (5 percent of GDP), and public private partnerships (PPPs) (2 percent of GDP). Subsectors of the public sector Sub-sectors covered 1 Central government X 2 State and local government 3 Other elements in the general government 4 o/w: Social security fund 5 o/w: Extra budgetary funds (EBFs) 6 Guarantees (to other entities in the public and private sector, including to SOEs) X 7 Central bank (borrowed on behalf of the government) X 8 Non-guaranteed SOE debt 1 The country's coverage of public debt The central government, central bank, government-guaranteed debt Used for the Default analysis Reasons for deviations from the default settings 2 Other elements of the general government not captured in 1. 0 percent of GDP 0.0 3 SoE's debt (guaranteed and not guaranteed by the government) 1/ 2 percent of GDP 2.0 4 PPP 35 percent of PPP stock 2.0 5 Financial market (the default value of 5 percent of GDP is the minimum value) 5 percent of GDP 5.0 Total (2+3+4+5) (in percent of GDP) 9.0 1/ The default shock of 2% of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country's public debt definition (1.). If it is already included in the government debt (1.) and risks associated with SoE's debt not guaranteed by the government is assessed to be negligible, a country team may reduce this to 0%. . 2 >>> 2. The stock of PPG debt has increased significantly over the past decade, driven by investments in hydropower projects, and more recently the COVID-19 pandemic. Bhutan has experienced rapid economic growth in the last decade, supported by public sector-led hydropower development. While large investments in hydropower resulted in substantial external debt accumulation, risks of debt distress were mitigated by a bilateral agreement with India, the main creditor of the country’s external debt. Hydropower loans are mostly supplied by the Government of India (GoI) and on-lent to SOEs, which carry out the financing and the management of hydropower infrastructure on behalf of the government. Non-hydropower external PPG debt has helped finance infrastructure projects focusing on urban development, rural electrification, and the agriculture sector, with most owed to external creditors in concessional terms. On domestic debt, there has recently been successful issuances of government bonds, but domestic debt is mostly in shorter-term T-Bills for cash management purposes. Compared with FY2016/17, PPG debt increased by about 23 percent of GDP. Hydropower debt increased from about 81 percent to 92 percent of the GDP, reflecting loan disbursements for ongoing hydropower projects from the GoI. Non-hydropower external PPG debt rose from about 24 percent to 33 percent, remaining within the threshold under the government’s public debt policy of 35 percent of GDP. In addition, domestic debt rose slightly from 6.6 percent to 9.7 percent in the same period. The increase in non-hydropower external PPG debt and domestic debt in FY2019/20 and FY2020/21 reflects higher gross financing needs, driven by the impact of and responses to the COVID-19 pandemic. 3. Total PPG debt stood at 135 percent of GDP in FY2020/21. External debt accounted for 93 percent of total PPG debt, with the remaining being domestic debt. Hydropower debt was the largest part of external debt, comprising 73 percent of the PPG external debt stock in FY2020/21. Most of the hydropower projects were financed by India, with 70 percent of PPG external debt denominated in India rupees. Non-hydropower debt comprised 27 percent of the total external PPG debt stock in FY2020/21, which is predominantly owed to multilateral (87 percent) and bilateral creditors (12 percent), with some guaranteed SOE debt (2 percent). About 93 percent of the total external PPG debt was from official creditors, with the GoI lending the largest share at 65 percent, followed by the Asian Development Bank 3 >>> (ADB, 12.5 percent) and the International Development Association (IDA, 11.4 percent).4 The domestic PPG debt was mostly in the form of treasury bills (5.5 percent of total PPG debt) and 3-year and 10-year government bonds (1.6 percent). About 96 percent of the total PPG debt was based on a fixed interest rate, with the remaining four percent pegged to a floating rate. 4. The hydropower-related debt from the GoI is akin to foreign direct investment (FDI). As emphasized in the last three DSAs5, India provides financing for hydropower projects under an intergovernmental agreement, which guarantees returns from electricity exports and mitigates exchange rate risks. The GoI bears the construction and financial risks and commits to buy all surplus electricity at a purchase price at cost (including costs of the project, financing costs, and operation and maintenance charges) plus a margin. The price of electricity is set at the time of project commissioning, when actual costs are known, and are set to allow revenue to service debt and a financial return, with the rate revisited every three years to incorporate changes in costs. Hydropower projects are insured (and re-insured) for natural disaster. In addition, debt service begins only after the hydropower projects are commissioned. The financing arrangements mitigate exchange rate risks because both the electricity export receipts and the hydropower debt services are denominated in Indian Rupees, to which the Ngultrum is pegged. In other words, risks associated with hydropower-related project and debt is largely mitigated by the guarantees provided by the GoI. 5. The near-term growth outlook is weighed down by pandemic- and geopolitical-uncertainties, but hydropower exports should help support medium-term growth and current account.6 Growth had been strong prior to the COVID-19 pandemic, due to solid performances in the hydropower and service sectors. Compared with the 2018 DSA, recent growth outcomes are weaker, with GDP contracting by 2.4 percent in FY2019/20 and 3.7 percent in FY2020/21, resulting from the immediate impact of the pandemic and lockdown measures. While the hydropower sector supported industrial growth, construction and manufacturing sectors were adversely affected by labor shortages, high input prices, and weaker demand. On the demand side, private investment and consumption contracted sharply due to domestic COVID-19 containment measures and lower income. Expansionary fiscal policy in the past two years supported the pandemic response and recovery efforts. The 12th Five Year Plan (FYP) was re-prioritized and front-loaded, with higher expenditures on health, essential food and fuel, and income support. The National Resilience Fund (NRF) provided income support to individuals directly affected by the pandemic and interest payment support to individuals and businesses. Reflecting pandemic-related current and capital expenditure, the fiscal deficits in the near term are higher than envisaged in the 2018 DSA, 4 >>> contributing to a higher starting debt stock of 135 percent of GDP in FY2020/21. Over the medium term, GDP growth, current account and fiscal positions are expected to improve, with hydropower-related imports declining and electricity exports picking up, broadly in line with the assumptions in the 2018 DSA. The planned fiscal adjustment is supported by revenue mobilization, including the planned introduction of the Goods and Services Tax (GST), a significant increase in hydropower revenue over the medium term, and a projected economic recovery. 6. The main baseline macroeconomic assumptions underpinning the 2022 DSA are as follows: • Real GDP growth and inflation: After two consecutive years of contraction, growth is expected to expand by 4.4 percent in FY2021/22, supported by Bhutan’s rapid vaccination campaign 7 and ongoing fiscal support, but weighed down somewhat by pandemic lockdowns, higher commodity prices, and weaker external demand stemming from geopolitical tensions. Over the medium term, growth will be driven by new hydropower plants coming on stream, a recovery and reorientation of the tourism sector towards higher value visitors, and a recovery in services and manufacturing sectors. The capacity of hydropower generation is expected to approximately double with the onboarding of four hydropower projects, which will support GDP growth, and result in an increase in electricity exports and hydropower revenues.8 Long-term growth is projected to be around 5.8 percent, supported by reforms that boost economic diversification, digitalization, and private-sector-led growth. This is broadly along the lines of the last DSA but below the pre-COVID ten-year historical average (6.2 percent). The inflation rate rose from 3 percent in FY2019/20 to 8.2 percent in FY2020/21 owing to a surge in food prices. In the near term, average inflation in FY2021/22 is expected to remain elevated at 7.9 percent (6.5 percent end-of-period), owing to continued supply disruptions and high non-food inflation. Over the medium- and long-term, inflation is projected to be in line with that in India, given the ngultrum’s peg to the rupee. The GDP deflator is assumed to move in tandem with inflation. Amid the pandemic and geopolitical tensions, uncertainty around the economic outlook is elevated, with the balance of risks tilted to the downside. External risks include a sharper-than-expected global slowdown and/or a slowdown in India, including from future pandemic waves, an intensification of geopolitical tensions, and a prolonged decline in tourism, which could result in lower external demand for non-hydropower-related goods and services. Domestic risks stem from pandemic-related uncertainties. Other domestic risks include prolonged financial sector strains amid limited fiscal space, including from any contingent liabilities in the financial sector masked by the broad-based pandemic support measures. Furthermore, delays in hydropower projects and lower-than-expected hydropower production could have significant impact on growth, fiscal revenues, and exports. In addition, Bhutan could be vulnerable to climate-related shocks. For 5 >>> instance, climate-induced changes to glacial-fed rivers and adverse weather patterns could reduce hydropower generation and exports. • Fiscal balance: The fiscal (primary) deficit is projected to peak at 10.2 (8.8) percent of GDP in FY2021/22 due to the planned increase in COVID-19-related current and capital expenditure and subdued revenue performance. In contrast, the 2018 DSA had projected a primary surplus in the near term, in absence of any COVID-related measures. The fiscal deficit is expected to moderate from FY2022/23 as pandemic-related fiscal measures are phased out amid an improvement in economic conditions. Nevertheless, the phasing out of support measures is expected to gradual, given pandemic and geopolitical uncertainties. Domestic revenues (excluding grants) are expected to increase over the medium term, supported by hydropower revenues and policies aimed at mobilizing non-hydropower revenues, including the planned introduction of the GST in FY2022/23. External grants are projected to decline as Bhutan’s GDP per capita rises. In the long term , the primary fiscal balance is expected to stabilize at around 1.7 percent of GDP, broadly in line with the assumptions in the 2018 DSA. • External balance: The current account deficit (CAD) is expected to narrow slightly to 10.6 percent in FY2021/22.9 Starting from FY2022/23, the CAD is projected to moderate further, due to a sharp increase in electricity exports associated with the doubling of hydropower capacity and a gradual decline in hydropower-related imports after the completion of several hydropower construction projects. High oil prices and weaker external demand resulting from the war in Ukraine are expected to weigh on the balance of payments, however, Bhutan’s sizeable exports of ferro -alloy could provide some offset. The overall balance of payments, which has been supported by grant financing, is expected to remain positive over the medium term. In the long term, the current account is projected to stay in surplus, supporting the overall balance and reserve accumulation. Compared with the 2018 DSA, the increase in exports is driven by the onboarding of several hydro projects in the short and medium term, which is expected to double the generation capacity by FY2026/27. External risks could include higher commodity prices, including of fuel and food, weaker external demand from geopolitical tensions, and lower exports from delays in the onboarding or construction of hydropower projects. • Financing mix: The gross financing needs in the projection period are expected to be financed by both external and domestic debt. The financing mix envisages that external loans (including from IDA) would finance around 80 percent of gross financing needs in the medium term, with the remaining 20 percent financed by domestic borrowing. In the long term, the share of domestic financing is expected to increase gradually to around 40 percent of total financing needs by 2042, with a gradual shift from short-term treasury bills to medium- and longer-term bonds, due to further developments of the domestic bond market, consistent with authorities’ debt market development plan.10 The share of concessional external debt is expected to decline over the long term as Bhutan 6 >>> graduates from the LDC status and as its income level rises. The cost of domestic debt is assumed to be around 6.5 percent for longer-dated bonds. 7. The realism tools suggest that macroeconomic and fiscal assumptions are broadly reasonable (Figures 3 and 4). The 3-year adjustment in the primary balance is near the median of the sample of the 3-year fiscal adjustments for low-income countries (LICs) that were under an IMF supported program since 1990. Under various assumptions on fiscal multipliers, growth would be lower than in the baseline scenario. The deviation of the growth projection from what is implied by the fiscal multipliers can be explained by the fact that growth in FY2021/22 largely reflects the gradual normalization of economic activities from COVID-19, a sizable base effect from the sharp contraction in FY2019/20 and FY2020/21, and the on-streaming of hydropower projects that support exports and economic growth. 11 Moreover, the contribution of government capital to GDP growth is broadly consistent with historical average. Over the projection horizon, other factors including reforms that boost economic diversification, digitalization, and private-sector-led growth are expected to support long-term GDP growth. Finally, historically, the PPG external debt has been driven by a large CAD, reflecting large hydro-related imports. Going forward, the CAD is projected to moderate, reflecting the increase in electricity exports and a gradual decline in hydropower-related imports.12 8. Bhutan’s debt carrying capacity (DCC) is assessed as medium, based on the October 2021 WEO and the 2020 World Bank CPIA. The Composite Indicator (CI) is based on a weighted average of several factors such as the country’s real GDP growth, remittances, international reserves, world growth, and the World Bank CPIA score. The CI is calculated based on the last two WEO vintages (October 2021 and April 2021 WEO), using 10-year averages of these variables (5 years of historical data and projections, respectively). While the latest CI based on the October 2021 WEO and the 2020 WB CPIA suggests a strong debt carrying capacity for the current vintage (3.08), the country classification would only be revised up from medium to strong if two consecutive signals suggest a strong rating. Given that the classification 7 >>> based on the previous vintage was medium, the DCC is considered medium for the purpose of the 2022 DSA, the same as the 2018 DSA. 9. The DSA thresholds applicable for Bhutan are correspondingly medium. For external debt, the thresholds are 180 percent for the present value (PV) of external debt to exports ratio and 40 percent for the PV of the external debt to GDP ratio. For external debt servicing, the thresholds are 15 percent of debt service to exports ratio and 18 percent debt services to revenue ratio. Finally, the application benchmark for public debt is 55 percent for the PV of total public debt in percent of GDP. 10. Under the baseline scenario, Bhutan’s PPG external debt indicators exceed the thresholds for several years, before falling below the thresholds in later years. From a stock perspective, the present value (PV) of debt to GDP ratio would exceed the threshold until 2039, with the PV of debt to exports falling below the threshold in 2034, reflecting a projected pick-up in hydro-related exports. From a flow perspective, the debt service to exports ratio and the debt-service to revenue ratio would fall below their respective thresholds from 2039, as hydropower projects are expected to generate exports and revenue to cover external debt service (Figure 1). Specifically, the total PPG debt to GDP ratio is expected to moderate from around 135 percent in 2021 to about 105 in the medium term (by 2027) and reduce further to about 37 percent in the long term (by 2042, Table 2). Similarly, the external debt to GDP ratio will fall 8 >>> from around 125 percent in 2021 to 102 percent in the medium term, and to 35 percent in the long term (Table 1). 11. Stress tests suggest that Bhutan’s external debt trajectory could be vulnerable to the exchange rate and export shocks, similar to the 2018 DSA. A depreciation in the ngultrum could increase the value of Bhutan’s external liabilities, which are largely de nominated in foreign currency (particularly in rupees).13 An exchange rate shock could then imply a higher debt stock and higher debt service, with the PV of debt to GDP ratio and debt service to revenue ratio falling below the thresholds later in 2040. Similarly, a shock to exports would imply a deterioration in Bhutan’s repayment capacity, with the PV of debt to exports ratio and debt service to exports ratio above the thresholds even towards the end of the horizon. Export shocks could stem from delays in the onboarding or construction of hydropower projects. In addition, as noted earlier, Bhutan is vulnerable to climate shocks. 14 12. Similar to the 2018 DSA, Bhutan’s public debt follows closely the dynamics of external debt and does not pose an additional risk to the debt profile. Domestic debt only accounted for about 7 percent of total outstanding debt in FY2020/21. While the 2022 DSA assumes a gradual increase in domestic financing to about 40 percent of new debt, external debt remains the most important source of financing. Under both baseline and stress scenarios, the PV of the debt to GDP ratio would exceed the threshold until around 2035. Similarly, the PV of debt to revenue ratio and debt service to revenue ratio would also be on a downward trajectory. Going forward, the authorities plan to further develop the domestic debt market, including through the issuance of longer-term domestic bonds (Figure 2). 13. The 2022 DSA assesses Bhutan at moderate risk of external and overall debt distress, similarly to the 2018 DSA. While the mechanical results point to a high risk of overall and external debt distress, with breaches in the indicators under the baseline scenario, judgment was applied given unique mitigating factors supporting the sustainability of Bhutan’s debt stock. Almost three quarters of Bhutan’s PPG external debt is linked to hydropower project loans from GoI, which covers both financial and construction risks of the projects and commits to buy all surplus electricity at a price reflecting cost plus profits. In addition, debt dynamics are set to improve further over the medium term driven by a significant increase in electricity exports and a decline of imports associated with hydropower construction. Overall, the analysis shows that external debt sustainability could be vulnerable to export and depreciation shocks, 9 >>> while the overall debt sustainability could be susceptible to contingent liabilities shocks. Within the moderate rating, Bhutan is assessed to have limited space to absorb additional shocks without being downgraded to a high risk of debt distress - (Figure 5). As noted earlier, the baseline is subject to important risks, including uncertainties related to the pandemic and geopolitical tensions, further delays in the completion of hydropower plants, and the materialization of financial sector contingent liabilities. Going forward, a gradual fiscal consolidation and revenue mobilization, a stable peg with the Indian rupee, and reforms to improve productivity and competitiveness of the non-hydropower sector, could help support debt sustainability. 14. The authorities broadly agreed with staff’s assessment of debt sustainability and the need for revenue mobilization, and fiscal consolidation over the medium term. The authorities noted that although public debt ratio has increased to relatively high levels, the risk of debt distress remained moderate due to the unique mitigating factors supporting the sustainability of Bhutan’s debt stock. Furthermore, the authorities expect a gradual fiscal consolidation and a moderation in the debt-to-GDP ratio over the medium-term, driven by a significant increase in electricity exports and the completion of hydropower construction. On revenue mobilization, in addition to the introduction of the GST in July 2022, the authorities are planning on direct tax and property tax reforms to further broaden the tax base and increase revenue. The authorities concurred that pandemic support measures would need to be more targeted going forward given sustainability and financial stability considerations. Finally, the authorities reiterated the importance of further developing the domestic bond market as an alternative source of funding and to strengthen fiscal-monetary coordination. 10 >>> Table 1. Bhutan: External Debt Sustainability Framework, Baseline Scenario, 2019-2042 (In percent of GDP, unless otherwise indicated) Actual Projections Average 8/ Historical Projections 2019 2020 2021 2022 2023 2024 2025 2026 2027 2032 2042 External debt (nominal) 1/ 105.7 123.6 125.3 127.0 125.0 120.2 113.1 107.5 102.3 74.2 35.1 106.0 101.7 Definition of external/domestic debt Residency-based of which: public and publicly guaranteed (PPG) 103.6 121.9 125.3 127.0 125.0 120.2 113.1 107.5 102.3 74.2 35.1 104.5 101.7 Is there a material difference between the Yes two criteria? Change in external debt -4.9 17.9 1.7 1.7 -2.0 -4.9 -7.0 -5.6 -5.2 -4.9 -3.8 Identified net debt-creating flows 23.1 13.9 12.8 5.6 4.4 -1.9 -5.4 -5.2 -5.9 -8.7 -6.5 18.7 -4.6 Non-interest current account deficit 19.1 11.6 10.4 8.9 8.0 3.2 -1.7 -2.6 -4.0 -7.4 -5.2 20.1 -2.0 Deficit in balance of goods and services 18.4 12.9 11.9 14.5 10.7 4.8 1.1 -0.1 -1.3 -4.7 -2.9 21.4 0.8 Exports 31.7 32.4 31.0 30.2 32.0 36.0 38.5 39.4 39.7 34.3 27.1 Debt Accumulation Imports 50.2 45.4 42.9 44.6 42.7 40.8 39.6 39.3 38.4 29.6 24.2 18.0 30 Net current transfers (negative = inflow) -7.0 -7.1 -5.9 -10.3 -6.1 -5.2 -5.3 -4.8 -4.3 -3.4 -2.5 -7.1 -5.0 of which: official -4.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 16.0 Other current account flows (negative = net inflow) 7.7 5.7 4.3 4.8 3.3 3.6 2.5 2.2 1.6 0.7 0.2 5.8 2.1 25 Net FDI (negative = inflow) 0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 14.0 Endogenous debt dynamics 2/ 3.9 2.4 2.4 -3.3 -3.5 -5.1 -3.7 -2.6 -1.8 -1.3 -1.3 12.0 20 Contribution from nominal interest rate 1.4 0.8 1.4 1.6 1.7 2.5 3.1 3.5 3.9 2.9 0.8 Contribution from real GDP growth -5.0 2.6 4.6 -5.0 -5.3 -7.5 -6.8 -6.1 -5.7 -4.2 -2.1 10.0 15 Contribution from price and exchange rate changes 7.6 -1.0 -3.7 … … … … … … … … 8.0 Residual 3/ -28.0 4.0 -11.1 -3.9 -6.4 -2.9 -1.7 -0.4 0.7 3.8 2.7 -13.0 -0.1 of which: exceptional financing 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6.0 10 4.0 Sustainability indicators 5 PV of PPG external debt-to-GDP ratio ... ... 112.4 113.0 112.3 108.5 103.3 97.7 92.1 63.9 27.0 2.0 PV of PPG external debt-to-exports ratio ... ... 363.1 374.6 351.3 301.1 268.2 248.2 232.0 186.3 99.5 0.0 0 PPG debt service-to-exports ratio 9.4 5.5 11.5 21.7 18.0 17.8 17.0 19.4 19.1 20.6 12.0 2022 2024 2026 2028 2030 2032 PPG debt service-to-revenue ratio 16.3 8.1 14.0 36.6 29.1 29.7 28.4 32.2 31.6 28.7 12.2 Gross external financing need (Million of U.S. dollars) 550.7 331.7 334.0 410.6 395.2 304.3 168.9 189.4 145.5 -20.2 -259.8 Debt Accumulation Grant-equivalent financing (% of GDP) Key macroeconomic assumptions Grant element of new borrowing (% right scale) Real GDP growth (in percent) 4.4 -2.4 -3.7 4.4 4.5 6.7 6.2 5.9 5.8 5.8 5.8 3.6 5.7 GDP deflator in US dollar terms (change in percent) -6.4 0.9 3.1 6.0 3.9 3.4 2.9 2.6 2.4 2.2 2.2 0.0 3.0 Effective interest rate (percent) 4/ 1.2 0.8 1.1 1.4 1.5 2.2 2.8 3.4 3.9 3.9 2.2 2.0 3.2 External debt (nominal) 1/ Growth of exports of G&S (US dollar terms, in percent) -1.9 0.8 -5.3 7.9 15.1 24.4 16.8 11.0 9.3 4.1 6.1 0.2 10.0 of which: Private Growth of imports of G&S (US dollar terms, in percent) -1.2 -10.9 -6.2 15.2 3.9 5.6 6.0 7.7 6.0 5.2 6.4 -2.2 5.2 140 Grant element of new public sector borrowing (in percent) ... ... ... 26.9 27.5 25.2 25.9 26.3 26.3 22.9 22.9 ... 24.8 Government revenues (excluding grants, in percent of GDP) 18.2 21.8 25.4 17.9 19.8 21.5 23.0 23.7 24.1 24.6 26.6 21.7 22.9 120 Aid flows (in Million of US dollars) 5/ 633.7 845.4 201.9 336.2 173.2 172.3 198.3 195.4 192.5 207.8 373.7 Grant-equivalent financing (in percent of GDP) 6/ ... ... ... 15.6 7.6 7.3 7.0 6.5 5.9 4.6 3.2 ... 6.8 100 Grant-equivalent financing (in percent of external financing) 6/ ... ... ... 54.6 46.4 47.8 55.4 54.0 54.0 53.5 72.4 ... 52.9 Nominal GDP (Million of US dollars) 2,452 2,416 2,397 2,653 2,881 3,179 3,474 3,775 4,089 6,052 13,208 80 Nominal dollar GDP growth -2.3 -1.5 -0.8 10.7 8.6 10.3 9.3 8.7 8.3 8.1 8.1 3.6 8.8 60 Memorandum items: 40 PV of external debt 7/ ... ... 112.4 113.0 112.3 108.5 103.3 97.7 92.1 63.9 27.0 In percent of exports ... ... 363.1 374.6 351.3 301.1 268.2 248.2 232.0 186.3 99.5 20 Total external debt service-to-exports ratio 10.2 6.9 11.5 21.7 18.0 17.8 17.0 19.4 19.1 20.6 12.0 PV of PPG external debt (in Million of US dollars) 2693.8 2998.2 3235.5 3448.8 3588.6 3687.7 3766.5 3866.1 3562.8 0 (PVt-PVt-1)/GDPt-1 (in percent) 12.7 8.9 7.4 4.4 2.9 2.1 0.2 -0.7 2022 2024 2026 2028 2030 2032 Non-interest current account deficit that stabilizes debt ratio 24.0 -6.3 8.7 7.3 9.9 8.0 5.4 3.0 1.1 -2.5 -1.4 Sources: Country authorities; and staff estimates and projections. 0 1/ Includes both public and private sector external debt. 2/ Derived as [r - g - ρ(1+g) + Ɛα (1+r)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, ρ = growth rate of GDP deflator in U.S. dollar terms, Ɛ=nominal appreciation of the local currency, and α= share of local currency-denominated external debt in total external debt. 3/ Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes. 4/ Current-year interest payments divided by previous period debt stock. 5/ Defined as grants, concessional loans, and debt relief. 6/ Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt). 7/ Assumes that PV of private sector debt is equivalent to its face value. 8/ Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years. 11 >>> Table 2. Bhutan: Public Sector Debt Sustainability Framework, Baseline Scenario, 2019-2042 (In percent of GDP, unless otherwise indicated) Actual Projections Average 6/ 2019 2020 2021 2022 2023 2024 2025 2026 2027 2032 2042 Historical Projections Public sector debt 1/ 106.5 131.2 134.9 133.5 130.9 124.2 116.4 110.7 105.4 77.2 36.9 109.4 105.4 Definition of external/domestic Residency- of which: external debt 103.6 121.9 125.3 127.0 125.0 120.2 113.1 107.5 102.3 74.2 35.1 104.5 101.7 debt based of which: local-currency denominated Change in public sector debt -6.9 24.7 3.8 -1.5 -2.6 -6.7 -7.8 -5.7 -5.2 -4.8 -4.3 Is there a material difference Identified debt-creating flows -3.6 11.1 3.3 1.8 -0.6 -5.2 -5.8 -4.9 -3.8 -3.9 -3.8 -0.7 -3.8 Yes between the two criteria? Primary deficit 0.7 1.5 5.3 8.8 6.0 2.8 0.4 -0.1 -0.7 -1.6 -2.1 0.9 0.6 Revenue and grants 24.3 31.2 33.8 28.7 24.1 26.2 28.0 28.2 28.1 28.0 29.4 31.2 27.6 of which: grants 6.1 9.4 8.4 10.8 4.3 4.6 5.0 4.5 4.1 3.4 2.8 Public sector debt 1/ Primary (noninterest) expenditure 25.0 32.6 39.0 37.5 30.1 29.0 28.4 28.1 27.4 26.4 27.3 32.1 28.3 Automatic debt dynamics -4.3 9.6 -2.0 -7.1 -6.6 -8.0 -6.2 -4.8 -3.1 -2.2 -1.7 of which: local-currency denominated Contribution from interest rate/growth differential -5.3 2.2 4.4 -7.1 -6.6 -8.0 -6.2 -4.8 -3.1 -2.2 -1.7 of which: foreign-currency denominated of which: contribution from average real interest rate -0.5 -0.4 -0.7 -1.4 -0.9 0.2 1.1 1.7 3.0 2.2 0.5 of which: contribution from real GDP growth -4.8 2.6 5.1 -5.7 -5.7 -8.2 -7.2 -6.5 -6.0 -4.5 -2.2 160 Contribution from real exchange rate depreciation 1.0 7.4 -6.4 ... ... ... ... ... ... ... ... 140 Other identified debt-creating flows 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 120 Privatization receipts (negative) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 100 Recognition of contingent liabilities (e.g., bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 80 Debt relief (HIPC and other) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 60 Other debt creating or reducing flow (please specify) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 40 Residual -3.3 13.6 0.5 -3.2 -2.0 -1.5 -2.1 -0.8 -1.4 -0.9 -0.4 7.3 -1.5 20 Sustainability indicators 0 PV of public debt-to-GDP ratio 2/ ... ... 122.2 120.6 119.2 113.5 106.6 100.9 95.3 66.9 28.8 2022 2024 2026 2028 2030 2032 PV of public debt-to-revenue and grants ratio … … 361.8 420.8 495.2 433.5 380.8 357.9 338.4 238.7 97.9 Debt service-to-revenue and grants ratio 3/ 13.0 6.5 12.1 46.5 38.8 42.0 33.8 35.3 34.9 32.5 16.0 Gross financing need 4/ 3.8 3.5 9.3 22.1 15.4 13.8 9.8 9.8 9.1 7.5 2.6 of which: held by residents of which: held by non-residents Key macroeconomic and fiscal assumptions 160 Real GDP growth (in percent) 4.4 -2.4 -3.7 4.4 4.5 6.7 6.2 5.9 5.8 5.8 5.8 3.6 5.7 140 Average nominal interest rate on external debt (in percent) 1.2 0.7 1.2 1.4 1.5 2.2 2.8 3.4 3.9 3.9 2.2 2.1 3.2 120 Average real interest rate on domestic debt (in percent) 2.3 4.3 1.0 -4.6 0.3 2.1 2.4 2.7 2.2 2.5 3.5 0.8 1.5 100 Real exchange rate depreciation (in percent, + indicates depreciation) 1.0 7.0 -5.0 … ... ... ... ... ... ... ... 2.0 ... 80 Inflation rate (GDP deflator, in percent) 1.3 3.7 4.8 6.4 5.9 5.2 4.7 4.4 4.2 4.0 4.0 5.0 4.6 60 Growth of real primary spending (deflated by GDP deflator, in percent) -19.0 27.7 15.1 0.2 -16.1 2.7 4.0 4.8 3.3 6.3 6.6 4.7 2.2 40 Primary deficit that stabilizes the debt-to-GDP ratio 5/ 7.5 -23.2 1.5 10.3 8.6 9.4 8.2 5.6 4.5 3.1 2.2 -4.7 5.9 PV of contingent liabilities (not included in public sector debt) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 20 0 2022 2024 2026 2028 2030 2032 Sources: Country authorities; and staff estimates and projections. 1/ Coverage of debt: The central government, central bank, government-guaranteed debt . Definition of external debt is Residency-based. 2/ The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections. 3/ Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt. 4/ Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows. 5/ Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question. 6/ Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years. 12 >>> 13 >>> Figure 2. Bhutan: Indicators of Public Debt Under Alternative Scenarios, 2022-2042 PV of Debt-to-GDP Ratio 160 140 120 100 80 60 40 Most extreme shock: One-time depreciation 20 0 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 PV of Debt-to-Revenue Ratio Debt Service-to-Revenue Ratio 700 60 600 50 500 40 400 30 300 20 200 100 Most extreme shock: One-time 10 Most extreme shock: Growth depreciation 0 0 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 Baseline Most extreme shock 1/ TOTAL public debt benchmark Historical scenario Borrowing assumptions on additional financing needs resulting from the Default User defined stress tests* Shares of marginal debt External PPG medium and long-term 75% 75% Domestic medium and long-term 8% 8% Domestic short-term 17% 17% Terms of marginal debt External MLT debt Avg. nominal interest rate on new borrowing in USD 2.4% 2.4% Avg. maturity (incl. grace period) 20 20 Avg. grace period 5 5 Domestic MLT debt Avg. real interest rate on new borrowing 6.0% 6.0% Avg. maturity (incl. grace period) 2 2 Avg. grace period 1 1 Domestic short-term debt Avg. real interest rate -0.6% -0.6% * Note: The public DSA allows for domestic financing to cover the additional financing needs generated by the shocks under the stress tests in the public DSA. Default terms of marginal debt are based on baseline 10-year projections. Sources: Country authorities; and staff estimates and projections. 1/ The most extreme stress test is the test that yields the highest ratio in or before 2032. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented. 14 >>> Table 3. Bhutan: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2022-2032 (In percent) Projections 1/ 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 PV of debt-to GDP ratio Baseline 113 112 108 103 98 92 86 80 74 69 64 A. Alternative Scenarios A1. Key variables at their historical averages in 2022-2032 2/ 113 127 143 160 176 194 211 228 246 262 278 0 #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A B. Bound Tests B1. Real GDP growth 113 121 130 124 117 110 103 96 89 82 76 B2. Primary balance 113 114 112 107 101 96 89 83 77 72 67 B3. Exports 113 119 128 122 115 109 102 95 88 81 75 B4. Other flows 3/ 113 114 112 107 101 95 89 83 77 71 66 B5. Depreciation 113 141 133 127 120 113 105 98 91 85 78 B6. Combination of B1-B5 113 128 133 127 120 113 106 98 91 84 78 C. Tailored Tests C1. Combined contingent liabilities 113 117 114 109 104 98 91 85 79 74 69 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 40 40 40 40 40 40 40 40 40 40 40 PV of debt-to-exports ratio Baseline 375 351 301 268 248 232 225 211 203 193 186 A. Alternative Scenarios A1. Key variables at their historical averages in 2022-2032 2/ 375 396 396 415 448 488 551 604 672 737 810 0 375 345 300 271 252 237 229 214 204 190 179 B. Bound Tests B1. Real GDP growth 375 351 301 268 248 232 225 211 203 193 186 B2. Primary balance 375 356 310 277 257 241 233 220 212 201 194 B3. Exports 375 454 571 508 471 442 430 405 388 367 352 B4. Other flows 3/ 375 357 311 277 257 240 233 219 211 200 192 B5. Depreciation 375 351 295 263 243 227 220 207 199 189 183 B6. Combination of B1-B5 375 438 315 431 399 374 362 340 327 310 298 C. Tailored Tests C1. Combined contingent liabilities 375 367 317 284 263 246 239 225 217 207 200 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 180 180 180 180 180 180 180 180 180 180 180 Debt service-to-exports ratio Baseline 22 18 18 17 19 19 20 20 21 21 21 A. Alternative Scenarios A1. Key variables at their historical averages in 2022-2032 2/ 22 19 21 22 27 29 33 37 44 50 57 0 22 18 18 18 21 21 22 22 22 21 20 B. Bound Tests B1. Real GDP growth 22 18 18 17 19 19 20 20 21 21 21 B2. Primary balance 22 18 18 17 20 19 20 21 22 21 21 B3. Exports 22 22 30 30 34 33 35 36 40 39 39 B4. Other flows 3/ 22 18 18 17 20 19 20 21 22 21 21 B5. Depreciation 22 18 18 17 19 19 20 20 20 20 20 B6. Combination of B1-B5 22 21 28 27 30 30 32 33 34 33 33 C. Tailored Tests C1. Combined contingent liabilities 22 18 18 17 20 20 21 21 21 21 21 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 15 15 15 15 15 15 15 15 15 15 15 Debt service-to-revenue ratio Baseline 37 29 30 28 32 32 32 32 31 30 29 A. Alternative Scenarios A1. Key variables at their historical averages in 2022-2032 2/ 37 31 34 36 45 48 52 58 66 72 80 0 37 29 30 30 34 34 35 34 33 30 28 B. Bound Tests B1. Real GDP growth 37 31 36 34 39 38 38 38 37 36 34 B2. Primary balance 37 29 30 29 33 32 32 32 32 31 30 B3. Exports 37 30 31 31 35 34 34 35 37 35 34 B4. Other flows 3/ 37 29 30 29 33 32 32 32 32 31 30 B5. Depreciation 37 36 37 35 40 39 40 39 38 36 35 B6. Combination of B1-B5 37 32 36 34 38 38 38 39 38 36 35 C. Tailored Tests C1. Combined contingent liabilities 37 29 30 29 33 32 32 32 32 30 29 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 18 18 18 18 18 18 18 18 18 18 18 Sources: Country authorities; and staff estimates and projections. 1/ A bold value indicates a breach of the threshold. 2/ Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows. 3/ Includes official and private transfers and FDI. 15 >>> Table 4. Bhutan: Sensitivity Analysis for Key Indicators of Public Debt , 2022-2032 Projections 1/ 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 PV of Debt-to-GDP Ratio Baseline 121 119 114 107 101 95 89 83 77 72 67 A. Alternative Scenarios A1. Key variables at their historical averages in 2022-2032 2/ 121 117 114 110 106 103 100 96 94 91 88 0 #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A B. Bound Tests B1. Real GDP growth 121 129 140 135 132 128 124 119 116 112 109 B2. Primary balance 121 121 118 110 105 99 92 86 80 75 70 B3. Exports 121 124 129 121 115 109 102 95 88 82 76 B4. Other flows 3/ 121 121 117 110 104 99 92 86 80 74 69 B5. Depreciation 121 149 139 128 120 112 103 95 88 80 74 B6. Combination of B1-B5 121 119 118 111 105 99 93 87 81 75 70 C. Tailored Tests C1. Combined contingent liabilities 121 127 120 113 107 101 94 88 82 77 72 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. TOTAL public debt benchmark 55 55 55 55 55 55 55 55 55 55 55 PV of Debt-to-Revenue Ratio Baseline 421 495 434 381 358 338 315 295 275 255 239 A. Alternative Scenarios A1. Key variables at their historical averages in 2022-2032 2/ 421 486 431 386 371 359 347 338 327 316 307 0 46 39 42 40 45 47 47 47 47 48 47 B. Bound Tests B1. Real GDP growth 421 530 518 467 453 443 427 415 402 388 379 B2. Primary balance 421 504 449 395 371 351 327 307 286 265 249 B3. Exports 421 515 493 433 408 387 361 339 314 290 270 B4. Other flows 3/ 421 503 448 393 370 350 326 306 284 263 246 B5. Depreciation 421 626 538 465 430 401 369 343 315 289 266 B6. Combination of B1-B5 421 495 450 395 372 352 328 308 287 266 250 C. Tailored Tests C1. Combined contingent liabilities 421 526 459 403 379 359 334 314 293 273 256 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Debt Service-to-Revenue Ratio Baseline 46 39 42 34 35 35 35 34 34 34 32 A. Alternative Scenarios A1. Key variables at their historical averages in 2022-2032 2/ 46 39 43 35 37 38 38 37 37 38 37 0 46 39 42 40 45 47 47 47 47 48 47 B. Bound Tests B1. Real GDP growth 46 41 50 42 46 46 47 47 47 48 48 B2. Primary balance 46 39 44 37 37 36 36 35 35 35 34 B3. Exports 46 39 42 35 37 36 36 36 38 37 36 B4. Other flows 3/ 46 39 42 34 36 35 35 35 35 34 33 B5. Depreciation 46 41 48 41 44 43 44 43 43 42 41 B6. Combination of B1-B5 46 38 43 35 37 37 37 36 36 35 34 C. Tailored Tests C1. Combined contingent liabilities 46 39 48 38 37 36 36 35 35 34 33 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Sources: Country authorities; and staff estimates and projections. 1/ A bold value indicates a breach of the benchmark. 2/ Variables include real GDP growth, GDP deflator and primary deficit in percent of GDP. 3/ Includes official and private transfers and FDI. 16 >>> Gross Nominal PPG External Debt Debt-creating flows Unexpected Changes in Debt 1/ (in percent of GDP; DSA vintages) (percent of GDP) (past 5 years, percent of GDP) 100 140 Residual 80 proj. 120 Interquartile 50 60 range (25-75) Price and exchange rate 100 40 80 Real GDP 0 Change in PPG growth debt 3/ 60 20 Current DSA Nominal interest rate 40 Previous DSA -50 0 Median DSA-2016 Current 20 account + FDI -20 -100 Distribution across LICs 2/ 0 Change in 5-year 5-year 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Contribution of unexpected PPG debt 3/ historical projected -40 changes change change Public debt Gross Nominal Public Debt Debt-creating flows Unexpected Changes in Debt 1/ (in percent of GDP; DSA vintages) (percent of GDP) (past 5 years, percent of GDP) Residual 40 Current DSA Previous DSA proj. 100 DSA-2016 Interquartile 160 Other debt 20 80 range (25-75) creating flows 140 Real Exchange 60 120 rate 0 depreciation 100 40 Real GDP Change in debt 80 growth -20 20 60 Real interest rate -40 0 40 Primary deficit 20 -20 -60 Median 0 5-year 5-year Change in debt -40 Distribution across LICs 2/ 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Contribution of unexpected historical projected changes change change -60 1/ Difference between anticipated and actual contributions on debt ratios. 2/ Distribution across LICs for which LIC DSAs were produced. 3/ Given the relatively low private external debt for average low-income countries, a ppt change in PPG external debt should be largely explained by the drivers of the external debt dynamics equation. 17 >>> 18 >>> Figure 5. Bhutan: Qualification of the Moderate Category, 2022-2042 1/ PV of debt-to GDP ratio PV of debt-to-exports ratio 120 400 350 100 300 80 250 60 200 150 40 100 20 50 0 0 2022 2026 2030 2034 2038 2042 2022 2026 2030 2034 2038 2042 Debt service-to-exports ratio Debt service-to-revenue ratio 25 40 35 20 30 25 15 20 10 15 10 5 5 0 0 2022 2026 2030 2034 2038 2042 2022 2026 2030 2034 2038 2042 Some Substantial Threshold Baseline Limited space space space Sources: Country authorities; and staff estimates and projections. 1/ For the PV debt/GDP and PV debt/exports thresholds, x is 20 percent and y is 40 percent. For debt service/Exports and debt service/revenue thresholds, x is 12 percent and y is 35 percent. 19 >>>