How private consumption and credit caused the Rupee Crisis

The Bhutanese had earlier highlighted the role played by the vehicle and fuel imports, government expenditure and Royal Monetary Authority’s reserve management, and the balance of trade as some of the causes of the rupee crisis.

The bulk of the report, however, focuses on private consumption and credit growth as the main causes of the rupee crisis.


Credit expansion

The report says that an alarming trend in recent years has been the phenomenal surge in credit expansion by the financial institutions.

As of December 2011, the total credit of the financial institutions increased from a total of Nu. 36bn in 2010 to Nu. 47.5bn which means a 32% increase. Similarly, in 2009/10, the credit had grown from Nu. 26bn to Nu. 36 bn. Thus, in two years, there was an increase of Nu. 21.5 bn in the overall credit of the financial institutions.

It says that in 2009-10, the BDBL started deposit operations and two new banks T Bank & Druk PNB and a new insurance company BIL were established increasing credit growth.

Estimating that 75% of the incremental credit is used for imports from India, the report says that the rupee requirement for last two years would be about Nu. 16 bn.

Of the overall credit portfolio of the financial institutions, 25.3% was allocated to the building and construction sector, followed by manufacturing sector at 17.5%; others include personal loans at 19.4%, and trade and commerce at 14.3%.

It says that high domestic credit growth has been influenced by factors such as speculation in land prices, emergence of new banks, limited alternative investment opportunities, secure and good returns on housing finance, rising cost of construction, favorable and comfortable loan repayment periods, etc.

The report points out that the share of banks’ credit to the private sector grew from 72% in 2002 to 96% in 2011. The balance credit came from the non-bank financial institutions such as pension fund and insurance companies which are also actively engaged in lending.

One of the reasons cited by the report for the credit growth in the private sector has also been due to heavy consortium financing of large projects such as Tashi InfoComm, Druk Ferro Alloys, Druk Deothjung Resorts, Bhutan Concast, Drukwang Fello Alloys, and several others.

The report also says that State Owned Enterprises (SOEs) such as Dungsam Cement Corporation Limited with loans of Nu. 2.1bn, Dagachu Hydroelectric Project Corporation with equity of Nu.1.738 bn and loan of Nu. 500mn loan and DHI Infra with an equity Nu. 200mn from DGPC’s reserve fund have all resorted to local financing in the last two years. It says that such financing of SOEs have contributed to the domestic credit growth and impacted on the

While nominal GDP growth has been on an average of 13.6% from Financial Year (FY) 2002-03 to FY 2010-11, the average credit growth was 27.4% for the same period. This, the report says, is an indication of aggressive lending.

Since FY 2006/07, the credit growth was higher than GDP growth. It says that is not sustainable, especially since the growth in credit expansion is taking place at a rate twice the growth of the economy itself.

According to the rating agency FITCH, when bank lending grows faster than the GDP over a certain period, it is a signal for the central bank to tighten monetary policy. This is an important lesson learnt from the financial meltdown that led to the collapse of banks in the US says the report.

The report points out that as and when credit growth peaked, the RMA resorted to sale of convertible currency to meet rupee shortages in FY 2004/05, FY 2007/08 and FY 2011/12.

The report says that local currency credit extended by financial institutions to the public and private sector translates into imports from India leading to rupee debt. It says that published statistics on external debt for Bhutan do not incorporate this. This explains the transmission of credit growth to the current rupee shortfall problem (via currency and liquidity mismatch) says the report. This also strengthens the case for RMA to actively monitor the credit expansion in the financial system to avoid any adverse repercussions.

RMA’s moves to restrict credit by increasing the reserve requirements which are  the highest in the SAARC region especially the Cash Reserve Ratio  has had a limited impact on the overall growth of the financial institution’s credit. The report says that there is room for further intervention in the area for prudential regulations and enforcement to discourage credit to highly exposed sectors.



In order to facilitate timely implementation of budgeted activities, pre-financing is provided to finance donor funded activities and recouped only upon receipt of donor funds. As of 27 February 2012, pre-financing of Nu.1.5 billion for GoI funded activities under SDP and other projects has been provided. Such pre-financing impacts the Rupee reserve due to non-receipt of funds on time and adds to the demand for Rupee as more than 60% of pre-financing would lead to imports from India.


Imports for hydropower projects

The report says that Imports related to hydropower development increased from Nu. 640mn in 2007/08 to Nu. 12.37bn in 2010/11. This is expected to increase substantially with the start of more projects. The report says there is no direct impact on rupee reserves as all expenses related to hydropower development are financed through grants and loans from India.

The report, however, says that the development of the hydropower sector has contributed significantly to imports especially relating to heavy transport vehicles Historically, finance in the heavy transport sector picked up with the start of the construction of mega hydropower projects prior to 2004 (Tala, Basochhu, and Kurichhu projects) and after 2009 with the start of the Puna-I hydropower project.

The investment in hydropower development through the multiplier effect has also led to strong growth in other sectors such as construction, manufacturing, trade and commerce. It says that the initial establishment and growth of other auxiliary noncore hydropower sectors around the development of hydropower projects, including trade and commerce which are mostly import driven are not financed through hydropower flows and exert demand on Rupee for import related payments.


Import of fuel and vehicles

The total value of vehicle import from India in terms of Rupee outflow within the span of ten years (2002-2011) in terms of vehicle import was Nu 7.90 billion, whereas, the outflow of dollars for import of vehicles from third countries was US$ 110mn. The high volume of vehicle imports from India was driven by easy access to credit and lower tax.

The import of fuel (petrol and diesel) increased from 42.76 million liters at Rs 720.89 million in 2002 to 111 million liters at Rs 4.25 billion in 2011.


Import of food and other items

Imports of food and some other items have been one of the major items. These imports according to the report have had a substantial drain on the Rupee reserve.

In 2010 these imports are Nu 1.1bn for meat and animal products, Nu 898mn for charcoal, Nu 846 mn for rice, Nu 710mn for wood charcoal, Nu 676mn for vegetables and fruits, Nu 506mn for paper products, Nu 314mn for beer, Nu 304 mn for textiles and clothing, Nu 276mn for furniture and Nu 158 mn for wood products.


Private education expenses

As per the Department of Adult and Higher Education, the number of students studying under private financing excluding post graduate students in India had increased from 2,057 in 2006 to 3,475 in 2011 but the actual numbers could be much more as many private students do not register. The educational expenses of Bhutanese students studying under self financing were estimated about Rs 352mn in 2006 and increased to about Rs 600mn in 2011. Some estimates put the figure as high as Rs 1bn as the actual spending could be more.


Medical expenses

The medical expenses of Bhutanese patients in India also lead to Rupee outflows. With increasing number of patients being referred to India over the years, the medical expenses have almost doubled to Nu. 121.35 million in FY 2010/11 as compared to FY 2003/04.


Pilgrimage expenses

As per the NSB, the number of travelers to India by air increased from 14,616 in 2005 to 20,318 in 2009, and the corresponding expenditure increased from about Rs 292mn to Rs 406mn. However, the actual spending could be much more as there is no requirement for Bhutanese travelers to India to register with the DoI.


Remittances by Indian workers in Bhutan

According to the Ministry of Labor and Human Resources, there are 51,616 Indian laborers in Bhutan as of end of February 2012. Annual remittance by this group of workers is estimated to be about Rs 256mn, which causes Rupee outflows.


Exports to India

The total exports to India increased from Nu. 2.8bn in 2002 to Nu. 25bn in 2011. Between 2002 and 2011, the total exports to India averaged about 32% of GDP. The growth rate of export has been much lower than the nominal GDP growth rate. During 2010, export to India grew at the rate of 15.90% while the nominal GDP growth rate was 18.38%.


Erratic inflows

The report says that the inflows for budgetary support and hydro power grants and loans have been erratic as the maximum outflows are incurring in the beginning of every year for debt servicing. It says that the average time lag between inflows and outflows ranges between four to six months. This mismatch in inflow and outflow rupee creates shortage in some quarters of the year.


Increase in disposable income and consumption

The report says that overall, gross national disposable income has been constantly increasing over the years. On an average, gross disposable income grew by 13.5% in the 9FYP and 12.8% in the 10FYP. Increase in disposable income causes consumption to rise. During the 9FYP, the average total consumption was 60% of gross disposable income (GDI) and rose to about 63 % of GDI in the 10FYP.

In the 9FYP, average private consumption which includes hydro-power projects was about 39% of GDP while government consumption was about 21% of GDP. By the end of the 10FYP, average private consumption is expected to reach 41% of GDP.


High investment

In the 9FYP, the average investment was about 50% of GDP and consists of expenditures on new plant, equipment, new construction, etc. The average investment rose to 52% of GDP in the 10FYP. On an average, private investment was more than 39% and the government investment was about 11% of GDP in the 9FYP. The average private investment slightly rose to 41% while average government investment was contained at 11% of GDP in the past three years of 10 FYP. The trends of high private investment were facilitated by lower domestic lending rates.

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