Bhutan is witness to the ongoing economic crisis in Sri Lanka, which is a combination of excessive government spending via loans, decline in revenue and depleted reserves.
Nepal is also facing a crisis of depleting reserves and has restricted imports. Pakistan is looking for an IMF bailout.
India’s growth has slowed down for the third consecutive quarter, and it is hit by huge inflationary pressures and international uncertainties. Its Rupee or INR is at an all-time low against the dollar, also impacting the Ngultrum pegged to the INR.
Highest ever fiscal deficit
In middle of this comes the 2022-2023 Annual Budget Report presented by the Finance Minister, Namgay Tshering, which presents an eye popping and the highest ever fiscal deficit of Nu 22.882 billion (bn) which is 11.25 percent of GDP.
Fiscal deficit, simply put, is the amount of money not available in the budget due to a mismatch between the expenditure and the revenue. The total expenditure projected for 2022-23 is Nu 74.807 bn but the revenue projected is only Nu 51.925 bn.
This is higher than the previous record of 2021-2022 budget year, which is Nu 17.498 bn at 9.30 percent of GDP.
To get an idea the last ‘normal budget’ in 2019-2020, before the pandemic hit, the fiscal deficit was at 1.79 percent or just Nu 3.385 bn.
The 12th plan projection made during the first meet-the-press with the current government in January 2019, projected a fiscal deficit of Nu 29 bn for the entire plan at 2.4 percent fiscal deficit with the flexibility to keep it within 3 percent.
However, with the this being the last budget of the five-year-plan, the average fiscal deficit is at now 5.97 percent which double of any projection, and aim for the plan period.
The budget report explains the fiscal deficit as an economic fallout from the prolonged pandemic which required extensive policy responses, leaving a significant dent in the fiscal space.
It said sizeable stimulus packages and weak revenue collection have resulted in the deterioration of fiscal positions.
The next big question is how the government plans to fund such a large fiscal deficit.
Of the Nu 22,882 bn deficit, it will be financed through the net external concessional borrowing of Nu 270 million (mn) and net domestic borrowing of Nu 20.356 bn.
Domestic borrowing will essentially be done through Treasury Bills or T-Bills which are for short periods and some may be through longer term bonds.
These T-Bills are overwhelming bought by Financial Institutions primarily using their 20 percent Statutory Liquidity Ration (SLR) deposits they have to maintain with the RMA.
The problem for the government here is that in addition to the Nu 20.365 bn it has to raise through this mechanism for the new financial year, many T-Bills of Nu 14 bn of the previous budget are mostly maturing by August and September this year, which means it has to be paid back with interest to the banks. There is also a 3-year Nu 3 bn bond maturing in September 2023 apart from 10-year bonds of Nu 3.7 bn that will mature down the line.
With the revenue shortage, the government can renew its old bonds and issue new ones, but the problem is that this is building an enormous domestic debt that will pull in a lot of money from the banks.
It is fine as long as the SLR deposits are used as these cannot be loaned out, but once the banks dip into deposits then it could create a credit crunch for the private sector that wants to borrow from the banks.
The problem is also refinancing risks for this enormous debt.
The Public Debt Situation Report of the Finance Ministry for the quarter ending in March 2022 says though most of the T-Bill would be maturing within one year, the refinancing risks is low due to current liquidity glut with the banks, the main investors of T- Bills.
“However, in the medium term if the COVID-19 situation improves, and bank lending activities pick up, such high level of T-Bills could pose refinancing risks,” states the report.
Another issue is that all this domestic borrowing does not come free. In the 2022-23 financial year alone, the government will have to cough up Nu 683.71 mn in interest payments for these T-Bills and Bonds.
With the economy not set to improve anytime soon, this enormous domestic debt stock will be a huge burden for any incoming government after the 2023 general elections.
Under the ‘Risks and Challenges’ part of the annual budget report, it says “With increasing development activities, the need for financing is also on the rise. The economy has experienced an increasing level of fiscal deficit adding on to the Government’s fiscal burden. Given the narrow tax base, it continues to remain a challenge.”
The next matter of concern in the Annual Budget Report is the declining foreign currency reserves.
In the financial year 2020-21 there was enough reserves to fund 28 months of imports declining to 22 months in 2021-22 and then with further decline expected in 2022-23 at 17 months and 2023-24 at 16 months.
The Constitutional requirements is having enough reserves to fund 12 months of essential items imports.
The Budget report says, “Due to widening of the Current Account Balance, the gross reserve assets in the FY 2021-22 is estimated to deplete to US$1,328.024 mn from US$1,559.250 mn in previous FY. Of the total gross international reserves, Convertible Currency (CC) reserves estimate is US$1,157.408 mn and Indian Rupee (INR) reserve estimate is Rs. 13,076 (US$ 171.6) mn.”
In 2022-23, the reserves will decline further to Nu 1,298 mn.
The Budget says this declining trend is due to no new investments generating foreign exchange earnings.
“The recent trend indicates that there has been a significant increase in imports without much corresponding inflows, which could pose possible risks to the pegged exchange rate regime,” says the report.
Risks and Challenges
The Budget report has highlighted certain external and domestic risks and challenges in the 2022-23 financial year that can harm economic growth prospects.
On the external front it says against the already turbulent backdrop of global inflationary pressures following the COVID-19 pandemic, the on-going Russia-Ukraine conflict has further exacerbated supply chain disruptions, leading to spike in commodity and fuel prices.
It says these external factors are likely to affect manufacturing competitiveness and impact investment prospects.
“The combination of supply disruptions and trade shock will weigh on growth, result in a sharper rise in inflation, and a wider current account deficit. Widening of the current account deficit will put a strain on the economy’s overall foreign currency reserves and exchange rate stability,” says the report.
According to the budget report, Bhutan, being a strongly import-dependent economy with a pegged exchange rate regime, any depreciation of the Indian rupee versus the US dollar would raise the cost of imports from third countries as well as the expense of servicing convertible currency debt.
In terms of Domestic Risks, the report says risks still remain due to pandemic related uncertainties that could impede economic recovery measures.
It says although the vaccine roll outs have raised hopes of a turnaround in the pandemic, renewed waves and new variants of the virus pose risk for the outlook. The unpredictability of the COVID-19 outbreaks with prolonged mobility restrictions are among the concerns, which could hamper the growth trajectory and rebound in domestic consumer demand.
“The economy also faces the challenge of increasing imports without a corresponding increase in exports. The resumption in economic activities has resulted in a significant increase in imports, worsening trade balance and widening the current account deficit. As the inflows are limited to external grants, loans and hydropower receipts, meeting the balance of payment obligations is projected to place further strain on the foreign currency reserves,” says the report.
Other risks include hydropower projects delays and deterioration in revenue performance due to underperformance by corporations and business entities owing to lockdown, supply- chain disruption and rise in prices of fuel and essential commodities.
Surge in External Debt
According to the Budget report, external debt is expected to increase from Nu 229.202 bn on 30 June 2022 to Nu 239.814 bn by 30 June 2023, an increase of 4.6 percent.
The growth is mainly due to hydro loan disbursements, projected at Nu 11.737 bn for 2022-23.
The next is Nu 5.470 bn of budgetary loan disbursements from multilateral development banks and JICA. Of this Nu 2.800 bn is program borrowings from the ADB and Nu 2.670 bn project-tied borrowings. The entire program borrowings are for financing the government’s budgetary activities, whereas Nu 1.278 bn of the project-tied borrowings are for on- lending to SOEs.
The external debt-to-GDP is projected to reach 117.9 percent in FY 2022-23 and steep jump in following FY 2023-24 hitting at 129.1 percent.
The projected hike in 2023-24 is mainly contributed by the capitalization of interest during construction (IDC) of Punatsangchu-II estimated at Nu 42.333 bn with the expected commissioning in June 2023. Besides, the projected loan disbursement for on-going hydroelectric projects – Kholongchu and Punatsangchu-I will also contribute to the increase in the external debt stocks and debt indicators.
However, the external debt-to-GDP ratio is expected to fall sharply from 2024- 25 with the start of repayment of Punatsangchu-II and simultaneous increase in estimated GDP.