september 2017 Investment Climate Assessment of Bhutan Removing Constraints to Private Sector Development to Enable the Creation of More and Better Jobs MASSIMILIANO SANTINI TRANG THU TRAN ANDREW BEATH SEPTEMBER 2017 Investment Climate Assessment of Bhutan Removing Constraints to Private Sector Development To Enable the Creation of More and Better Jobs ©2017 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); Inter- national Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non-commercial purposes. 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All photos courtesy of © Olivier Jammes (olivierjammes.com) Contents Acknowledgments and Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Objective and Data Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . viii Structure of Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . viii Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Economic Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Constraints to Private-Sector Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Chapter 1: Economic Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Macroeconomic Profile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.2.1  Growth and Poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 1.2.2 Sectoral Structure and Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.2.3 External Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1.2.4 State-Owned Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1.3 Enterprise Sector Profile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1.3.1  Firm Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1.3.2 Dynamics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1.3.3  Labor Productivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1.3.4 Export Orientation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 1.4 Profiles of Key Sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 1.4.1 Hydropower . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 1.4.2 Tourism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 1.4.3 Information and Communications Technology . . . . . . . . . . . . . . . . . . . . . 16 1.4.4 Agribusiness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Chapter 2: Constraints on Private-Sector Development . . . . . . . . . .21 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 2.2 Access to Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 2.2.1 Severity of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 2.2.2 Sources of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 2.3 Access to Skills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 2.3.1 Severity of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 2.3.2 Sources of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 2.4 Access to External Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 2.4.1 Severity of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 2.4.2 Sources of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 iii 2.5 Market Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 2.5.1 Severity of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 2.5.2 Sources of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 2.6 Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 2.6.1 Severity of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 2.6.2 Sources of Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Chapter 3: The Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 3.2 Crosscutting Reform Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42 3.2.1  Access to Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 3.2.2  Access to Skilled Labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 3.2.3  Access to External Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 3.2.4 Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 3.2.5 Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 3.3 Sector-Specific Reform Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . 55 3.3.1 Tourism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 3.3.2 Information and Communications Technology . . . . . . . . . . . . . . . . . . . . . 57 3.3.3 Agribusiness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 3.3.4 Hydropower . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Chapter 4: Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Annex 1: The Enterprise Survey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Annex 2: Bhutan Licensing Regimes and Estimated Size of Private Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 2.1 Estimated Size of the Enterprise Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 2.2 Extent of Informality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Annex 3: Additional Tables and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 3.1 Measures of Labor Productivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 3.2 Price Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 3.3 Determinants of Labor Productivity and Employment Growth . . . . . . . . . 84 3.4 Physical and Human Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 3.5 Labor Regulations and Perception on Labor Constraints in Bhutan . . . . . 88 3.6 Main Corporate and Business Taxes Bhutan . . . . . . . . . . . . . . . . . . . . . . . . . . 89 Tables Table 1: Priority Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xii Table 2: Changes in Employment Composition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Table 3: Share of New and Young Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Table 4: Growth of Firms, 2012–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Table 5: Firm’s Linkages to External Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Table 6: Average Firm Performance, by Export Status . . . . . . . . . . . . . . . . . . . . . 12 Table 7: Major Hydroelectric Projects in Bhutan . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Table 8: Agricultural Products in Bhutan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Table 9:  Comparison of Bhutan’s Financial Sector Indicators with Those of Peer Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Table 10: Access to Finance in Bhutan (WBES 2015) . . . . . . . . . . . . . . . . . . . . . . . . 28 Table 11: Summary of Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 Table 12: Bhutan ES Sample Frame . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 Table 13: ES Achieved Sample . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Table 14: Business Registration Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Table 15: Share of Informal Firms in Bhutan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 iv Investment Climate Assessment of Bhutan Table 16: Median Labor Productivity (value added per full-time worker) by Industry in Bhutan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 Table 17: Determinants of Labor Productivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 Table 18: Determinants of Employment Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 Table 19: Drivers of Expansion Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 Table 20: Quality and Investments in Physical and Human Capital . . . . . . . . . . . 87 Table 21: Labor Regulations in Bhutan and South Asia . . . . . . . . . . . . . . . . . . . . . . 88 Table 22: Firm’s Perception of Different Labor Constraints . . . . . . . . . . . . . . . . . . 88 Table 23: Main Corporate and Business Taxes in Bhutan . . . . . . . . . . . . . . . . . . . . 89 Figures Figure 1: Sectoral Composition of Bhutan’s Economy . . . . . . . . . . . . . . . . . . . . . . . 3 Figure 2: Share of Nonagricultural Private Employment . . . . . . . . . . . . . . . . . . . . . 4 Figure 3: Export Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Figure 4: Foreign Direct Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Figure 5: Government-Linked Companies with DHI Equity . . . . . . . . . . . . . . . . . . . 7 Figure 6: Characteristics of Private-Sector Firms . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Figure 7: Size and Sectoral Distribution of Firms of Small Geographically Isolated Economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Figure 8: Business Entry and Employment Growth . . . . . . . . . . . . . . . . . . . . . . . . . 10 Figure 9: Labor Productivity (value added per worker) . . . . . . . . . . . . . . . . . . . . . . . 11 Figure 10: Median Labor Productivity by Sector (value added per worker) . . . . . . 11 Figure 11: Bhutan’s Agricultural Exports, 2011–14 . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Figure 12: Business Environment and Competitiveness Ranking . . . . . . . . . . . . . 22 Figure 13: Perception of Investment Climate Constraints, 2009 and 2015 . . . . 23 Figure 14: Aggregate Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Figure 15: Share of Firms Indicating Access to Finance Is Biggest Obstacle . . . 25 Figure 16: Financing Needs and Financial Access by Firm Size . . . . . . . . . . . . . . . 26 Figure 17: Lending Interest Rate and Interest Spread . . . . . . . . . . . . . . . . . . . . . . . 27 Figure 18: Demand-Side Factors Inhibiting Access to Finance . . . . . . . . . . . . . . . . 29 Figure 19: Share of Firms Citing Labor Regulations as Biggest Obstacle . . . . . . 30 Figure 20: Relative Cost and Productivity of Labor . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Figure 21: Competition for Labor with Public Sector . . . . . . . . . . . . . . . . . . . . . . . . 32 Figure 22: Share of Firms Citing Customs and Trade Regulations or Transport as Biggest Obstacle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 23: Logistic Performance Index 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Figure 24: Time and Cost to Import and Export . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Figure 25: Tax Rates and Tax Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Figure 26: Number of BIT Firms by Status in DRC Tax Database, 2016 . . . . . . . . 79 Figure 27: Correlation of Income and Labor Productivity . . . . . . . . . . . . . . . . . . . . 81 Figure 28: Price Levels Relative to 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Figure 29: Producer Price Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Investment Climate Assessment of Bhutan v Acknowledgments and Notes Objective and Data Sources This report was prepared upon the request of the Ministry of Economic Affairs (MoEA), Royal Government of Bhutan (RGoB), and represents Bhu- tan’s third Investment Climate Assessment (ICA), building on previous assess- ments in 2002 and 2010. The analysis draws primarily on the 2015 World Bank Enterprise Survey, complemented by other quantitative and qualita- tive information.1 The report aims to provide a detailed assessment of firm performance and constraints as they enter, operate, and exit domestic and international markets. The report provides policy recommendations that will support Bhutan to achieve an investment climate conducive to private sector growth and the creation of the productive and gainful employment envisaged by Bhutan’s 12th Five-Year Plan. Acknowledgments The 2015 Enterprise Survey and this report have been developed in conjunc- tion with the Royal Government of Bhutan. The 2015 Enterprise Surveys was enumerated by the National Statistics Bureau (NSB), using a sampling frame and sample constructed with help from MoEA and its Regional Trade and Industry Offices. MoEA provided overall direction for the analysis and recommendations of the report. Massimiliano Santini supervised the preparation of the report and led the policy dialogue around it. The research and writing was carried out by Trang Thu Tran and Andrew Beath, with substantial contributions from Sanjay Kathuria, Viridiana Rios, Siddharth Sharma, and Thomas Yates. Support for 1. See Annex 1 for a description of the sampling methodology of the Enterprise Survey. Other information includes data on macroeconomic indicators, including GDP, trade flows, price levels, and interest rates; data on regulatory and institutional quality as provided by the World Economic Forum Competitiveness ranking and the Doing Business reports; micro-level data on the country’s labor force’s characteristics; and other WBG studies at the sector levels on growth prospects and constraints in agribusiness, tourism, and characteristics of the labor market and financial sector. vii data analysis was received from Jialiang Zhu. The report received inputs from Stefania Abakerli, Wafa Aranki, Om Notes Bhandari, Christian Eigen-Zucchi, Tanvir Hossain, Kuk To benchmark the performance and constraints of firms Hwan Jeong, Sebastian James, Charles Kunaka, Yoichiro in Bhutan, this report employs comparisons with peer Ishihara, Esperanza Lasagabaster, Tenzin Lhaden, Elaine countries. In addition to neighboring countries such as MacEachern, Sumit Manchanda, Antonia Preciosa India and Nepal and the South Asia region generally, Menezes, Sabin Raj Shrestha, and Susanne Wendt. The comparisons are made with countries outside of the report gratefully acknowledges the comments and advice region including Botswana, Mauritius, Costa Rica, Leso- provided by reviewers Andrea Goldstein, Jean Michel tho, and Lao People’s Democratic Republic. These coun- Marchat, and Gaurav Nayyar. Arvind Jain and Jorge Luis tries were selected due to their similarities with Bhutan in Rodriguez Meza managed the 2015 Enterprise Survey terms of the quality of institutions, remoteness, strength during the set-up and enumeration period, provided sup- of trade links with a large neighboring country, large port to NSB, and finalized the dataset. Thanks to Susan natural resource sector, and/or a large tourism sector. Boulanger for copyediting and Shepherd Inc. for the As Enterprise Survey data rarely includes data on micro design. firms for peer countries, comparisons made between Bhutanese businesses in 2009 and 2015 or between Bhu- Analysis and recommendations pertaining to access to tan and other countries exclude micro firms. finance, labor policy, and the agribusiness sector have been drawn, respectively, from the Financial Sector Structure of Report Development Action Plan (Murgatroyd et al. 2016), Bhu- The report is divided into four chapters: tan’s labor market assessment (World Bank, Ministry of Labor and Human Resources, RGoB, 2016), and Bhu- Chapter 1: describes the structure, dynamics, and tan’s agribusiness sector assessment (World Bank 2017a). performance of Bhutan’s macroeconomy, private sector, and leading industries. The World Bank Group (WBG) team would like to thank the following for their inputs and insightful exchanges Chapter 2: uses data from the Enterprise Survey and during the field visits and phone interviews: Bhutan Stan- other qualitative and quantitative sources to analyze dards Bureau, NSB, Ministry of Finance’s Department the constraints that inhibit increases in private sector of Revenue and Custom, MoEA’s Policy and Planning investments and productivity in Bhutan. Division, MoEA’s Industry Department (including the FDI office), MoEA’s Cottage and Small Industry Depart- Chapter 3: presents crosscutting and sector-specific ment, Bank of Bhutan, Bhutan National Bank, Bhutan policy recommendations designed to alleviate constraints Development Bank, Bhutan Chamber of Commerce, impeding the development of the private sector in the management team and tenant companies at Thim- Bhutan. phu Techpark, private-sector companies, and govern- ment officials participating in the July 2016 workshop Chapter 4: presents the study conclusions. and roundtable discussion in Thimphu and subsequent phone interviews. Lastly, the team would like to thank the World Bank Group Bhutan country office for all the sup- port provided. viii Investment Climate Assessment of Bhutan Executive Summary Economic Structure The development of the hydropower sector has fueled rapid growth and poverty reduction in Bhutan, although the stagnancy of the pri- vate sector hinders the creation of productive employment. Between 2000 and 2015, Bhutan’s gross domestic product (GDP) per capita more than doubled to US$2,500 and the incidence of poverty fell to just two percent. Beyond the booming hydropower sector, however, major sectors of Bhutan’s economy are stagnant. The growth of private-sector firms—particularly in manufacturing and services—is stunted by Bhutan’s small domestic market, high trade costs, and investment climate imperfections. Large private-sector firms are rare; only two percent of firms hold limited liability company (LLCs) status, and only two percent of firms attract foreign ownership. The lack of dynamism in the private sector limits the access of Bhutan’s population to productive employment, with the public sector and agriculture collectively accounting for 76 percent of jobs (Bhutan, MoLHR 2015c). By tapping markets for tradable services, Bhutan can leverage its institutional assets to attract investment and increase productiv- ity. The rapid growth of markets for tradable services—such as tourism and information and communication technologies (ICT)—provide Bhutan with an opportunity to develop high-value niche industries that are unconstrained by the geographical barriers that have historically inhibited the ability of local firms to grow and to provide stable, well paying jobs. While tourism is already providing Bhutan with substantial foreign exchange earnings, the economic impacts of the sector can be enhanced and broadened by better attuning policy to the changing technologies and preferences of the market. In com- parison to tourism, Bhutan’s ICT industry is fledgling. However, the country’s special characteristics—good governance, low corruption, civil and political stability, an English-speaking workforce, and cheap and reliable electricity— present investors in the sector with an attractive value proposition. Properly nurtured, the ICT sector can emerge as a valuable driver of both high-value exports and high-wage employment for recent graduates. ix By developing niche premium products that draw frequently cited access to finance as the constraint that on Bhutan’s unique international reputation, the most inhibited firm growth. Limits on access to finance agribusiness and manufacturing sectors can ben- stem from factors discouraging borrowing, as well as efit a broad section of the population. Bhutan’s agri- those discouraging lending. Lenders, on the one hand, business and manufacturing firms exhibit low levels of are discouraged by a lack of credit information and by productivity due to a lack of innovation, underuse of a complex, unpredictable, and ineffective restructuring quality certification, a reliance on foreign intermediaries, and insolvency regime. Borrowers, on the other hand, are limited investment, and high transportation costs. How- discouraged by the high prices, poor quality, and limited ever, by developing niche products and better leveraging availability of financial services; by constraints on the the country’s unique reputation—borne of the govern- types of productive assets that can be collateralized; and ment’s commitment to preserving the country’s unique by low financial literacy. culture and environment—to exact a premium in high- value external markets and attract foreign investment, A limited supply of skilled labor constrains the Bhutan can increase the productivity of its cottage indus- development of high value-added products. After tries and commercial agriculture. Given the extent to access to finance, labor was the second most frequently which such sectors are a major source of employment for cited constraint in the 2015 WBES, a complaint likely the rural populations, the development of these sectors triggered by the limited access of firms to skilled labor. offers the potential to deliver broad-based benefits to the Due to Bhutan’s historically low levels of education, the population. domestic supply of skills—such as auditing, accounting, and information technology—is limited. Moreover, gen- Constraints to Private- erous public sector compensation packages discourage recent graduates from seeking private-sector jobs. Given Sector Development its proximity to the skilled workforce of northeast India The ability of Bhutanese firms to develop high- and its favorable quality of life, Bhutan could potentially value services and products, however, is con- address its skills shortage by attracting expatriate work- strained by imperfections in factor markets and ers. However, current caps on foreign workers and the limited access to product markets. While recent inconsistent application of labor regulations cause skilled reforms have improved Bhutan’s investment climate, migrants to be crowded out by unskilled construction much work remains to be done to enable the private workers. sector to fully exploit available opportunities in trade- able services and in markets for high-value premium Transport and logistical deficiencies and limited products. Limited access to key factors of production—­ foreign investment curtail the access of Bhutanese particularly finance and skilled labor—undermine the firms to external markets. While relatively few firms ability of small and large firms alike to increase pro- rank access to external markets as a primary obstacle, ductivity and grow. The access of firms to domestic and data from Doing Business and the Logistics Performance international markets is further limited by deficiencies Index suggest that exports are constrained by the high in transport, logistics, customs producers, marketing, costs of accessing external markets. While Bhutan’s road and competition policy. network and custom procedures have recently improved, transportation costs are exacerbated by insufficient capac- Limited access to finance—caused by both supply ity at Phuentsholing port, poor domestic connectivity, and demand-side factors—constrains the growth of and cumbersome logistics. A lack of awareness among small firms. In 2015, the World Bank’s Enterprise Sur- firms of standards and certification, insufficient access to vey (WBES) conducted detailed interviews with managers trade finance facilities, poor contract management, and of 367 nonagricultural firms in Bhutan. Managers—­ deficient knowledge of external markets also limits mar- particularly of micro- and small enterprises—most ket access. Flows of foreign investment are suppressed x Investment Climate Assessment of Bhutan by regulatory barriers, skill shortages, and insufficient occupations. Over the medium term, the RGoB should investment promotion, which further restricts the access address the discrepancy in compensation packages that of domestic firms to foreign markets and technologies. causes graduates to prefer employment in the public sector. The state’s dominant role in the economy has nar- rowed the space for the private sector to mature, Better marketing, more efficient border man- while the current public procurement system is agement, enhanced transportation and logistical insufficient to promote firm development. The state infrastructure, and increased foreign investment has played an important role in modernizing Bhutan by can improve access to external markets. The providing essential public goods and enabling the achieve- enhancement of firms’ marketing capabilities, creation of ment of economies of scale in certain sectors. However, e-commerce initiatives and online platforms to match the large size of some state-owned enterprises and the firms with export partners, and greater awareness of qual- extent to which affiliates of such enterprises enjoy access ity standards and certifications will enable firms to reach to policy makers potentially discourages private invest- higher value export markets. The adoption of a risk-based ments and thereby limits competition. Several enterprises border clearance regime, coordination of customs proce- also complain that regulations are applied subjectively dures, and support for the domestic transportation and and without consistency. While Bhutan’s public procure- logistics sectors can also help reduce export costs, while ment framework performs well by international stan- the development of sector-specific investment promo- dards, it could also do more to promote the development tion strategies can help increase inflows of productivity- of firm capabilities and thereby support the development enhancing foreign direct investment (FDI). Finally, by rein- of the private sector. forcing the “Brand Bhutan” strategy, the RGoB can assist firms in realizing a premium for their products. Recommendations The competitive environment for firms can be Improving the capacity of firms to grow requires fur- enhanced by rationalizing the role of state-owned ther reforms to increase the supply of and demand enterprises, establishing mechanisms for public- for financial products. Bhutan has recently undertaken private dialogue, and revising public procurement reforms to increase access to finance, including establish- procedures. The role of state-owned enterprises and ing a credit information bureau, three new commercial the close relationship between DHI and policy makers banks, and a minimum reference rate for lending. How- potentially discourage private investment. To ensure that ever, further measures are needed. By broadening and the development of the private sector is not being artifi- deepening the credit information system, reforming the cially stymied, the role of state-owned enterprises should restructuring and insolvency regime, and adjusting reg- be reviewed and, in cases where a rationale for contin- ulations to increase financial competition, the RGoB can ued public ownership is lacking, options for divestiture increase the supply of finance. By expanding the scope of explored. Platforms for private-public policy dialogue asset registries and bolstering financial literacy, the RGoB should also be established to ensure that the private sec- can increase demand for financial products. tor has appropriate access to policy makers. The RGoB should introduce a new competition law and revise public To enable the growth of high-value products and procurement procedures to help build the capabilities of high-tech industries, the private sector must have private-sector firms. access to a greater supply of skilled workers. To relax the constraint that skills shortages place on firms Addressing sector-specific constraints through over the short term, the RGoB should develop chan- targeted reforms will facilitate the growth of high nels for skilled migration while also providing vocational potential industries. The performance of the hydro- training to prepare the adult population for higher skilled power, tourism, ICT, and agribusiness sectors will strongly Investment Climate Assessment of Bhutan xi impact the diversification of employment and exports, as high-value niche agribusiness exports can be encouraged well as growth in household incomes. To realize the poten- by reforming the existing subsidy regime; implementing tial of the tourism sector, it is important to update policies the Brand Bhutan strategy; and encouraging investments to reflect the evolution of tourist flows, preferences, and in storage and logistics. Finally, to maximize the benefits technologies. To realize the promise of Bhutan’s nascent of hydropower generation for the rest of the economy, ICT sector, it is important to address factors that unnec- mechanisms should be explored to increasingly engage essarily exacerbate investment risks. The development of local firms and workers in project construction. Table 1: Priority Policy Recommendations Policy Area Recommendations Timeline Crosscutting Recommendations Access to Expand scope of collateralizable assets. Short Finance Deepen and broaden credit information. Approve and implement new insolvency bill. Medium Reduce risks of e-banking for customers. Access to Introduce dedicated channel for skilled migration. Short Labor Provide vocational training to adult labor force. Realign public compensation packages with private sector. Medium Access to Promote use of e-commerce platforms. Markets Increase awareness and use of quality standards and certifications. Short Develop and implement investment promotion strategy. Introduce risk-based border inspections and coordinate border procedures. Medium Competition Create a public-private dialogue platform to provide equal access to policy feedback. Short Monitor anticompetitive practices and effect of state-owned enterprises on private investment. Taxation Increase awareness of taxation policy and accounting standards. Short Sector-Specific Recommendations Tourism Build capacity of three-star accommodation and restaurant providers. Short Support development of programs to geographically and temporally diversify flows. ICT Develop sector-specific high-skilled migration channel. Upgrade skills of existing and prospective ICT workers. Short Develop and implement sector-specific investment promotion strategy Upgrade Internet infrastructure Medium Agribusiness Develop regulations, oversight roles, and communication strategy for Brand Bhutan. Short Promote storage and logistics investments to facilitate exports of high-value products. Medium Reform subsidies and interventions to optimize incentives for private investment. Hydropower Commission study of involvement of local firms/workers in hydropower projects. Short Increase capacity of local firms/workers to participate in hydropower projects. Ensure that hydropower agreements include appropriate provisions to facilitate contracting of Medium Bhutanese firms and employment of Bhutanese workers. xii Investment Climate Assessment of Bhutan Acronyms ACC Anti-Corruption Commission IFC International Finance Corporation ADB Asian Development Bank IFRS  International Financial Reporting BBIN MVA Bangladesh, Bhutan, India, and Nepal Standards Motor Vehicles Agreement ISP Internet service provider BCAA Bhutan Civil Aviation Authority LCU local currency unit BDBL Bhutan Development Bank Ltd. LLC limited liability company BEA Bhutan Exporters Association MDPP minimum daily package policy BICMA  Bhutan Information, Communications and PPP public-private partnership Media Act 2006 m&e monitoring and evaluation BIT Business Income Tax MA-OTRI Market Access Overall Trade Restrictive- BNB Bhutan National Bank ness Index BoB Bank of Bhutan MFI microfinance institution BOiC  Business Opportunity and Information MFN most favored nation Centre MIPA  Movable Property and Immovable Prop- BPO business process outsourcing erty Security Act CIB Credit Information Bureau MoEA Ministry of Economic Affairs CIT Corporate Income Tax MoF Ministry of Finance CRST Central Registry for Secured Transactions MoIC  Ministry of Information and CSI cottage and small industry Communications CSO Civil Society Organizations Act MoLHR Ministry of Labour and Human Resources DHI Druk Holding and Investments Ltd. MoWHS Ministry of Works and Human Settlement DIT Department of IT and Telecom NSB National Statistics Bureau DOAT Department of Air Transport OECD  Organisation for Economic Co-operation DRC  Department of Revenue and Customs, and Development Bhutan PEMS Public Expenditure Management System EDP Entrepreneurship Development Program RAA Royal Audit Authority FDI foreign direct investment RAMIS  Revenue Administration Management GDP gross domestic product Information System GLC government-linked company REDCL  Rural Enterprise Development Corpora- GNH Gross National Happiness tion Limited ICA Investment Climate Assessment RGoB Royal Government of Bhutan ICT  information and communications RKC Revised Kyoto Convention technology RMA Royal Monetary Authority xiii RRCO Regional Revenue and Customs Offices TDS tax deducted at source RTIO Regional Trade and Industry Offices TPN Taxpayer Number SAARC  South Asian Association for Regional UNCTAD United Nations Conference on Trade and Cooperation Development SANDRP South Asia Network on Dams, Rivers and WBES World Bank Enterprise Survey People WBG World Bank Group SOE state-owned enterprise WCO World Customs Organization TFP total factor productivity WEF World Economic Forum TCB Tourist Council of Bhutan xiv Investment Climate Assessment of Bhutan Chapter 1 Economic Overview Summary Bhutan has experienced rapid economic growth and poverty reduction over the past two decades. However, despite ongoing structural transformation, employ- ment remains dominated by agriculture and the public sector, with minimal job creation in manufacturing and construction. Private-sector firms are overwhelm- ingly small and struggle to attract investment and access international markets without assistance from intermediaries. Bhutan’s large companies are generally state-owned enterprises overseen by Druk Holdings and Investments (DHI), sev- eral of which compete against private-sector firms. Due to the small size of the domestic market and the high cost of transporting goods across the country’s borders, Bhutan’s prospects for economic development will rely on its ability to export services and premium products. Booms in hydropower exports and tourism have driven recent increases in economic growth, but both sectors are facing challenges in attaining their potential to stimulate the broader economy in an inclusive and sustainable manner. The country’s nascent ICT sector is a potential source of high-value service exports, but it faces growing pains that are discouraging further investments. The agribusiness sector is beginning to export several high-value niche products, but is inhibited by a lack of supportive infrastructure. 1.1 Introduction Bhutan’s natural endowments constrain economies of scale and gains from trade, but also have provided the basis for the development of hydropower and tourism. The small size of Bhutan’s population and land area, its landlocked geography, and its mountainous topography present deep constraints that inhibit the exploitation of two of the most fundamental sources of economic development: economies of scale and gains from mer- chandise trade. Bhutan’s history of isolation—borne of the country’s geogra- phy and topography—has also inhibited the incorporation of local producers into global value chains and resulted in minimal flows of foreign investment. However, natural endowments have also provided Bhutan with substantial wealth in hydropower generation and the ability to export surplus electric- ity to India. Bhutan’s topography, cultural assets, and historical isolation also make it a coveted destination for international tourists. 1 Bhutan’s unique institutions present both com- Opportunities provided by the booms in hydropower plications and opportunities for private-sector and tourism have stimulated the creation of new development. Historically, the Royal Government of firms. Bhutan’s private sector is in a state of transition Bhutan has—in accordance with the guiding principle of as it seeks to develop market niches that are profitable maximizing Gross National Happiness (GNH)—avoided yet consistent with GNH principles. While the economy foreign investment and curtailed the activities of certain is rapidly creating new firms, the overwhelming majority industries due to concerns of adverse cultural and envi- of these firms are sole proprietorships. New firms are also ronmental impacts.2 To promote economic development, concentrated in the service sector, with relatively few in the RGoB has instead undertaken public investments in manufacturing or—given the extent to which Indian firms strategic sectors. Despite this historical legacy and the dominate hydropower contracts—in construction. In addi- small size of the domestic market, Bhutan is nonetheless tion, very few firms export directly. Instead, firms often rely attractive to investors due to its civil and political stabil- on middlemen from neighboring countries to trade goods ity, low levels of corruption, and broadly Anglophone across borders. The structure and dynamics of Bhutan’s population, which collectively represent a package of evolving private sector is detailed further in Section 1.3. characteristics unique in the South Asia region. More- over, whereas cultural and environmental protections The performance of four key sectors—hydropower, have sometimes been perceived as a constraint to private-­ tourism, information and communications technol- sector activity, producers are now seeking to utilize GNH ogy, and agribusiness—will likely shape Bhutan’s principles to exact a premium for Bhutanese in high-end future development. Hydropower, which accounts for export markets. very large shares of exports, imports, and government rev- enue, has substantial impacts on the broader economy that Over recent years, Bhutan’s economy has been must be carefully managed. The rapid expansion of tour- transformed by growth in hydropower and tourism. ism has brought growing pains that will need to be resolved In 1988, Bhutan opened its first major hydroelectric facil- if the sector is to provide sustainable economic returns. ity at Chukha and began exporting surplus electricity to The nascent ICT industry offers the potential to stimulate India. Since then, a further five facilities have been com- youth employment and high-value exports, but further pol- pleted, boosting exports, public revenue, and construction. icy adjustments are required to attract increased foreign Tourism has similarly grown rapidly in recent years. Vir- investment. Finally, with agriculture currently employing tually closed to tourists until 1974, Bhutan attracted only two-thirds of Bhutan’s private-sector workforce, improv- 7,158 tourists as recently as 1999, but welcomed 130,000 ing agribusiness performance is critical to improving the visitors in 2014. Developments of hydropower, tourism, well-being of the country’s population. Each of these four and related industries have resulted in dramatic increases sectors is profiled in greater detail in Section 1.4. in economic growth, public spending, and reductions in poverty (World Bank 2014). In addition to underpinning 1.2 Macroeconomic the growth of tourism and hydropower, Bhutan’s state- owned enterprises have promoted economic diversifi- Profile cation. Despite these developments, however, Bhutan’s Despite changes in the structure of Bhutan’s econ- employment structure remains overwhelmingly agrarian, omy, employment remains overwhelmingly agrarian, and exports and foreign direct investment are low rela- and external integration is low relative to compara- tive to comparable countries. Bhutan’s macroeconomy is ble countries. The benefits of the rapid economic growth examined in greater detail in Section 1.2. experienced in recent decades have been shared broadly across the population, with Bhutan currently exhibiting very low levels of poverty and a high level of access to basic 2. GNH attempts to balance spiritual and material advancement to services (Subsection 1.2.1). The transformation of the achieve total well-being. GNH principles are anchored in Bhutan’s constitution and implemented through medium-level strategies. economy has been driven mainly by a large increase in the 2 Investment Climate Assessment of Bhutan generation and export of hydroelectricity, with the impor- indicating that just 2 percent of the population live on tance of manufacturing and services falling below that of less than US$1.90 a day, which is the second lowest level comparable middle-­ income countries. Agriculture and of poverty in South Asia and substantially lower than the the public sector dominate employment, with relatively regional average of 19 percent. Bhutan’s economy has few people employed in manufacturing (Subsection 1.2.2). also shared the benefits of increasing prosperity. Over the Bhutan’s exports consist of a small number of products fifteen years prior to 2015, the average income and expen- and are sent mainly to India and Bangladesh, while flows diture of the bottom 40 percent of the distribution grew of foreign direct investment are increasing but remain low at the same rate as the overall average. Access to basic ser- compared to peer countries (Subsection 1.2.3). Bhutan’s vices and asset ownership also improved over the period, state-owned enterprises—which, since 2007, have operated with the Gross National Happiness Survey in 2015 indi- under the aegis of Druk Holdings and Investments—have cating that 98 percent of households own mobile phones been instrumental to diversifying the economy, although and 99 percent have access to electricity from the national the strong linkages that persist between policy makers and grid. state-owned enterprises potentially discourage the growth of the private sector (Subsection 1.2.4). 1.2.2 Sectoral Structure and Employment 1.2.1  Growth and Poverty Hydropower has transformed Bhutan’s econ- In the past two decades, Bhutan has experienced omy, although manufacturing and services have rapid economic growth and declines in poverty. not achieved the importance characteristic of Between 2000 and 2015, Bhutan’s per capita gross ­middle-income countries. Between 1980 and 2015, domestic product (GDP) doubled to US$2,500. Bhutan the output share of agriculture declined from 44 to 17 has almost eliminated extreme poverty, with estimates percent (Figure 1). This structural transformation has, A. Bhutan’s Structural Transformation: 1980–2015 B. Sectoral Shares in Value Added (2015) 50.0 100% 45.0 44.6 43.6 90% 40.0 39.4 80% 39 42 35.0 34.9 52 30.0 70% 62 64 25.0 60% 20.0 17.4 15.0 50% 22 10.0 35 12 8.9 8.3 40% 5.0 9 2.9 30% 0.0 21 17 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 8 27 20% 27 Agriculture, value added (% of GDP) 10% 11 19 17 6 Manufacturing, value added (% of GDP) 2 6 0% Other industry, value added (% of GDP) Bhutan Botswana Lesotho Lao PDR South Asia Services, etc., value added (% of GDP) Agriculture, value added (% of GDP) Manufacturing, value added (% of GDP) Other industry, value added (% of GDP) Services, etc., value added (% of GDP) Figure 1:  Sectoral Composition of Bhutan’s Economy Source: World Development Indicators data. Investment Climate Assessment of Bhutan 3 however, been driven predominantly by the sharp increase Bhutan 2009 26 74 in hydropower generation—which comprised 34 percent Bhutan 2015 15 85 Botswana 2010 14 86 of exports in 2015—and associated construction activities Costa Rica 2010 22 78 (Bhutan NSB and WB 2014). As such, the reduction in the India 2014 45 55 economic share of agriculture has not—at least over the Lao PDR 2016 34 66 past 10 years—been accompanied by an increase in man- Lesotho 2016 55 45 Mauritius 2009 45 55 ufacturing or services. As of 2015, the share of services Nepal 2009 40 60 in value added was lower in Bhutan (40 percent) than the Nepal 2013 38 62 average for South Asian countries generally (52 percent), 0 20 40 60 80 100 as well for other small, landlocked economies such as Percentage of equivalent FT employment Botswana (64 percent) and Lesotho (62 percent). Manufacturing Services Due to the concentration of economic growth in Figure 2:  Share of Nonagricultural Private Employment Source: WBES. Unless otherwise indicated, the source of all tables and capital-intensive sectors and the employment of figures is the 2015 WBES. foreign labor in the construction sector, employ- ment remains concentrated in agriculture and the public sector. While Bhutan’s rapid economic growth of close to 8 percent over the past two decades would ordinarily be sufficient to absorb surplus labor, eco- account for 85 percent of nonagricultural private-sector nomic growth has been concentrated overwhelmingly in employment, a figure that is higher than other small geo- capital-intensive sectors, such as metals, mineral prod- graphically isolated economies (Figure 2). ucts, hydropower, and the chemical sector. In addition, labor-intensive sectors that have grown—such as com- mercial construction, infrastructure, and hydropower 1.2.3 External Sector projects—have relied on foreign labor. As of 2014, Bhu- Bhutan’s exports are concentrated, relatively tan’s employment structure remains at the threshold of unsophisticated, and are declining in real terms. As an agrarian economy (World Bank 2016a), with agricul- a share of GDP, Bhutan’s exports of goods and services ture accounting for almost 70 percent of all private sec- have steadily declined since 2008 and are below those of tor jobs (ibid.). Moreover, the public sector accounts for other small economies such as Botswana and Mauritius almost one-fifth of overall employment, which is approx- (Figure 3-A). In real terms, the total value of exports is imately the share of the private nonagricultural work- less than in 2007. Bhutan’s exports and export markets force (Table 2). Per 2015 WBES data, service-sector firms are highly concentrated, with electricity and ferrosilicon accounting for 34 percent and 20 percent, respectively, of exports in 2014. Most exports go to India and, to a lesser Table 2: Changes in extent, to Bangladesh (Figure 3-B). The sophistication Employment Composition of Bhutan’s exports, as measured by the weighted aver- age of importers’ income levels, is also low, falling below 2004 2010 2014 that of all other South Asian countries (Figure 3-C). With Agriculture farming sector 63.20% 56.20% 56.70% the expansion of tourism, exports of travel and trans- Nonfarm sector: 36.80% 43.80% 43.30% portation services grew rapidly between 2009 and 2013 Nonfarm private 24.60% 24.40% Nonfarm public 19.30% 18.90% (Figure 3-D). As of 2014, however, Bhutan’s top five export products were: electricity (34 percent), ferrosili- Source: Bhutan National Bureau of Statistics 2015; World Bank 2016a. Public employment includes civil services, armed forces, con (20 percent), semifinished iron products (5 percent), SOEs, and other agencies. cement (5 percent), and cardamom (3 percent). 4 Investment Climate Assessment of Bhutan A. Exports of Goods and Services as Share of GDP (%) B. Share of Top 5 Products and Markets in Total Exports 1.2 80 1.0 70 0.8 60 50 0.6 40 0.4 30 20 0.2 10 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2011 2000 2001 2002 2003 2005 2006 2007 2008 2009 2010 2012 2013 2015 2004 2014 Bhutan Botswana Mauritius    Top 5 products Top 5 markets Source: World Development Indicators.  ource: Replotted based on Lopez-Acevedo et al. 2016 and S COMTRADE data. C. Normalized Weighted Average of Income of Importers D. Services Exports: 2009–2013 1.4 100 1.2 80 1.0 60 Mil USD 0.8 40 0.6 20 0.4 0.2 0 2009 2010 2011 2012 2013 0 Transport Travel n sh an a al an ka s ve ta di ep de an ut st In is Communications Insurance di N ki Bh an la iL al Pa ng M gh Sr Financial services Royalties and licence fees Ba Af 2000–2004 2010–2014     Government services Source: Lopez-Acevedo et al. 2016 (based on COMTRADE data). Source: UNCTAD. Figure 3:  Export Indicators Inflows of FDI have increased since 2005, but stock remains well below the South Asian average and are low relative to comparator countries. Bhu- levels exhibited by other small resource-based economies tan received negligible FDI prior to 2005. Since then, such as Lao PDR and Botswana. FDI inflows are heav- FDI inflows have been volatile, but higher overall (Fig- ily concentrated in the hotel sector and among regional ure 4). The net inward stock of FDI in Bhutan rose from investors. 4.3 percent in 2011 to 9.7 percent in 2015, although the Investment Climate Assessment of Bhutan 5 A. FDI Inflows into Bhutan (US$ Millions) B. Inward FDI Stock, % of GDP 80 Nepal 70 Bhutan 60 India 50 40 Brazil 30 Botswana 20 Lao PDR 10 0 Costa Rica –10 0.0 10.0 20.0 30.0 40.0 50.0 60.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015    2015 2011 Source: UNCTAD World Investment Report 2016 data. Source: UNCTAD World Investment Report 2016 data. Figure 4:  Foreign Direct Investment 1.2.4 State-Owned Enterprises3 operational links between DHI and RGoB. The Royal Druk Holdings and Investments (DHI) was cre- Charter directs the Ministry of Finance to support GLCs ated in 2007 to oversee the operations of in the form of subsidies for “social functions,” sovereign ­ government-linked companies (GLCs), which have guarantees, on-lending, and additional financing, as well been critical to diversifying the economy. Due to as facilitating bilateral and multilateral negotiations and Bhutan’s small domestic market, sparse population, and considering “policy feedback provided by DHI.” DHI, in high transportation costs, the risks associated with pri- turn, provides dividends to the Ministry of Finance at an vate investment are higher than for most other countries. amount agreed annually and consults with the Ministry For this reason, public investment in commercially ori- of Finance about “investments, divestments and the issu- ented GLCs—that is, commercial ventures with full or ance of securities.” The Board of Directors of DHI are partial public ownership—has been critical to diversify- appointed by RGoB representatives, with the chairperson ing the Bhutanese economy and stimulating several high appointed by His Majesty the King. value-added industries, including hydropower and infor- ­ mation technology. DHI’s investments encompass a broad range of sectors and forms of ownership. To avoid competing Although autonomous, DHI maintains strong links with the private sector, DHI is expected to focus on ven- with the Ministry of Finance. Under the terms of the tures with long gestation periods and/or low returns and Royal Charter establishing DHI, the company assumed strategic investments with high risk, while divesting shares ownership of all shares of GLCs and the responsibility for in companies in which the private sector can assume a implementing “commercially oriented projects . . . devel- greater role. However, between 2009 and 2015, DHI’s oped by the government.” Although the Royal Charter assets more than tripled, growing from Nu 51 billion to describes DHI as an “autonomous” entity, there are strong Nu 154 billion. Currently, DHI has shares in 20 differ- ent companies operating in the manufacturing, energy, natural resources, financial services, communication, 3. This section draws from the following sources: DHI 2017; Lam- sang 2016; and DHI 2011. aviation, trading, and real estate sectors (Figure 5). Of 6 Investment Climate Assessment of Bhutan Figure 5:  Government-Linked Companies with DHI Equity Source: DHI Annual Report 2016. the 20 GLCs, 11 are fully owned by DHI, three are con- management of GLCs are now competitively selected trolled by DHI, and DHI holds stakes below 51 percent and thereafter put on short-term, performance-based in the remaining six. contracts, with employees eligible to an additional 15 per- cent allowance above civil service pay subject to meeting DHI has introduced reforms to improve the perfor- individual and group targets. The Bank of Bhutan and mance of GLCs. For the GLCs it oversees, DHI is man- the Bhutan Power Corporation have reportedly reaped dated to appoint board members and CEOs based on substantial benefits from these changes, with profits of merit; provide a common platform for technologies, pro- the former rising from Nu 183 million in 2007 to Nu 865 curement, and human resource development; and extend million in 2014 and profits of the latter rising from Nu capital through borrowing and issuance of debt, equity, 455 million in 2007 to Nu 1.3 billion in 2015. Overall, system-based man- or other securities. DHI has instituted ­ DHI’s profits have risen from Nu 4.8 billion in 2008 to agement in GLCs and provided associated training. Senior Nu 10.8 billion in 2015. Investment Climate Assessment of Bhutan 7 1.3 Enterprise Sector 1.3.1  Firm Characteristics Most of Bhutan’s 28,000 existing businesses are Profile small and engage in service activities.4 Data from the Bhutan’s private sector is dominated by micro- 2015 WBES provides for a snapshot of firms in Bhutan enterprises and dependent upon intermediaries (Figure 6). Nonagricultural businesses are concentrated to reach external markets. Bhutan’s private sector in services such as tourism (29 percent) and construction, consists overwhelmingly of microenterprises with a sole retail, wholesale, and other activities (62 percent) and proprietor and focuses on services such as tourism (Sub- are mostly located in Thimphu and Paro. A large major- section 1.3.1). While the service sector has rapidly gener- ity of firms are micro (75 percent) or small (16 percent) ated new firms, the economy is creating relatively few new and overwhelmingly consist of a sole proprietor (92 per- manufacturing firms or corporations (Subsection 1.3.2). cent), with a mere 2 percent of firms operating under Bhutanese firms are productive relative to those in com- parator countries, but this performance is strongly driven 4. Bhutan maintains differing licensing schemes to provide smaller by non-tradable sectors (Subsection 1.3.3). While few firms with simplified registration processes and better financial incentives. However, as licensing and other industrial statistics are Bhutanese firms export directly, a comparatively high managed in isolation by different line departments at MoEA (see proportion of firms export indirectly by using middlemen Annex 2), information on firms is poorly consolidated and firm status is not monitored beyond initial entry. As a result, a lack of accurate (Subsection 1.3.4). data undermines Bhutan’s ability to monitor the private sector. By size By sector By ownership 1% 0% 7%1% 8% 2% 16% 29% 62% 76% 98% Micro (<=5) Small(5–20) Food Other manufacturing Domestic, private Foreign owned Medium (20−99) Large(100+) Tourism Other services Domestic, state owned By female ownership By legal status By region 2% 6% 9% 14% 41% 59% 58% 19% 92% With female owners Sole proprietorship LLC Thimphu/Paro Phuentsholing No female owners Other Gelephu/Sarpang Samdrup Jongkhar Figure 6:  Characteristics of Private-Sector Firms 8 Investment Climate Assessment of Bhutan A. Firm Size Distribution (employment) B. Share of Firms by Sector Bhutan 2009 19 81 Bhutan 2015 15 85 .4 Botswana 2010 17 83 Costa Rica 2010 21 79 .3 India 2014 39 61 Lao PDR 2016 19 81 .2 Lesotho 2016 15 85 Mauritius 2009 37 63 .1 Nepal 2009 30 70 Nepal 2013 27 73 0 0 2 4 6 8 0 20 40 60 80 100 log FT Employment Percentage of Firms Bhutan 2015 Botswana 2010 Mauritius 2009 Manufacturing Services Lesotho 2016 Costa Rica 2010   Figure 7:  Size and Sectoral Distribution of Firms of Small Geographically Isolated Economies Note: Employment is measured as number of equivalent full-time workers. a limited liability regime. Few firms have foreign owner- Table 3: Share of New ship (2 percent). Around 40 percent of firms have some and Young Firms female ownership, which is much higher than the South Young Median Asian average (18 percent). The small size and service-­ (1–4 Avg. Size Size at orientation of Bhutanese firms is distinctive, even among Years) at Entry Entry small geographically isolated economies (Figure 7). Bhutan 2009 19.0% 11.7  5 Bhutan 2015 24.6% 10.7  5 Botswana 2010  5.0% 16.9  6 1.3.2 Dynamics Costa Rica 2010  5.8% 11.4  5 Small service-sector firms are being created rap- India 2014 10.4% 24.4 12 idly, although Bhutan lags its peers in the creation Lao PDR 2016  5.3%  9.4  5 of corporations. Bhutan has a higher share of newly Lesotho 2016  0.4% 34  6 created (“young”) firms than other small geographi- Mauritius 2009 31.8%  9.8  4 cally isolated countries (Table 3).5 WBES data indicate Nepal 2013  5.2%  7.9  5 that the rate of increase rose between 2009 and 2015, which is consistent with the increase in business registra- tions reported by Bhutan’s National Statistics Bureau. LLCs between 2009 and 2014 was low relative to other The growth in new businesses has been driven by ser- countries, even after accounting for Bhutan’s population vices, with no change in manufacturing and a decline in and income. For firms that survived from 2012 to 2015, entry in construction (Figure 8). New businesses are over- more than 60 percent added jobs, a higher share than all whelmingly sole proprietorships and the average entry of comparator countries (Figure 8-B).6 While smaller firms grow faster, large firms created almost half of new jobs between 2012 and 2014. 5. While the WBES is cross-sectional and has limited information on business dynamics, information on firm characteristics at entry enables the construction of two measures: (i) entry by limited liability 6. As young firms grow faster in general (Li and Rama 2015), this companies through the entrepreneurship database, and (ii) entry of may be because Bhutanese firms are younger on average than firms licensed businesses as recorded by MoEA. in peer countries. Investment Climate Assessment of Bhutan 9 A. Entry of Licensed Businesses in Bhutan B. Employment Growth: Bhutan and Comparator Countries8 8,000 1 7,220 6,707 .8 6,000 5,235 5,215 Probability 4,808 .6 4,000 .4 .2 2,000 503 594 756 467 0 363 −100 −50 0 50 100 0 237 221 256 242 335 2010 2011 2012 2013 2014 Growth Rate of Employment (%) Production & manufacturing Bhutan 2015 Costa Rica 2010 India 2014 Lao PDR 2016 Construction Growth rate is annualized % change in permanent FT Services employment, normalized by average employment Figure 8:  Business Entry and Employment Growth Source: Bhutan National Bureau of Statistics, Statistical Yearbook (2015) (new licenses recorded by MoEA). Table 4: Growth of Firms, 2012–14 than US$10,000 per worker. Moreover, not only is the Avg. Avg. Contr. median business in Bhutan more productive: businesses in Employ. Sales to Emp. the top quartile of the distribution in Bhutan exhibit rela- Growth Growth Growth tively higher labor productivity than their regional peers.8 2012–14 2012–14 2012–14* Micro (<=5)  2.12  2.88 11% Manufacturing firms, however, are relatively Small (5–20) 13.15 14.99 14% unproductive compared to service sector firms. Medium (20–99) 10.44  8.39 15% The median labor productivity of manufacturing firms Large (100+)  3.76  2.71 46% in 2015, at US$1,500 per worker, is lower than all other Food  5.63 13.16  1% peer countries except for Nepal. Between 2009 and 2015, Other Mfg.  0.98  7.74  8% the median labor productivity in Bhutan’s manufactur- Tourism  2.78  4.12 27% ing sector decreased by around 50 percent. In contrast, Other Services  6.92  5.79 64% the median firm in the services sector has doubled labor All firms  4.99 5.50 productivity (Figure 10).9 In relative terms, the produc- *Growth is calculated as the annualized growth rate of FT tivity gaps between manufacturing and service sectors permanent employment, normalized by average employment. in Bhutan are larger than in all comparator countries.10 Source: World Bank, MoHLR (2016a). Aggregate employment growth is only calculated for businesses that existed and survived between 2012 and 2015. 8. To account for firm size, growth is calculated as the annualized 1.3.3  Labor Productivity growth rate of full-time permanent employment, normalized by average employment. Since employment information from two years Bhutanese firms are relatively productive (Fig- ago is only available for permanent full-time employees, this growth ure 9).7 The median value added per worker in Bhutan rate ignores temporary employment. 9. Differences in labor productivity across countries and over time accords with the country’s income level and is signifi- should be interpreted with caution as they may reflect changes in the cantly higher than that observed elsewhere in the region. sample or in industrial composition. Nevertheless, quartile regres- sions on the full sample and panel firms in Bhutan show that the Between 2009 and 2015, estimated median productivity increase in median productivity between 2009 and 2015 is statisti- almost doubled, rising from US$5,700 per worker to more cally significant, driven by services. 10. Such large productivity gaps may indicate barriers to entry, inef- ficient labor or financial markets, and/or difficulties in transferring 7. See Annex 3.1 for an explanation of the methodology. skills across sectors. 10 Investment Climate Assessment of Bhutan A. Median Labor Productivity B. Average Labor Productivity at the “Frontier” Botswana 2010 27.9 Mauritius 2009 230.2 Costa Rica 2010 25.8 Botswana 2010 193.7 Mauritius 2009 20.0 Costa Rica 2010 114.2 Bhutan 2015 10.4 Bhutan 2009 85.2 Lesotho 2016 9.3 Bhutan 2015 54.7 Bhutan 2009 5.7 Nepal 2013 34.5 Lao PDR 2016 5.6 Lesotho 2016 33.3 India 2014 4.7 India 2014 30.9 Nepal 2013 2.5 Lao PDR 2016 23.3 Figure 9:  Labor Productivity (value added per worker) Note: “Frontier” is defined as between 75th and 99th percentiles. Labor productivity is measured as value added per equivalent FT worker, in thousand US$, 2010 prices. Prices are deflated using the CPI. Mauritius 2009 16.0 Costa Rica 2010 14.6 Botswana 2010 8.1 Manufacturing India 2014 4.6 Lesotho 2016 3.6 Lao PDR 2016 3.3 Bhutan 2009 3.0 Nepal 2013 1.9 Bhutan 2015 1.5 Costa Rica 2010 34.3 Botswana 2010 33.4 Mauritius 2009 22.8 Bhutan 2015 12.7 Services Lesotho 2016 9.7 Bhutan 2009 6.3 Lao PDR 2016 6.2 India 2014 4.8 Nepal 2013 3.0 Figure 10:  Median Labor Productivity by Sector (value added per worker) Note: “Services” refer to construction, wholesale and retail, hotel and restaurants, transport, and other service activities (ISIC Rev. 3 sectors 45–99). Non-tradable service activities experienced the different activities (Table 16; Annex 3.1). Across ser- highest gain in value added per worker, which was vices, construction, wholesale, and retail are by far the likely driven by domestic consumption. Within the most productive and have grown the fastest since 2009. manufacturing and service sectors, large variations exist ­ Tourism-related activities, including travel agency ser- in both the levels and growth of labor productivity across vices and land transport, have also grown significantly. Investment Climate Assessment of Bhutan 11 The entire tourism industry, however, remains less pro- ll other comparator countries except Lao PDR (Table 5). ductive than other non-tradable service activities. High The proportion of firms directly exporting in 2015 was labor productivity of non-tradable industries might less than half the level observed in 2009 due to a reduc- reflect changes in demand rather than improvements in tion in export-orientation among manufacturing firms.12 efficiency alone.11 As with most other countries, manufacturing exporters are larger on average (Table 6), while exporting firms in manufacturing are more productive and more capi- 1.3.4 Export Orientation tal-intensive. Interestingly, 15 percent of Bhutanese firms Although very few Bhutanese firms export directly, indirectly export,13 which is higher than most compara- the share of indirect exporters is comparatively tor countries. As noted in the 2012 Diagnostic Trade and high. In 2015, only 3.4 percent of Bhutanese firms Integration Study (Bhutan MoEA 2012), exports of goods directly exported goods or services, which is lower than Table 5: Firm’s Linkages to External Markets Exports Exports Imports Exports Directly Directly Exports Inputs Has Quality Directly (Mfg.) (Services) Indirectly (Mfg.) Certification Bhutan 2009 7.8% 33.5% 1.2%  1.3% 74.7%  6.0% Bhutan 2015 3.4% 10.3% 2.1% 14.5% 53.7%  4.4% Botswana 2010 7.0% 12.2% 6.1%  4.6% 85.7% 22.3% Costa Rica 2010 9.3% 27.4% 4.6%  7.6% 79.4% 15.6% India 2014 7.8% 13.3% 4.1%  3.1% 17.8% 28.1% Lao PDR 2016 2.9%  9.8% 1.2%  5.0% 14.7%  1.6% Lesotho 2016 9.8% 31.4% 6.5% 12.8% 71.8%  2.5% Mauritius 2009 9.0% 19.0% 3.4%  7.0% 65.3% 11.6% Nepal 2013 4.3%  5.7% 3.1%  4.1% 51.5%  8.4% Table 6: Average Firm Performance, by Export Status Manufacturing Services Nonexporter Exporter Nonexporter Exporter Employment  12.8   90.5   7.2  66.5 Value Added per Worker 2,307  8,393 9,711 7,888 ($US) Capital per Worker ($US) 3,434 17,194 Note: Due to small sample size of exporters, these estimates are imprecise and should be interpreted with caution. 12. The share of exporters declined by 50 percent among small, 11. Inflows associated with hydropower projects increased domes- medium, and large firms, suggesting sample composition alone is not tic demand for goods and services, which would increase prices in driving this decline. While the decline in the share of exporting firms the non-tradable service sector more than in tradable sectors. Data in manufacturing might be driven by changes in sample composition prior to 2015 indicate that prices for most service activities increased between 2009 and 2015, the low share of manufacturing firms that faster than for manufacturing goods (see Figure 28 and Figure 29 export is consistent with low labor productivity in the sector. in Annex 3.2). Similarly, tax return data in 2013 suggest that ROI is 13. The WBES defines indirect exporters as those who sell goods highest in trade (112 percent) and other services sectors (44 percent), to an agent who exports the product without modifications. Direct whereas it is low in manufacturing (16 percent). exports are the sale of goods to an immediate recipient abroad. 12 Investment Climate Assessment of Bhutan such as potatoes, apples, mandarins, and cardamoms are 1.4.1 Hydropower15 controlled by Indian middlemen. Such arrangements While India has historically provided technical and reflect the difficulty of overcoming fixed costs for export- financial assistance to develop Bhutan’s hydro- ing from Bhutan, but also suggest that there exists an power industry, recent projects have leveraged unmet demand that firms can exploit once they improve joint ventures and public-private partnerships. efficiency along their value chains. Bhutan has the potential to generate an estimated 23,760 megawatts (MW) of hydroelectric power, but at peak Profiles of Key 1.4  times consumes only 300 MW (Premkumar 2016). With Sectors economic and population growth creating a shortage of electricity in India, the RGoB and the Government of Bhutan’s economic performance is linked to the India (GoI) agreed in 1974 to jointly construct Bhutan’s success of a small number of sectors.14 Hydropower first major hydroelectric plant, Chukha, which was com- currently generates more foreign exchange and public missioned in 1988. In 1994 and 1996, the GoI agreed to revenue than any other segment, although more could finance the construction of two additional plants: Kuri- potentially be done to encourage positive spillovers to chu, commissioned in 2002, and Tala, commissioned in other sectors (Subsection 1.4.1). Tourism has also devel- 2007. More recently, two smaller plants—Basochhu I oped into a key source of foreign exchange, but the and II, commissioned in 2001 and 2005—were jointly changing composition and spending patterns of tourists financed by the Austrian government. Bhutan’s first PPP- are threatening the sustainability of the industry (Subsec- financed plant—Dagachhu, of which India’s Tata Power tion 1.4.2). In contrast to hydropower and tourism, ICT has a 26 percent equity stake—was commissioned in and agribusiness are emerging sectors with strong growth 2015 and features a 25-year sales agreement with India’s potential. ICT, currently concentrated in the Thimphu Tata Power Trading Company (ADB 2014). Techpark, can potentially leverage Bhutan’s abundant supply of electricity, English-speaking population, and In 2006, Bhutan and India agreed to jointly develop civil stability to attract investments (Subsection 1.4.3). ten additional projects, although it is unclear whether Agriculture in Bhutan has historically exhibited low pro- the targeted capacity will be attained. In 2006, GoI ductivity, although exports of niche products are increas- and RGoB agreed to an ambitious plan to develop an addi- ing and new marketing initiatives can potentially exact a tional 10,000 MW of hydropower by 2020. The first three premium for Bhutanese products and boost incomes of projects—Punatsangchhu I and II and Mangdechhu— rural households (Subsection 1.4.5). are due to be commissioned in the next two years. The financing of an additional four projects—to be operated as joint ventures by the Druk Green Power Cooperation and Indian public sector companies—was approved by 14. Due to Bhutan’s natural advantages in mineral deposits and the GoI in 2014 (SANDRP 2016). While construction has cheap power, mining has been identified as one of the five jewels of commenced on one of these projects, media reports have the economy by the RGoB (ACC 2016). However, the sector remains significantly underdeveloped. The mining sector contributes signifi- speculated that—given slow progress in planning for the cantly to exports but its contribution to GDP and employment is neg- other six projects—Bhutan may only achieve 3,000 MW ligible (3% and 1%, respectively, in 2015, Bhutan National Bureau of Statistics 2016). Currently, the most immediate impediment to the in generation capacity by 2020 (Premkumar 2016). Cur- sector’s development is a weak governance framework, exacerbating rently, the country has an installed hydropower capacity of environmental concerns endemic to mining activities (ACC 2016). This lack of clear policies, knowledge, and distribution of property 1,606 MW, although this will increase by 3,658 MW with rights (land leases) causes significant uncertainty, potentially dis- the completion of the five plants under construction. couraging investments in mining and mineral processing given the capital-intensive nature of such investments. Beyond the regulatory framework, Bhutan will need to develop a highly skilled labor force to engage in higher value-added activities, to offset the geographical disadvantages that raise the cost of both exports and imported inputs 15. This section draws from the following sources: Bhutan, MoWHS for the sector. 2012 and Premkumar 2016. Investment Climate Assessment of Bhutan 13 Table 7: Major Hydroelectric Projects in Bhutan Grant/ Orig. Cost Final Cost Funding Project Loan Loan Project MW Comm. (Mil. USD) (Mil. USD) Source Model Ratio Interest Status Chukha 336 1988    $13 $38 GoI (1974) IG 60:40:00 5 Completed Kurichhu 60 2002    $50 $88 GoI (1994) IG 60:40:00 10.75 Completed Basochhu I 24 2001    $23 $22 Austria JV — 6 Completed Basochhu II 40 2005    $22 $28 Austria JV — 6 Completed Tala 1,020 2007   $217 $630 GoI (1996) IG 60:40:00 9 Completed Dagachhu 126 2015   $127 $201 Various PPP — 9 Completed Punatsangchhu I 1,200 2019*   $528 $1,458* GoI (2007) IG 40:60 10 Construction Punatsangchhu II 1,020 2018*   $586 $1,154* GoI (2010) IG 30:70 10 Construction Mangdechhu 720 2018*   $449 $698* GoI (2010) IG 30:70 10 Construction Kholongchhu 600 2019*   $628 — GoI (2014) JV 30:70 — Construction Nikacchu 118 2019*   $198 — Various PPP — — Construction Wangchhu 570 2019*   $994 — GoI (2014) JV — — Planning Bunakha 180 2020*   $455 — GoI (2014) JV — — Planning Chamkharchhu 770 2020* N/A — GoI (2014) JV — — Planning Sunkosh Res. 2,560 2020* $1,495 — GoI (TBD) IG — — Planning Kuri-Gongri 2,640 2020* $3,083 — GoI (TBD) IG — — Planning Amochhu 540 2020* N/A — GoI (TBD) IG — — Planning Komachhu 336 2030*   $474 — TBD PPP — — Planning Rotpashong 1,230 2030* $1,686 — TBD PPP — — Planning BinduKhola 13 2020* N/A — TBD TBD — — Planning Sunkosh LB 35 2020* N/A — GoI (TBD) IG — — Planning *Denotes estimate. Source: Premkumar 2016; ADB 2014. The export of hydroelectricity to India has pro- Bhutan’s external debt, which stood at 99 percent of GDP vided Bhutan with an unparalleled infusion of pub- at the end of 2015 (Bhutan MoF and World Bank Group lic revenue and foreign exchange. Currently, around 2016). The dominance of hydropower exports as a source 70 percent of Bhutan’s installed hydropower capacity is of foreign exchange also raises the specter of “Dutch exported to India (ADB 2014). In 2015, hydroelectricity Disease”—­ that is, the competitiveness of other industries comprised 34 percent of exports and, as of 2014, contrib- is undermined by the increased competition for resources uted 40 percent of public revenue. Economic growth has (such as labor and materials) with the hydropower sector. boomed as a result, while the construction activity asso- Currently, imports for hydropower construction consti- ciated with both hydroelectric facilities and public invest- tute half of the country’s current account deficit, which ments has driven poverty reduction (World Bank 2014, stood at 26 percent in December 2016 (Bhutan, MoF and Bhutan MoF and World Bank Group 2016). World Bank Group 2016). Moreover, the inherent volatil- ity in hydropower generation—which is likely to increase The growth of Bhutan’s hydropower sector has, as climate change affects winter snowfalls and the flow however, not come without financial, economic, of glacier-fed rivers—could result in large fluctuations and environmental costs and risks. Costs related to in government revenue and expenditure if not properly hydropower now constitute approximately two-thirds of managed. 14 Investment Climate Assessment of Bhutan 1.4.2 Tourism Flows are temporally and geographically con- Policies relating to tourism have sought to gener- centrated and dominated by older demographic ate revenue while minimizing cultural and envi- groups. Currently, 87 percent of bed nights occupied by ronmental impacts. Since it opened its borders to tourists occur in Paro, Thimphu, Punakha, or Bumthang, international visitors in 1974, Bhutan has maintained while the country’s other 16 districts each account for less a unique focus on “high-value, low-impact” tourism. than one percent of occupied bed nights. Visits to Bhutan For all foreign tourists originating from countries other occur much less frequently during summer and winter, than India, Bangladesh, and the Maldives (the so-called with more than 70 percent of occupied bed nights gener- “regional market”), Bhutan applies the minimum daily ated over a five-month period. Historically, most tourists package policy (MDPP). The policy requires tourists have been over 55 years of age, and this characteristic to travel on prepaid, fully guided, all-inclusive package has not changed with the increase in tourist volumes. tours and to stay in accommodations that are at least Currently, persons under 45 years of age comprise only of a “3-star” standard.16 It also requires that a sustain- 27 percent of tourists visiting Bhutan. able development fee (SDF) (currently $65 per person per day)17 be paid to RGoB. The MDPP is $250 per The concentration of tourist flows reduces the day during the “high season” and $200 per day at other value proposition of tourism for the country and times of the year.18 As of 2015, the sector generated an for the tourists themselves. The concentration of estimated $280 million in revenues or more than 20 per- increasing volumes of tourist traffic in a short season and cent of non-hydro export income. within a limited geographic area negatively impacts Bhu- tan’s environment and religious and cultural heritage and, The volume and profile of tourists has changed in in the process, adversely impacts the value proposition recent years, resulting in shifts in stay and spend- for higher spending visitors.20 The seasonality of flows ing patterns. Between 2009 and 2014, the number of reduces the consistency of revenues and decreases the tourists visiting Bhutan rose dramatically from 23,500 to volume of employment associated with the tourist indus- more than 130,000. The growth was driven not by the try, while the geographic concentration of flows deprives high spending North American market that has histori- the poorest areas of the country of the economic bene- cally dominated arrivals, but in large part by tourists from fits of tourism and results in an extremely limited tour- China and India,19 the latter of which now accounts for ism product, which provides little incentive for visitors to more than half of all foreign visitor arrivals. As western make subsequent trips to Bhutan. tourists stay longer and spend more per day than Asian visitors, these changes have reduced average revenues per Satisfaction of visitors with Bhutan’s tourism ser- tourist. vices is low, and very few tourists make return vis- its to the country. Only 17 percent of non-regional respondents to the 2014 Bhutan Visitor Survey strongly agreed that “Bhutan offers good value for money” and, in most 16. Accommodations above this standard generally attract a pre- Asian and Western European markets, satisfaction was mium above the MDPP. less than 10 percent. Of the visitors reporting the least 17. Persons traveling alone must pay a surcharge of $40 per day, while those traveling in groups of two or more people must pay a satisfaction, the greatest number were on packages with surcharge of $30 per day. Discounts are applied to children, full-time three-star hotel accommodations and food offerings. students, and those visiting Bhutan for more than eight nights. 18. The high season runs from March through May and from Sep- Likewise, while visitors were generally satisfied with the tember through November. quality of their tour guides, they expressed lower levels 19. The number of tourists from Canada and the United States has declined over the past five years. Arrivals from China almost doubled between 2013 and 2015, and arrivals from regional markets, which 20. According to tour operators, site managers, religious bodies, and are not subject to the MDPP, grew by 66 percent in the year ending government officials, the rapid growth of the low-spending regional September 2015. Royalty paying visitors grew from 7,000 in 2001 to market is creating significant challenges in terms of visitor safety and 68,000 in 2014. effective management of cultural heritage and religious sites. Investment Climate Assessment of Bhutan 15 of satisfaction with the quality of food and accommo- undertake functions such as member education, certifica- dations. Reports from key informants indicate that many tion, data collection, market research, marketing, strate- tourists become “Dzonged out” and express a desire gic planning, and dispute resolution. for immersive cultural experiences, current offerings of which are very limited. 1.4.3 Information and Communications Technology The concentration of flows is caused by factors The Thimphu Techpark has served as the main vehi- that can potentially be adjusted by policy reforms, cle for creating an externally focused ICT sector in investments, and changes in operator behavior. The Bhutan. Bhutan, which was without television until 1999 seasonal pattern of tourism in Bhutan runs counter to and is renowned as a rustic, remote, and largely uncon- travel patterns in major source markets and is not caused nected Shangri-La, strikes many as an unlikely candidate by climate or other structural factors. Promotion by tour for a tech hub. Accordingly, the Thimphu TechPark, a operators is minimal during the “lean season,” which 50,000 square foot facility that opened in May 2012 as may be partially due to the change in the MDPP during a partnership between the government and the private these periods.21 The geographic concentration of tour- sector, has been controversial (Thimphu TechPark 2017). ist flows along the country’s “Western Circuit” is driven Backers of the park argued that Bhutan’s civil stability, both by path dependence and by a lack of access, the its cheap and abundant electricity—a key business con- latter of which is being addressed by investments in road straint elsewhere in South Asia—and its well-educated, and air links. The demographic concentration of tourist tech-savvy, and English-speaking young workforce would flows appears to be driven by the lack of products and present an attractive proposition for investors (United itineraries attractive to a broader variety of markets, such Nations Department of Economic and Social Affairs as families and youth (e.g., adventure tourism, immersive 2016). Skeptics argued that, with Bhutan’s tiny domestic experiences, and so on). market and reputation for Luddism, the notion of a Bhu- tanese ICT industry was pure fantasy (Bhutan Broadcast- The management of Bhutan’s tourist industry is ing Service 2013; M. Dorji 2013). characterized by an apex body and three private- sector organizations. The Tourism Council of Bhu- The Techpark struggled to attract clients—and tan (TCB), a semi-autonomous government agency investors—in its initial years. Major multinational that reports to the prime minister, is the “Apex Tourism companies that had previously expressed interest backed Body” and is responsible for setting and implementing out, while local companies complained that the park did tourism-related government activities. However, a all ­ not suit their needs and rebuffed invitations to relocate variety of other ministries and agencies set policies and (T. Dorji 2016). By January 2013, the first and second make investments that directly impact the tourism sector, floors of the facility were still vacant (Bhutan Broadcast- and there is a lack of intragovernmental communication ing Service 2013), and, with the park’s chief operating and cohesion. The private sector is represented by three officer noting that the park was facing “cash flow chal- large but relatively young associations of tour operators, lenges” due to a lack of rental income, the project was hotels and restaurants, and guides. However, these associ- derided as a “white elephant” (M. Dorji 2013). In Octo- ations function primarily as lobbying entities and do not ber 2014, Singapore’s Assetz Property Group—which had partnered with Druk Holdings and Investments to develop, build, finance, own, and operate the park and 21. “Tour operators selling packages at or near the minimum daily had held 74 percent of Thimphu TechPark Pvt. Ltd.— price have . . . significantly reduced margins to work with ($135 per exited the arrangement, leaving RGoB’s commercial arm visitor per day vs. $185),” thereby rendering “these lower package prices . . . significantly less profitable than high season bookings.” as the sole shareholder. 16 Investment Climate Assessment of Bhutan The Techpark is now growing, attracting corpo- private-sector workforce, but the sector contributed just rations from around the world. Two U.S.-registered 18 percent to GDP in 2014. Yields per hectare have been companies—ScanCafe, which specializes in digitizing declining at a compounded annual rate of 1.84 per- and restoring vintage images, and Shaun Communica- cent over the last 27 years, which contrasts sharply with tions, which specializes in call center operations—were increases of between 0.25 percent to 0.50 percent per the first to move into the first floor. Attracted by Bhutan’s year observed for the rest of the world (Wik, Pingali, and stable business environment, low degree of corruption, Brocai 2008). Most producers grow cereal crops—maize cheap electricity, reportedly high levels of labor produc- and rice, particularly (Table 8)—for subsistence. However, tivity and worker retention, and tax holidays, four other due to the expansion of feeder roads that give producers international ICT firms—MultiRational from Australia, better access to markets in India, exports of several high- SELISE from Switzerland, Southtech from Bangladesh, value horticultural crops—and the proportion of firms and Zoop from Canada—have also moved into the park. cultivating such crops—have recently increased (Bhutan Currently, the Techpark employs more than 700 people MoAF 2011).22 From 2011 to 2014, exports of oranges (Thimphu TechPark 2017). ScanCafe, which opened its increased by 66 percent, apples by 35 percent, potatoes park facility in 2012 with only 20 staff now employs more by 175 percent, and areca nuts by 225 percent.23 Hor- than 300 and expects to continue growing. ticultural production is nonetheless highly concentrated, with 2008 data indicating that 10 percent of farmers Despite its recent new investments, Bhutan’s account for 73 percent of sales (Christensen, Fileccia, and nascent ICT sector is facing growing pains. Shaun Gulliver 2012). Communications could not recruit enough qualified staff for its call center operations and, after incurring Table 8: Agricultural large losses on training (T. Dorji 2016), decided to close. Products in Bhutan The remaining international firms expressed concern Commodity Production (mt) Value ($) that they may yet face similar fates. Stringent immigra- Rice (paddy) 77,314 47,752,765 tion regulations—which contradict the more lenient but Maize 66,779 27,497,235 unapplied FDI regulations—preclude the recruitment of Potatoes 52,959 19,470,221 foreign expatriates to temporarily fill critical skill short- Mandarin 38,184 32,007,176 ages. Several firms also expressed concern over deficits in Chili 7,312 9,247,529 “soft skills”—such as punctuality and professionalism— Wheat 5,647 2,574,368 among local employees and noted that this had negatively Apple 5,410 4,773,529 affected the firm’s reputation with international clients. Millet 5,024 1,625,412 Firms also noted that, even with subsidies, the cost of Areca nut 4,036 2,284,376 Internet access is twice as high as in neighboring coun- Mustard 3,578 4,735,588 tries and that regulations on payment transfers compli- Beans 3,459 2,085,574 cate multinational operations. Others questioned the Barley 2,050 841,103 government’s commitment to growing the nascent indus- Cardamom 942 14,320,284 try, given the lack of an FDI promotion strategy or efforts Mushrooms 9 76,412 to build awareness of the park. Source: Bhutan MoAF 2010. 22. New roads have enabled producers to bring products to the 1.4.4 Agribusiness Indian market that cannot be grown there at specific times of year While the agriculture sector is underperforming, due to differences in climatic conditions. exports of several high-value horticultural crops 23. Other exports include chilies, cardamom, and ginger, as well as several niche crops (mushrooms, honey, asparagus, hazelnuts, black are growing. Agriculture employs 70 percent of the pepper, and Sichuan pepper). Investment Climate Assessment of Bhutan 17 12,000 The activities of state-supported entities, created to address perceived market failures, risk distort- 10,000 ing factor and product markets and discouraging 8,000 private investment in agribusiness. The RGoB has USD 1,000s established several state-owned enterprises or quasi state- 6,000 owned enterprises to replace rural private sector initia- 4,000 tives perceived to be lagging. For instance, 16 Farm Shops in eastern Bhutan sell subsidized inputs and staple goods 2,000 to and purchase primary agricultural products from the poor living in remote rural areas. Commercial vendors, 0 however, complain that Farm Shops undercut their prices, y its Po ts es s om e es s rle m u ic ge ru to pl ln oo m R a forcing them out of business. Similarly, Bhutan Agro rf ta Ap n /B da te hr ra e at Be th us ar O he O C M Industries Limited, a state-owned company established W 2011 2014 in 1993, develops, distributes, and markets ­ value-added Figure 11:  Bhutan’s Agricultural Exports, 2011–14 (processed) agricultural goods and, in so doing, poten- Source: Bhutan MoAF 2016. tially crowds out private investment in food processing.25 Several mega-farms and demonstration farms also com- Agribusinesses in Bhutan are primarily microen- pete with private businesses by selling their products in terprises operating as sole proprietorships. Agri- the same markets. businesses, which are geographically concentrated in the Thimphu/Paro region, are smaller than businesses Existing agricultural subsidies risk diminishing the in other sectors and more likely to be sole proprietor- choices open to farmers and discourage innovation ships. Of the agribusinesses sampled by the 2015 WBES, and diversification. Vegetable farmers and rice farm- 91 percent are microenterprises, compared to 68 percent ers are currently given prepackaged sets of inputs, which of other firms. Likewise, almost all agribusinesses sam- effectively dictate production choices as similar support is pled are sole proprietorships. Agribusinesses export less not available for other commodities. In addition to reduc- than firms in other sectors, although exporting is closely ing incentives for diversification or innovation, such sub- correlated with firm size.24 Moreover, even exporting sidies deter investment by private-sector support services, firms tend to be poorly networked with external markets. such as seed companies, fertilizer importers, and distrib- Most farmers and traders sell to Bangladeshi or Indian utors. In addition, the subsidy has created an expecta- merchants operating within Bhutan or at border markets, tion among farmers that the government will continue rather than at the end market of the destination coun- to provide these items at little or no cost. Accordingly, tries. This limits firms’ exposure to innovation in product the RGoB is concerned that if it withdraws the subsidies, types, trade finance, product quality and other require- production will decrease precipitously. ments of end markets, marketing, and distribution. Per WBES data, virtually no agribusiness firms have received Efforts to better market Bhutanese products foreign investment. abroad are underdeveloped. In October 2014, Bhutan’s Department of Trade partnered with UNDP and Future Brand to develop a visual identity that would “add a pre- mium to the goods and services that are produced and 24. For example, medium-sized agribusinesses are 16 percentage points more likely to export at least 1 percent of their sales compared 25. Other than Druk Brewery, no similarly large, private food proces- to smaller firms. sor has emerged in Bhutan. 18 Investment Climate Assessment of Bhutan originate in Bhutan” (Future Brand 2015a). If properly management that will: (i) establish standards for products developed, Brand Bhutan can enable Bhutanese export- bearing the Brand Bhutan identity and associated labels; ers to access a quality premium in high-value markets. (ii) outline procedures for the private sector to use the However, the Ministry of Economic Affairs (MoEA) has brand; (iii) establish and publish sanctions and penalties yet to formally launch Brand Bhutan. Moreover, there is for misuse of the brand; and (iv) create systems for con- a need for MoEA to create a framework for the strategy’s trolling the quality of products sold under the brand. Investment Climate Assessment of Bhutan 19 Workers of Bhutan Power Company replace an old pole, Upper Motithang, Thimphu, July 2015. Chapter 2 Constraints on Private-Sector Development Summary Recent reforms have addressed several factors that previously impeded private-­ sector development, but Bhutan’s overall economic competitiveness lags other countries in the region due to constraints on access to inputs and to product markets. Access to Inputs. Limited access to finance—due to a lack of competition and credit information, a deficient insolvency regime, limited collateralizability, and widespread financial illiteracy—is a major constraint for micro and small firms. The limited supply of skilled labor—resulting from low overall levels of education, competition for talent with the public sector, and restrictions on hiring foreign workers—reduces the productivity of larger firms. Access to Markets. Despite an open trade policy and recent investments, the access of Bhutanese firms to external markets is inhibited by infrastructure gaps, an underdeveloped logistics sector, inefficient transit corridors, and restrictions on foreign investment. In several sectors, perceptions of unfair competition with state enterprises and a lack of private-public dialogue dampens investment incentives. Finally, while Bhutan’s institutional quality is one of the best in the region, defi- ciencies in accounting standards and corporate governance exacerbate regulatory uncertainty and discourage risk taking. 2.1 Introduction Over the last decade, reforms have improved Bhutan’s investment climate. Key reforms—such as the new Licensing Policy approved by the Cabinet; digitization efforts to simplify the process of registering properties; and ongoing revisions of FDI regulations—have improved the regulatory environment. The RGoB has also implemented reforms in several areas to improve access to finance. Forthcoming or proposed reforms include improv- ing usage of movable assets as collateral, revision of the Bankruptcy Act to strengthen legal rights for creditors and borrowers, and improvements to the Credit Information Bureau (CIB). Bhutan’s competitiveness is nonetheless constrained by financial underdevelopment, skills shortages, limited access to markets, and 21 A. Doing Business Distance-to-Frontier 2017 B. Global Competitiveness Index (GCI) 2016–17 100 6 80 5 60 4 40 3 20 5 6 7 8 9 10 11 2 5 6 7 8 9 10 11 Log GDP per capita 2015 Log GDP per capita 2015 Bhutan Botswana Costa Rica India Lao PDR Lesotho Bhutan Botswana Costa Rica Mauritius Nepal Other Countries India Lao PDR Lesotho Fitted values Mauritius Nepal Other Countries Fitted values Source: World Development Indicators and World Bank 2016d. Distance to Frontier (DTF) benchmarks economies with respect Source: World Development Indicators and Schwab 2016. to regulatory practice, showing the absolute distance to the best performance in each indicator. C. Components of Doing Business 2017 D. Components of GCI 2016–17 Doing Business Ranking, 2017 World Economic Forum Competiveness Index, 2016–2017 1st pillar: Institutions Starting a business Dealing with 12th pillar: Innovation 6 2nd pillar: Infrastructure 1 Resolving construction permits 5 31 insolvency 11th pillar: Business 4 3rd pillar: 61 sophistication 3 Macroeconomic 91 2 Enforcing 121 environment Getting electricity 1 contracts 151 10th pillar: 4th pillar: Health and 0 181 Market size primary education Trading across Registering 9th pillar: borders property Technological 5th pillar: Higher readiness education and training 8th pillar: Financial 6th pillar: Goods Paying taxes Getting credit market development market efficiency 7th pillar: Labor Protecting minority market efficiency investors Source: Schwab 2016. Source: Doing Business 2017 (World Bank 2016d). Figure 12:  Business Environment and Competitiveness Ranking an underdeveloped competition policy.26 Bhutan ease of doing business (World Bank 2016d), which is ranked 73th out of 192 countries in 2017 in the overall higher than all other South Asian economies (Fig- ure 12-A). However, Doing Business data also indicate that Bhutan has much room for improvement in access to 26. Many of the shortcomings identified by Doing Business and the Global Competitiveness Index align with those identified by previous credit, construction permits, bankruptcy procedures, and assessments of the constraints to private-sector growth in Bhutan. the protection of minority investors (Figure 12-C). The The World Bank’s 2010 Investment Climate Assessment (World Bank 2010), for example, identifies regulatory complexity and access to WEF Global Competitiveness Index, meanwhile, reports finance, transportation, and a skilled domestic labor force as Bhutan’s that Bhutan lags most comparator countries and is below main challenges. Similarly, the Asian Development Bank (ADB 2013) notes that the key impediments include: (i) inadequate and poor qual- the level predicted by its income level (Figure 12-B). In ity infrastructure, particularly in transport and connectivity in rural addition to the deep constraints of a small domestic areas; (ii) lack of access to finance by MSMEs; and (iii) limited and unequal access to quality education and labor market mismatches. market and adverse geography, Bhutan’s ranking in the 22 Investment Climate Assessment of Bhutan Share of Firms choosing a factor from the question “Which of the following elements of the business environment, if any, currently represents the biggest obstacle faced by this establishment?” Access to finance Labor regulations Tax rates Competition in the informal sector Transportation Electricity Inadequately educated workforce Access to land Customs and trade regulations Crime, theft and disorder Political instability Business licensing and permits Tax administration Corruption Courts 0 10 20 30 40 50 60 2009 (non-micro) 2015 (non-micro) 2015 (micro) Figure 13:  Perception of Investment Climate Constraints, 2009 and 2015 Global Competitiveness Index is lowered by the country’s business (Figure 13). Firms were much less likely to iden- limited financial development and a shortage of high- tify institutional factors such as political instability, cor- skilled workers (Figure 12-D). ruption, and courts as factors inhibiting the growth of the firm. This represents a contrast with other South Bhutanese managers perceive access to finance, Asian countries. For instance, the top obstacles cited by labor regulations, and taxation as the biggest con- Indian and Nepalese businesses in 2014 and 2013 were straints to firm growth.27 By a large margin, Bhu- corruption and political instability, respectively, while the tanese managers surveyed by the WBES 2015 cite access second most important obstacle for both countries was to finance, labor regulations, and tax rates as the greatest electricity.28 constraints presented by the country’s economic, institu- tional, and regulatory framework to the growth of their To assess the severity and sources of different business constraints, this chapter supplements 27. Despite the shortcomings of relying on subjective information, firm perceptions with data on firm performance, factors that firms perceive as inhibiting productivity and growth provide useful information as perception matters for investment cross-country benchmarking indicators, and decisions. Gennaioli, Ma, and Shleifer (2016), for example, find that investment plans and actual investments are well explained by business expectations. 28. See: https://www.enterprisesurveys.org/data/exploreeconomies/ Investment Climate Assessment of Bhutan 23 qualitative information. Section 2.2 examines access productive sectors remains low. While credit to the pri- to finance, which Bhutanese firms surveyed by the 2015 vate sector as a share of GDP increased rapidly between WBES were most likely to identify as their primary 2006 and 2010, it has been constant since 2010 and is constraint. Section 2.3 examines access to labor, which dominated by housing and personal loans (Figure 14 A encompassess labor regulation (the second-most fre- and B). Although lending to agriculture and trade and quently cited constraint in the WBES) and innovation commerce sectors has increased,30 the share of credit to and high-end skills (which the Global Competitiveness industry has barely changed in the last three years. Index suggests are major constraints on competitive- ness). Section 2.4 examines access to external markets, Managers—particularly of microenterprises—­ which encompasses logistics, transportation infrastruc- identify access to finance as a major constraint. ture, trade policies, and border processing. Section 2.5 In both the 2009 and 2015 WBES, access to finance was examines competition policy, which World Economic most frequently cited by managers as the constraint that Forum (WEF) data and anecdotal evidence suggest hin- most seriously inhibited firm productivity and invest- ders the performance of Bhutanese firms. Section 2.6 ment,31 a result that is consistent with the Establishment examines taxation, which is the third most frequently Survey Report 2016 by the Ministry of Labor and Human cited constraint in the 2015 WBES. Resources (Bhutan, MoLHR).32 The constraint is not uniform across firms, however (Figure 15). Whereas the 2.2  Access to Finance access to finance for larger firms in Bhutan is comparable to that elsewhere in South Asia, microenterprises are— Insufficient access to finance constrains Bhutan’s after accounting for sector and region—40 percent more private sector. Recent reforms have laid the foundations likely than larger firms to cite access to finance as their for the development of Bhutan’s financial sector. However, biggest obstacle.33 Microenterprises are often forced to tap the growth of firms—and the growth of microenterprises, alternate sources of financing—such as internal funds or in particular—continues to be impeded by inadequate retained earnings—or to forgo investments.34 While close access to credit (Subsection 2.2.1). Access to finance is restricted both by supply-side factors (such as a lack of financial competition, insufficient credit information, and sectors. In 2015, for example, Bhutan’s interest spread was 9.8 compared to the South Asian average of 5.1. Similarly, the lending an unpredictable restructuring and insolvency regime) and interest rate has stayed at around 14 percent in the last 10 years, by demand-side factors (such as an inability to collateralize higher than most peer countries. assets and a lack of financial literacy) (Subsection 2.2.2). 30. As of 2015, agriculture represented only 5 percent of aggregate credit. Lending to the trade and commerce sector has, however, increased from 12.7 percent in 2013 to 19.1 percent in 2015, which reflected the sector’s evident increase in labor productivity and 2.2.1 Severity of Constraint profitability. Despite recent reforms, the supply of credit is prob- 31. Over the two periods, the share of (non-micro) firms holding this view has not changed significantly. lematic. According to Doing Business, Bhutan ranked 32. Firms indicate that expectations about output demand is the most 82nd out of 183 countries on the ease of accessing credit important driver for hiring, while lack of credit is the most important obstacle to growth (Table 21 in Annex 3.3). in 2017, up from 177th in 2010. This improvement reflects 33. Non-micro Bhutanese firms are less likely than similar firms the success of reforms such as the establishment of the in South Asia to consider access to finance as a major or severe Credit Information Bureau (CIB) in 2010, the creation constraint and are more likely to have a bank loan or line of credit (47 percent versus 27 percent) and to use banks to finance invest- of three new commercial banks in 2010, and the incep- ments (Table 9). Microenterprises also use financial products less tion of a minimum reference rate for lending in August frequently, despite reporting higher average levels of productivity (Figure 16-B). 2016.29 Nonetheless, the supply of credit to Bhutan’s 34. Among microenterprises that invested, only 9 percent had bank financing compared to 25, 48, and 60 percent of small, medium, and large firms, respectively. Internal funds and retained earnings 29. Prior to 2016, regulations in Bhutan imposed interest rate caps represent the main source of financing for microenterprises, both for and restricted interest spreads based on banks’ individual cost struc- fixed assets and for working capital (89 and 91 percent, respectively). ture. These regulations limited price competition, curtailed product Among larger firms in Bhutan and South Asia generally, three-­ differentiation, and restrained the extension of credit to high-risk quarters of firms depend on internal financing to fund investments. 24 Investment Climate Assessment of Bhutan A. Domestic credit to private sector B. Credit share by sector Domestic credit to the private sector (% of GDP) Credit activity by sector 2015 (%) 120 100 2015 19.10% 24.46% 15.71% 80 60 40 2014 15.45% 25.65% 17.97% 20 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Bhutan Botswana Costa Rica India 2013 12.71% 26.99% 18.11% Lao PDR Mauritius Nepal South Asia 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Source: World Development Indicators. Agriculture/animal/husbandry Trade/commerce Manu/industry Service/tourism Housing Transport Loan against share Personal loan Credit card Others Source: RMA 2015. Figure 14:  Aggregate Credit 70% 65% 60% 49% 50% 50% 44% 42% 40% 32% 30% 25% 27% 24% 22% 19% 20% 9% 11% 10% 0% s ro l m e s g m es ro g ng ar al irm ge rg rin in iu is ic Pa kh Sm ic pa ol La ur M ed ra tu rv lf ng u/ sh ar To ve ac se Al M ph Jo /s nt be uf hu er ue im an up th & ep Th Ph m dr O od el m er G Fo Sa th O Figure 15:  Share of Firms Indicating Access to Finance Is Biggest Obstacle to half of larger firms invested in fixed assets, only 6 per- equivalent full-time worker, the counterpart median firm cent of microenterprises did so. Among microenterprises in India has twice as much capital, while the counterpart that did not invest, almost half attributed this to the high in Costa Rica has six times as much. For manufacturing cost of finance or a lack of internal funding. In contrast, firms for which data on assets is available, capital inten- 14, 17 and 7 percent of small, medium, and large firms, sity is the most important predictor of labor productivity. respectively, chose not to invest due to a lack of financing. Econometric analysis of various firm characteristics also indicates that firms for which access to finance is a con- Constraints on access to finance reduce labor pro- straint have lower employment growth rates (Annex 3.3).35 ductivity and employment growth. Evidence suggests that a lack of access to finance reduces labor productiv- ity in manufacturing. While the median manufacturing 35. Foreign firms also grow faster. To the extent that foreign firms are often less credit constrained, this result supports the hypothesis that firm in Bhutan has a capital stock of only US$3,500 per access to finance matters for employment growth. Investment Climate Assessment of Bhutan 25 A. Access to Financial Products (%) B. Value Added/Fixed Assets 120 98.9 micro(<=5) 100 94.9 88.1 79.0 80 small(5–20) 64.5 56.4 59.8 60 48.5 48.4 44.3 38.0 39.3 medium(20–99) 40 25.3 20.5 20 6.1 8.8 large(100+) 0 Have a checking Have a Invested in Have fixed assets or saving account credit line fixed assets funded by bank −5 0 5 borrowing Log return to capital (value added/K) Micro Small Medium Large excludes outside values Figure 16:  Financing Needs and Financial Access by Firm Size Note: Available for manufacturing firms only. 2.2.2 Sources of Constraint while the BDBL is the most important provider of credit Access to finance is limited both by factors that to the country’s farmers, it lacks a commercial banking discourage lenders from supplying financial prod- license and so is unable to finance agricultural exports. ucts and by factors that discourage potential bor- The lack of financial competition results in limited prod- rowers from demanding finance. Potential lenders uct development, high interest rates (Figure 17), and a are discouraged from supplying financial products and general reluctance among institutions other than BDBL services by the dominance of public banking institu- to lend to risky sectors (ibid.). tions; a lack of innovation in financial products; limited credit information; and a complex, unpredictable, and A weak insolvency scheme reduces the trans- ineffective restructuring and insolvency regime (Subsec- parency, cost-effectiveness, and simplicity of tion 2.2.2.1). Potential borrowers are discouraged from insolvency procedures and increases credit risk. accessing financial products by constraints on the extent Bhutan’s existing insolvency regime—governed primarily to which productive assets can be collateralized and a lack by the Bankruptcy Act 1999 and some provisions in the of financial literacy (Subsection 2.2.2.2). Companies Act—is outdated, lacks key provisions, and is governed by multiple statutes. Banks are consequently 2.2.2.1 Supply Side more risk-averse and lend less than they would under a Access to finance is restricted by high prices and developed insolvency regime. In particular, financial insti- the limited scope of products offered by the bank- tutions tend to focus more on safe loans—for instance, ing sector. Bhutan’s three largest banks—Bank of on firms whose collateral in fixed assets could be more Bhutan (BoB), Bhutan National Bank (BNB), and Bhu- easily foreclosed on—rather than undertaking potentially tan Development Bank Ltd. (BDBL), which collectively profitable investments. Such deficiencies explain the gaps account for 87 percent of bank assets—are all public between firms’ returns on investments and their ability to entities. Bhutan’s two privately controlled banks have receive bank credit. low and declining market shares, suggesting that they are relatively uncompetitive (Murgatroyd 2016).36 Moreover, Access of small and rural enterprises to finance is limited by shallow credit information and a lack of 36. The share of total assets held by the two private banks dropped mobile banking and/or microfinance institutions from 13.6 percent in 2013 to 12.8 percent in 2016 (Murgatroyd (MFIs). Bhutan’s Doing Business score of depth of credit 2016, 20). 26 Investment Climate Assessment of Bhutan A. Lending Interest Lending Interest Rate Rate B. Interest Spread Interest Speed 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Bhutan Botswana Costa Rica India Bhutan Botswana Costa Rica Lao PDR Lao PDR Mauritius Nepal Mauritius Nepal South Asia Source: World Development Indicators. Source: World Development Indicators. Figure 17:  Lending Interest Rate and Interest Spread Table 9: Comparison of Bhutan’s Financial Sector Indicators with Those of Peer Countries Strength Public Private of Legal Depth of Credit Credit Rights Credit Info. Registry Bureau Have Bank Have Have (0: weak; (0: low; Coverage Coverage Account Debit Card Credit Card 12: strong), 8: high), (% adults), (% adults), (% age 15+), (% age 15+), (% age 15+), Country 2016 2016 2016 2016 2014 2014 2014 Bhutan  4 6 26.0 0.0 33.7 17.2 0.3 Botswana  5 6 53.5 0.0 49.2 35.1 9.9 Costa Rica 10 7 100.0 30.5 64.6 53.6 14.5 India  6 7 21.4 0.0 52.8 22.1 4.2 Lao PDR  6 5 0.0 10.9 .. .. .. Mauritius  6 7 0.0 83.3 82.2 62.0 17.3 Nepal  6 0 1.8 0.0 33.8 6.7 0.4 South Asia 3.875 14.0 4.2 Source: Doing Business 2016 and FINDEX 2014. information and its credit registry’s coverage compares and while Bhutan’s high level of mobile phone penetra- favorably with the South Asian average (Table 9). However, tion would facilitate the expansion of mobile banking,38 the CIB currently only collects information from banks, such services do not currently exist in Bhutan. The MFI which limits the system’s utility.37 Farmers are at a partic- sector is similarly underdeveloped. Currently, only three ular disadvantage, as fewer than one in five have access to NGOs (Renew, Tarayana, and Loden) provide loans to bank credit (Murgatroyd 2016, 12). While mobile bank- ing has potential to extend credit to small enterprises and 38. As of July 2015, Bhutan was estimated to have 91 mobile phone other clients that cannot be served by traditional banks, subscribers per 100 inhabitants (US, CIA 2017). According to Murgatroyd (2016), Bhutan’s “two mobile cellular service providers are well placed to reach customers with affordable financial services 37. Plans exist to expand the CIB database coverage to incorporate given their existing customer base, marketing capabilities, physical information from utility companies—the two local telecom providers distribution infrastructure, and experience with high-volume, low- and the Bhutan Power Corporation—and to include loans made by value transactions like the sale of airtime” (11). B-Mobile—a local MFIs (including REDCL), as well as information from insurance cellular provider—has already partnered with some local banks to companies. issue e-money cards. Investment Climate Assessment of Bhutan 27 small enterprises and cooperatives in Bhutan (Murga- The average collateral requirement, as measured by troyd 2016). Priority lending to rural enterprises, admin- ­ collateral-to-principal ratios, has declined from 283 per- istered by BDBL and the Rural Enterprise Development cent in 2009 to 178 percent in 2015, but remains high Corporation Limited (REDCL), may be inadvertently (Figure 18-A). In addition to the high levels of collateral undermining the development of such sources of com- required, prevailing practices only allow for the collater- mercial finance due to the provision of loans for unpro- alization of fixed assets. Firms find it difficult to collater- ductive uses and the resulting high rates of default.39 alize moveable assets such as vehicles and inventory, and agricultural producers face similar problems in collater- 2.2.2.2 Demand Side alizing crops, crop transactions, and warehouse receipts. Restrictive requirements limit the ability of poten- tial borrowers to collateralize assets. One of the Limited financial awareness and financial manage- key complaints from Bhutan’s private sector is the exces- ment skills reduce use of financial products and sive amount of collateral required to obtain credit. services. As Bhutan’s financial system has only recently been liberalized, the population has had limited exposure 39. The Business Opportunity and Information Centre (BOiC), to modern financial products and services. The propor- which approved Nu 273 million in funding for cottage and small tion of the population with access to a bank account or industries over 20 months of operation, was closed in May 2016. The Bhutan Development Bank Ltd. (BDBL) provides collateral free credit or debit card is low compared to peer countries low-interest loans to cottage and small industries through revolving (Table 9). Among entrepreneurs and firm managers, fund I (RF-I). The new Rural Enterprise Development Corporation Ltd. provides micro-lending to rural enterprises through revolving financial literacy and the use of financial products and fund II (RF-II). T. Dorji (2016) notes that, “RF-II has a ceiling of services also are very low. In 2015, only 35 percent of Nu 100,000 per activity at the interest rate of 4 percent and is meant for non-formal rural activities like dairy, poultry and piggery, among firms surveyed prepared externally audited financial others.” Per a directive from the prime minister, RF-I is to target statements, which is 10 percentage points lower than schemes proposed by women entrepreneurs and recent graduates and those located in rural areas (T. Dorji 2016). the regional average (Figure 18). Only 27 percent of Table 10: Access to Finance in Bhutan (WBES 2015) Access to Finance Indicators Non-Micro Micro-Firms South Asia (Non-Micro) Firms with Checking or Saving Account 93.3 63.3 77.6 Firms with Loan/Line of Credit 46.5 19.8 27 Firms with Annual Financial Statement Reviewed 35.8 7 46.3 by External Auditors Loans Requiring Collateral 94.5 96.3 81.1 Value of Collateral Needed for Loan (% of loan amount) 352 226 236 Firms That Do Not Need a Loan 57.7 58 44.7 Firms Whose Recent Loan Application Was Rejected 8.3 32.6 14.4 Firms Using Banks to Finance Investments 32.2 0 21.8 Investments Financed Internally 75.1 86.1 73.9 Investments Financed by Banks 18.9 13.4 14.4 Investments Financed by Supplier Credit 0.9 0 1 Investments Financed by Equity or Stock Sales 3.4 5.6 6.9 Firms Using Banks to Finance Working Capital 42 9.4 25 Working Capital Financed by Banks 25.9 5.8 12.4 Working Capital Financed by Supplier Credit 1.1 0 4.3 Firms Identifying Access to Finance as a Major Constraint 16.4 44.2 26.5 Source: Author’s calculations from the WBES and https://www.enterprisesurveys.org/. 28 Investment Climate Assessment of Bhutan A. Median Value of Collateral Needed for Most Recent Loan B. Share of Firms with Audited Financial Statements micro(<=5) 125 micro(<=5) 0.07 small(5–20) 100 small(5−20) 0.27 medium(20–99) 200 medium(20−99) 0.65 large(100+) 225 large(100+) 0.84 0 50 100 150 200 250 0 .2 .4 .6 .8 Figure 18:  Demand-Side Factors Inhibiting Access to Finance small firms and 7 percent of microenterprises prepared low. Furthermore, the country’s minimum wage is rea- audited financial statements (Figure 18), which poten- sonable given the average wage.41 Overall, the policy tially explains the observed financing gaps. regime seems to strike a good balance between over- and under-regulation, and Bhutan performs relatively well 2.3  Access to Skills on the World Economic Forum’s Global Competitive- ness Report 2017 assessment of labor market efficiency, Access to skilled labor constrains the growth of ranking 27th out of 140 countries. Bhutan’s private sector. After access to finance, labor regulations are the business constraint most frequently Restrictive immigration rules and high salary costs cited by Bhutanese managers (Subsection 2.3.1). While are problematic for larger firms. Microenterprises are Bhutan’s de jure labor regulations compare favorably less likely than larger firms to complain about labor reg- with those of other countries in the region, the access of ulations (Figure 19), which may be due to larger firms ­ private-sector firms to labor—particularly skilled labor— hiring more foreign workers.42 Conditional on size, sector, is inhibited by three major factors: (i) low levels of edu- and regional composition, firms with foreign workers are cation among the population; (ii) competition with the 22 percent more likely to consider labor regulations as public sector; and (iii) regulations limiting the employ- the most important obstacle. Across all firms surveyed, ment of skilled foreign workers (Subsection 2.3.2). salary costs, immigration rules, and workers’ education are the most likely to be cited as particularly problem- 2.3.1 Severity of Constraint atic (Table 12, Annex 3.5). However, there is variation Despite frequent complaints by managers about between firms in the extent to which they are affected labor regulation, Bhutan’s domestic labor market by different forms of labor constraints, with restrictive policies align with international norms.40 Bhutan’s immigration rules particularly problematic for medium Labor and Employment Act places few restrictions on and large firms (49 and 54 percent, respectively). the hiring and firing of workers. For example, there are no limits on fixed-term contracts and few restric- Bhutan’s worker education and managerial expe- tions on terminating employees for economic reasons. rience is comparatively low, which reduces firm Regulations on work hours, annual leave, and occupa- tional health and safety are in accordance with inter- 41. The ratio of minimum wage to value added per worker in national standards, while labor taxes are comparatively Bhutan is 0.2, lower than that in all other countries with a minimum wage policy in South Asia (Table 13). 42. Once the presence of foreign workers is taken into account, there 40. Assessments of labor regulations in this section draw heavily from are no significant differences in perception about labor regulations World Bank 2016a. across firm sizes. Investment Climate Assessment of Bhutan 29 60% 51.9% 50% 40% 30% 25.3% 24.3% 25.5% 22.8% 23.4% 20% 18.6% 18.6% 15.4% 13.5% 11.6% 11.0% 10% 8.5% 0 s ro l m e es g m s ro g ng r al ha irm ce rg rin lin iu is ic Pa Sm g pa La gk ur vi o M ed ra tu lf u/ sh ar er To ve ac n Al M ph Jo /s rs nt be uf hu ue im e an up th & ep Th Ph rm dr O od el m G e Fo Sa th O Figure 19:  Share of Firms Citing Labor Regulations as Biggest Obstacle productivity. Levels of worker education and manager 2.3.2.1 Domestic Supply of Skills experience in Bhutan’s private sector lag those of other small Despite the recent rapid improvement in school service-driven economies such as Botswana and Mauritius enrollment rates, a majority of Bhutan’s workforce (Table 19; Annex 3.4). Furthermore, managers of Bhu- lacks formal education. Bhutan recently achieved tanese firms in 2015 have less experience than managers in near-universal enrollment in primary education and has 2009. Given that the education of firm owners and workers dramatically increased secondary and tertiary enrollment is one of the most important determinants of labor produc- rates. While these recent changes are impressive, they also tivity,43 Bhutanese firms are likely to benefit from attracting underscore the low levels of educational attainment among better educated workers and more skilled managers. the older population. As of 2014, more than 60 percent of Bhutan’s labor force—and 49 percent of nonagricultural private sector workers—lacked formal education, and only 2.3.2 Sources of Constraint 7 percent—and 8 percent of nonagricultural private sector Skills shortages are caused by a generally low level workers—had completed tertiary education (World Bank, of education, by recruitment of skilled workers into MoHLR 2016a). While the supply of skills in the economy the public sector, and by restrictions on the employ- is increasing due to higher educational attainment, it is also ment of foreign workers. Over the past decade, Bhutan being reduced by declines in labor force participation as has increased educational enrollment. However, due to his- women increasingly opt out of employment.44 torically low levels of schooling, the pool of well-educated workers in Bhutan remains relatively small (Subsection Specialized and soft skills are particularly scarce 2.3.2.1). Moreover, secondary and tertiary graduates in across the Bhutan labor force. WBES data show that Bhutan are overwhelmingly attracted to the public sector, nearly 40 percent of firm managers believe their employ- sector firms to recruit such making it difficult for private-­ ees’ job-specific skills fall below that required for the workers (Subsection 2.3.2.2). Due to immigration restric- firm’s scope of work (World Bank, MoHLR 2016a). The tions, firms cannot overcome skill shortages by employing dearth of computer and soft skills—such as leadership, foreign labor (Subsection 2.3.2.3), lowering productivity. 44. Female labor force participation rose from 38 percent in 2001 43. Table 17 (Annex 3.3) reports results from firm-level regressions to 67 percent in 2011, but fell to just 56 percent in 2015 (Bhutan, that formally analyze the determinants of labor productivity. MoLHR 2015a). 30 Investment Climate Assessment of Bhutan teamwork, and professionalism—appears to particularly the nonagriculture private sector. This is in line with concern managers. For instance, 60 percent of employers international averages.45 However, what is remarkable believe that their employees’ computer skills are inade- about public-sector employment in Bhutan is the extent quate, while 40 percent of managers at nonagricultural to which it is dominated by skilled employees and, as a sector firms report that their employees lack nec- private-­ result, consumes the country’s relatively small supply of essary skills in problem solving, critical thinking, and/ skills. Of those workers with tertiary education, more or leadership. Managers at a quarter of firms expressed than 66 percent are employed by the public sector, and concern about the teamwork of their workers. 51 percent work in the general government (that is, not in a state-owned enterprise) (World Bank, MoHLR 2016a). The scarcity of skills in Bhutan constrains the com- While more than 60 percent of Bhutan’s general labor petitiveness of manufacturing. In both manufactur- force lacks a formal education, only 22 percent of pub- ing and services, prevailing wages paid by firms in Bhutan lic sector workers do so. Likewise, workers with tertiary appear to be highly competitive compared with those paid education make up 21 percent of the public-sector work- by firms in other peer countries (Figure 20). Median wages force, but only 7 percent of the general workforce. in manufacturing in fact declined between 2009 and 2015. However, the productivity of manufacturing—as mea- The disproportionate number of skilled workers in sured by the ratio of value added to the cost of labor—fell the public sector reflects the preference of educated even further over the same period. As worker skills are a Bhutanese for public-sector employment. Whereas key determinant of productivity in manufacturing, the very the unemployment rate for those without formal educa- low level of productivity underscores the economic cost tion is just 0.2 percent, 12.3 percent of those with tertiary imposed by the shortage of skills for manufacturing firms. 45. Globally, an average of 18.9 percent of all workers are employed in the public sector and 13.8 percent in the government. Overall 2.3.2.2 Domestic Demand for Skills public-sector employment in Bhutan is on a par with the international Bhutan’s small stock of skilled workers are over- average, although general government employment (which excludes state-owned enterprises) is somewhat higher. However, this figure is whelmingly employed in the public sector. The pub- high for a small, landlocked country such as Bhutan that has a rela- lic sector employs a similar number of workers as does tively underdeveloped private sector (World Bank, MoHLR 2016a). A. Manufacturing B. Services Median value added per worker/labor cost 8 8 10 Median value added per worker/labor cost 5 Median annual labor cost Median annual labor cost 6 6 8 4 4 4 6 3 2 2 4 2 0 1 0 2 10 10 09 15 10 10 14 16 16 09 3 01 13 09 15 10 10 PD 14 16 16 ep 09 20 20 20 20 20 20 20 20 2 20 20 20 20 20 0 20 20 20 an an a a a R ho s al 2 iu an ic di al PD ep n Bo an a a a R o s ut ut ot R rit In iu a an ic di th sw N Bh Bh s au ut ut ta R rit In o so Le N w t La Bh Bh os au Bo M ta ts o Le La os C M C Labor cost VA/labor cost Labor cost VA/labor cost Figure 20:  Relative Cost and Productivity of Labor Note: Annual labor cost is measured in thousands of $US per worker, in 2010 prices. Value added is similarly measured in 2010 $US. A higher ratio of value added/labor cost, indicates a more competitive labor force. Investment Climate Assessment of Bhutan 31 education are unemployed (World Bank, MoHLR 2016a). labor at reasonable wage rates. WBES data indicate Surveys of the unemployed indicate that they are wait- that among firms who tried to hire in 2014, 57 percent ing for public-sector opportunities to become available. encountered hiring difficulties, of which most related to According to the 2014 Labor Force Survey, 71 percent applicants expecting higher wages (59 percent) and pre- of unemployed or otherwise inactive respondents with a ferring public-sector jobs (25 percent). Among managers higher-secondary education and 87 percent of those with a of large firms, 42 percent indicate that competition from tertiary education preferred a position in the public sector. the public sector is the main reason that they are unable to retain workers (World Bank, MoLHR 2016a). Public-sector jobs offer more generous benefits, as well as greater job security. While public-sector 2.3.2.3 Employment of Foreign Workers workers receive wages similar to those doing compa- While Bhutan has flexible labor regulations, it is dif- rable work in the private sector, overall compensation ficult for firms to recruit expatriate workers. Cur- packages—which include pensions, subsidized housing, ­ rent regulations on the employment of non-Bhutanese and provident fund payments—are more generous in the workers, outlined in the Handbook on Recruitment and public sector (Figure 21; World Bank, MoLHR 2016a).46 Employment of Foreign Workers, restrict occupation of As a result, competition from the public sector makes it employment and country of origin, other than India; very difficult for private firms to recruit and retain skilled impose a cap on the total number of foreign workers in Bhutan; and restrict firms from terminating the contracts of local employees (Bhutan, MoLHR 2015b). While for- 46. For instance, the 2014 Labor Force Survey establishes that while over 90 percent of public-sector workers receive key fringe benefits eign investment regulations prescribe greater flexibility to which all workers are entitled to by law, only 25 to 65 percent of for foreign firms, such policies appear not to have been private-sector workers receive any particular benefit (World Bank, MoHLR 2016a). There is a particular discrepancy in the generosity applied. Investors, rather, indicate that they are subject to of pensions, with Bhutan’s public-sector pensions exhibiting the the standard regulations and thereby limited in recruiting highest level relative to wages in all South Asian countries except Sri Lanka (ibid.). skilled foreign labor (see Subsection 1.4.3). 120% 100% 95% 96% 96% 96% 96% 97% 94% 95% 80% 63% 65% 60% 48% 44% 40% 32% 33% 29% 27% 20% 0% Paid annual leave Gratuity Provident fund Overtime Paid maternity/ Paid casual leave Paid sick leave Compensation for payments payments paternity leave work accidents or occupational diseases Public sector Private sector Figure 21:  Competition for Labor with Public Sector Source: World Bank, MoLHR 2016a. 32 Investment Climate Assessment of Bhutan Current policies inhibit firms from using expatriate of cross-border transport is increased by deficiencies in workers to fill skills gaps. As of April 2016, 48,122 infrastructure quality and logistics performance, while foreign workers were employed in Bhutan, comprising limited flows of foreign investment also reduce access to 19.8 percent of the workforce (Bhutan, MoLHR 2015c). markets (Subsection 2.4.2). The vast majority of foreign workers are less skilled, as indicated by their lower qualifications and wage levels 2.4.1 Severity of Constraint (World Bank, MoHLR 2016a). Almost all foreign workers Few firms rank transport, customs, and trade regu- are Indian, with only 323 non-Indian foreign workers as lation as a key constraint, although this reflects the of April 2016. As such, the cap imposed on foreign work- low number of firms on the cusp of exporting. Only ers appears to crowd out skilled foreign labor and inhibit 5 percent of all firms perceive customs procedures and firms from filling skill shortages. trade regulations as a top constraint, and less than 3 per- cent of firms consider transportation to be a top obsta- 2.4 Access to External cle (Figure 22). However, perceptions differ significantly Markets between exporters and non-exporters. Direct and indirect Access to external markets—caused by transport exporters are 10 percent more likely than non-exporters and logistics deficiencies and low levels of foreign to cite transportation as their biggest constraint. Of firms investment—inhibits the development of the pri- that export directly, 10 percent consider custom and trade vate sector. Bhutanese businesses do not rank access regulations to be the top constraint, compared to only to external markets as a primary obstacle, although 1 percent of those firms that do not export directly.47 this reflects the low proportion of firms that attempt to export. Doing Business and the Logistics Performance 47. A key challenge in accessing foreign markets is the high fixed Index (LPI) report that Bhutanese firms face high costs costs associated with exporting, which favor larger firms. These fixed costs are especially binding for Bhutanese firms given the country’s to access external markets (Subsection 2.4.1). While tariff constraints of geographical and economies of scale. Because of the barriers are low and customs facilities efficient, the cost fixed costs of exporting, exporters tend to be larger firms. 14% 13% 13% 12% 10% 10% 10% 9% 9% 9% 8% 7% 6% 5% 6% 5% 5% 5% 5% 5% 4% 4% 4%3% 4% 3% 2% 3% 2% 2% 2% 2% 1% 1% 1% 1% 0% 0% 0% 0% 0% 0% s o l m ge s To g m es ro g g ar ex rts rs rs rs al irm ge r rin in an iu is rte te rte ic Pa kh Sm ic o r ol La ur M ed ra tu ire exp or p rv lf ng po po u/ sh ar ve ac xp se Al M ph Jo Ex /s nt be uf ct -e hu er ue im re an up ct on th & ep Th Ph di m dr N O d el o D m o er N G Fo Sa th O Customs and trade regulations Transport Figure 22:  Share of Firms Citing Customs and Trade Regulations or Transport as Biggest Obstacle Investment Climate Assessment of Bhutan 33 LPI (Bhutan's rank: 135/160) 3.5 3 2.5 Timeliness (rank: 129) Customs (rank: 128) 2 1.5 1 0.5 0 Tracking & tracing Infrastructure (rank: 151) (rank: 131) Logistics competence International shipments (rank: 131) (rank: 108) Bhutan Region: South Asia Income: Lower middle income Figure 23:  Logistic Performance Index 2016 Source: World Bank Logistic Performance Index 2016. The high costs faced by importers and exporters The ability of Bhutanese producers to access external in Bhutan are reflected in the country’s low—and markets is hindered by gaps in domestic infrastructure, falling—LPI ranking. Bhutan’s overall LPI score fell by the underdeveloped state of Bhutan’s transport and between 2012 and 2016 from 2.52 to 2.32 (with 5 being logistics industry, and by limitations on air travel and the most efficient). and Bhutan ranked 135th out of all Internet connectivity (Subsection 2.4.2.1). While Bhutan 160 economies in 2016.48 Bhutan underperforms both enjoys tariff-free access to key trading partners and has the regional average and lower-middle income coun- developed sound customs procedures, inefficiencies at the tries in most indicators, but particularly in infrastructure, Port of Kolkata hinder the access of Bhutanese produc- logistic competence, and the ability to track and trace ers to third-country markets (Subsection 2.4.2.2). Finally, consignments (Figure 23). Bhutan’s logistical perfor- inflows of foreign investment—which can enable access mance resembles that of other landlocked countries in to external markets and technologies—are hampered by the region, including Afghanistan, which ranked 150th in sectoral restrictions, skills shortages, and the ad hoc nature 2016, and Nepal, which ranked 124th. of incentives (Subsection 2.4.2.3). The limited use of quality certification also inhibits market access, particu- larly to high-value markets (Subsection 2.4.2.4). 2.4.2 Sources of Constraint Access to external markets is inhibited by gaps 2.4.2.1 Transport, Logistical, and Internet in domestic infrastructure, deficiencies in transit Infrastructure corridors, and impediments to foreign investment. Despite recent public investments, Bhutan has poor domestic connectivity. Bhutan’s road network 48. Due to the methodology of the LPI, rankings for landlocked has recently been expanded. Since 1997, for instance, countries and small island states may reflect access problems outside the country assessed. As such, the low rating of a landlocked country the government has built more than 6,920 kilometers of might not adequately reflect its trade facilitation efforts. motorable roads (Bhutan National Bureau of Statistics 34 Investment Climate Assessment of Bhutan 2015). However, the southern east/west axis of the coun- the small market size and high operational costs caused try still suffers from limited connectivity, forcing traders by limitation to visual landings at all airports. Combined, and travelers to transit the Indian state of Assam. The these barriers limit competition and make flights into high overall transport costs are reflected in Doing Busi- Bhutan some of the most expensive in the world. ness, which reports that exports cost US$287 per con- tainer in Bhutan,49 compared to US$158 in India.50 The logistics sector is inhibited by the requirement that Bhutanese trucks entering India return empty. Bhutan’s transport and logistics industry is under- Indian trucker syndicates unofficially impede Bhutanese developed. According to the Diagnostics Trade and plated trucks from picking up goods on their return from Integration Study 2012 MoEA. 2012), Bhutan’s key India. Thus, while Indian truckers readily cross into Bhu- weaknesses include a lack of logistics infrastructure, pro- tan, Bhutanese truckers are forced to focus exclusively on fessional handling services, and economies of scale. These domestic transport. As a result, Bhutanese transporters problems are exacerbated by: (i) relatively high land prices carry only a fraction of cross-border freight (Subba 2017), for transport related infrastructure; (ii) few opportunities limiting the economic viability of the logistics sector and for logistics training and driver training; and (iii) the small reducing the incentives for private investment. size of most consignments carried by Bhutanese traders, which in turn limits the ability of freight forwarders’ ser- Bhutan’s Internet connectivity lags neighbor- vices to achieve economies of scale. The lack of special- ing countries. According to the quarterly State of the ized freight services particularly impedes the transport of Internet Connectivity Report prepared by Akamai Tech- perishable goods (such as agricultural and horticultural nologies (Akamai 2017), Bhutan’s average Internet con- products), which is one of the few industries with existing nectivity speed is 3.4 Mbps. This matches Nepal and demand for exports. exceeds Pakistan (2.3), but is slower than Bangladesh (4.2), India (6.5), Indonesia (7.2), Vietnam (9.5), and Despite recent investments, the cost of air trans- Thailand (16.0).52 Key informants in the Thimphu Tech- port to and within Bhutan is extremely high due to Park noted that, even with subsidies, the cost of Inter- limited competition and high operational costs.51 net access is twice as high as in neighboring countries. Bhutan has invested in upgrading its three domestic air- Indeed, the (unsubsidized) monthly Internet lease line ports in Gelephu, Bumthang, and Yongphulla, although tariff provided by Bhutan Telecom (at up to 30 Mbps or the cost of air travel remains high. The current market more) is currently 252,626 BTN (Bhutan Telecom Ltd. for air travel in Bhutan includes two main carriers, Bhu- 2017), or more than US$3,000, whereas monthly prices tan Airlines and Druk Air, and a third that operates only for broadband services (at speeds of at least 60 Mbps) in limited charter flights, Buddha Air. The entry of Bhutan Dhaka, Bangladesh, and Bangalore, India, are US$24.46 Airlines, a private carrier, has increased choices for con- and US$18.39, respectively (Numbeo 2017). sumers, but further entry into the market is limited by 2.4.2.2  Border Costs Bhutan has maintained low trade barriers to off- 49. This reflects transport from a warehouse in the largest business city to the most widely used seaport, airport, or land border and cap- set its high trade costs. Bhutanese producers enjoy tures the time for (and cost of) the actual transport; any traffic delays unfettered access to India and duty-free and quota-free and road police checks, as well as time spent on loading or unloading at the warehouse or border. access to Europe and the U.S. Bhutan has been part of 50. Bhutan’s poor connectivity is echoed by the World Economic the South Asia Free Trade Agreement since 2004 and, as Forum’s (WEF) Executive Opinion Survey in 2017, which reports that the “inadequate supply of infrastructure” is the second most a result, has low overall applied and most favored nation problematic factor for doing business in the country. The WEF’s (MFN) tariff lines with current trading partners. The Competitiveness Index 2017 also ranks Bhutan among the lowest in the world in quality of port infrastructure (136/140) and availability of airline seats (137/140). 52. Fastmetrics (2017) reports that Bhutan’s average Internet speed 51. This section draws heavily on the air transport sector assessment is 2.4 Mbps, compared to 2.7 Mbps in Bangladesh and 2.8 Mbps in by the ADB (2016). India. Investment Climate Assessment of Bhutan 35 2009 Market Access Overall Trade Restrictiveness Index cost in India and far lower than in Costa Rica or Mauri- (MA-OTRI) (Kee et al. 2009), which captures the policy tius (Figure 24-A; Figure 24-B). However, firm-level data distortions imposed on Bhutan’s export bundle, reports suggest Bhutan has a higher median processing time as that Bhutan’s level of access is second only to Nepal in well as a high level of variation compared to other land- South Asia. Bhutan also maintains near-zero tariffs on locked countries such as Lao and Lesotho. Anecdotal imports, especially for manufacturing goods (Bhutan, evidence further suggests increased congestion and ineffi- MoEA 2012). ciencies at Phuentsholing. Phuentsholing Port is generally efficient, although Access to third-country markets is hampered uncertainty is created by uneven implementation. by inefficiencies at the Port of Kolkata. Most In 2017, Bhutan ranks 26 out of 190 in the Doing Busi- Bhutanese freight uses three main transit corridors: ness’s Trading Across Borders indicator, based on proce- (i) Phuentsholing-­ Kolkata; (ii) Phuentsholing-Burimari; dures at the Phuentsholing-Jaigaon border crossing.53 For and (iii) Phuentsholing-­ Birgunji. Of these, the Kolkata both imports and exports, Bhutanese borders are some of corridor carries the most regular and largest volume of the fastest and least expensive in the region. In 2017, the country freight flows as it is used for the transit of third-­ typical cost to import and export is US$109 and US$160 goods. The performance of this corridor is, however, per container, which is less than one-fifth of the average hampered by lengthy clearance procedures and frequent strikes at the Port of Kolkata (Bhutan, MoEA 2012). Accordingly, the RGoB has been seeking to increase the 53. The methodology for scoring the “trading across borders” per- formance changed in 2015, rendering the ranking not comparable use of alternative transit routes—especially through the over time. border post at Changrabandha (India) and Burimari A. Time to Import and Export, 2017 (DB) B. Cost to Import and Export, 2017 (DB) Bhutan 13 Bhutan 160 14 109 Botswana 7 Botswana 165 32 496 Costa Rica 106 Costa Rica 495 44 455 India 344 709 144 India 505 Lao PDR 230 268 228 Lao PDR 308 Mauritius 60 538 57 Mauritius 431 Nepal 109 270 75 Nepal 373 0 50 100 150 200 250 300 350 400 0 100 200 300 400 500 600 700 800 Time to export (hours) Time to import (hours) Cost to export (US$ per container) Cost to import ($US per container) Figure 24:  Time and Cost to Import and Export Source: Doing Business 2017. Costs of exporting and importing are estimated as the total of cost for border compliance and documentary compliance. Border compliance includes the time and cost for obtaining, preparing, and submitting documents during port or border handling, customs clearance, and inspection procedures. Documentary compliance includes the time cost for obtaining, preparing, processing, presenting, and submitting documents. 36 Investment Climate Assessment of Bhutan (Bangladesh)—and to develop new entry and exit points cost of obtaining them, given Bhutan’s underdeveloped that connect more directly to the planned new industrial quality infrastructure and limited supply of certification estates along the border with India. services. 2.4.2.3  Foreign Direct Investment 2.5  Market Competition Despite gradual liberalization since 2010, entry Competition is reduced by oversized public invest- barriers remain high for foreign investors. FDI ments and deficiencies in public procurement. is important for Bhutan’s economic development as a Competition is less than satisfactory in many sectors (Sub- source of capital, innovation, management expertise, section 2.5.1). The oversized role of state-owned enter- and in enabling access to external markets. However, prises and their level of access to policy makers potentially equity restrictions exist and differ for various non-priority discourages private investment (Subsection 2.5.2). While sectors. The 2010 FDI policy has used a “negative list” Bhutan’s public procurement framework performs well approach toward entry barriers, which helps improve by international standards, it may be further refined to predictability for foreign investors. However, some equity promote competition. restrictions require revision to ensure desirable invest- ments are not inhibited. One example is the hotel sector. A minimum investment threshold exists to attract high- 2.5.1 Severity of Constraint value, low-impact tourism, but alternative incentives to Sectors of Bhutan’s economy suffer from low levels encourage home-stay tours in rural destinations might be of competition. While existing data do not permit the more effective. estimation of concentration by business sector, evidence suggests that the economy lacks healthy competition Foreign investment in agribusiness is discouraged in some areas. Bhutan ranks 102 out of 140 countries by difficulties in registering property. Given the land in “intensity of local competition” on the 2016–2017 intensiveness of agribusiness and the collateral require- Global Competitiveness Index (Schwab 2016). Accord- ments for obtaining credit in Bhutan, the ease of register- ing to Bhutan’s 2015 Statistical Yearbook (Bhutan National ing property is important for prospective foreign investors. Bureau of Statistics 2015), the manufacturing sector According to Doing Business, it takes on average 77 days is dominated by a small number of operators, two of to transfer a property title between Bhutanese nationals which—­ Bhutan Ferro Alloys Ltd. and Bhutan Carbide and likely takes much longer for transfers involving for- and Chemicals Ltd.—belong to the same conglomerate, eign investors. Such administrative barriers discourage the Tashi Group. In the service sector, stagnating wage foreign agribusiness firms from establishing operations in levels in the face of large labor productivity growth indi- Bhutan. cates the presence of monopsony power. Public procurement, which is large relative to the 2.4.2.4  Quality Certification economy and can impact competitiveness, per- Quality certification in Bhutan is low by interna- forms well.54 Public procurement accounted for 60 to tional standards. Currently, less than 5 percent of Bhu- 70 percent of Bhutan’s government budget, or around tanese firms have any internationally recognized quality 35 percent of GDP in 2012–13 (CSCP undated), com- qualification. This is significantly lower than in other pared to an average of 19 percent across South Asia countries. The low prevalence of quality certification might reflect low demand given that only a small share of firms export products. Nevertheless, a lack of firm- 54. As the largest buyer in the country, the government can influence private-sector capacity and competition in a major way through its level investments in quality standards contrasts with the procurement policy. One example includes recent efforts by the gov- country’s ambition to build Brand Bhutan. The under- ernment to roll out ICT infrastructure for online business registration and tax administration, which represents an opportunity to establish use of quality certification might stem from both a failure an environment in which services to the IT sector can compete and to understand the benefits of certification and the high develop. Investment Climate Assessment of Bhutan 37 (Djankov et al. 2016). The large size of Bhutan’s public Cooperatives has also drawn complaints by local shop procurement creates the potential for the sector to impact owners of unfair price competition (World Bank 2017a). the private sector. However, a recent World Bank assess- ment concludes that the public procurement system is sat- Various sectoral regulations also inhibit competi- isfactory (World Bank 2017a). Bhutan also scores well in tion. In the tourism sector, the current tariff policy effec- the World Bank’s 2017 Public Procurement Benchmark- tively guarantees a price floor and minimum profitability ing on aspects related to the efficiency of administrative for tour operators. Consequently, tour operators have few procedures (World Bank 2016f). incentives to compete and diversify their products. Anec- dotal evidence suggests that many tour operators offer identical packages on their websites. 2.5.2 Sources of Constraint Large state-owned enterprises, unequal access to policy makers, and public procurement policies 2.5.2.2 Policy Feedback inhibit private-sector development. In the absence of Conflicts of interest discourage private investment a robust competition policy, various interventions appear in sectors in which SOEs operate. With the 2007 state to inadvertently inhibit private-sector development (Sub- ownership policy, Bhutan has sought to improve the effi- section 2.5.2.1). The mandated role of DHI in providing ciency and effectiveness of SOEs through better gover- feedback to the Ministry of Finance creates a de jure con- nance by separating policy oversight from shareholder flict of interest that may discourage private investment oversight. However, DHI’s role in advising Ministry of (Subsection 2.5.2.2). Finally, Bhutan’s public procurement Finance policies creates prima facie conflicts of interest in framework also may be inadvertently inhibiting the devel- industries in which GLCs compete with private firms. opment of private sector firms (Subsection 2.5.2.3). The mere appearance of such conflicts of interest may also discourage private investment. In addition, GLCs 2.5.2.1 Competition Policy may exercise a competitive advantage over private firms Bhutan’s competition policies are still rudimentary. in the respective sector that over time may result in higher In 2015, the Gross National Happiness Commission prices and lower quality for consumers. began reviewing a draft National Competition Policy, but currently no laws address anticompetitive practices, 2.5.2.3 Public Procurement monopolies, and cartels. The Consumer Protection Act, The current public procurement framework is enacted in 2012, sets out the rights and responsibilities limited in its potential to develop firm capabil- of consumers and is administered by the Office of Con- ities. The absence of a policy covering market analy- sumer Protection. The passage of the Act appears to have sis to inform the creation of an effective procurement provided a slight boost to competition, but awareness of strategy for contracts and the lack of a clear policy on the Act seems low and firms indicate that the playing field bidder debriefs could contribute to higher bidding costs, is still unfair (Bertelsmann Stiftung 2016). rebidding costs, or the selection of the wrong bidder, as well as disincentives to participation for potential bidders State interventions in some sectors have raised (World Bank 2017b). The public procurement framework concerns about crowding out of private invest- has provisions for preferential treatment by types of firms ments. State-owned enterprises (SOEs) have achieved (domestic firms and Cottage and Small Industry [CSI] economies of scale in various strategic industries, includ- sectors), which has been the typical tool for governments ing those in which private firms operate. However, key to encourage specific groups. However, conversations informants suggest that, in sectors such as small-scale with private-sector representatives suggest that bidding mining, woodcraft, and construction, where potential evaluation criteria are not formulated in a way that profitability is relatively high, private investments have incentivizes businesses to improve their capabilities. For been deterred by SOEs. The establishment of Farm example, no provision ensures that the quality of a firm’s Shops by the Department of Agricultural Marketing and human resources matches the requirements of a job. 38 Investment Climate Assessment of Bhutan 2.6 Taxation inspections in 2015 than in 2009 and fewer inspections than in comparator countries such as Costa Rica and India. Tax The high proportion of firms that cite taxation as a inspections are also applied more consistently. In Bhutan, major business constraint reflects the predominance most firms have only one tax inspection per year, whereas of poor accounting practices. Taxation was the third- in Costa Rica and India firms may experience between one most cited constraint by Bhutanese firms in 2015. However, and six tax inspections per year (Figure 25-C). the proportion of Bhutanese firms noting taxation as a con- straint is below the South Asian average, and the overall tax burden in Bhutan is similar to comparator countries 2.6.2 Sources of Constraint (Subsection 2.6.1). Rather than actual tax rates or proce- Poor accounting practices—common among micro dures, the perception of burdensome taxes reflects poor and small firms—result in a lack of transparency in accounting practices, which in turn necessitate discretion- taxation assessments. Many micro and small firms ary judgments by officials to determine tax burdens (Sub- report that taxation is a significant burden on their opera- section 2.6.2). tions, yet such firms are also most likely to be eligible for tax exemptions.56 Moreover, where firms lack detailed accounts, tax officials apply discretionary judgment to calculate tax 2.6.1 Severity of Constraint payments.57 As such, a lack of financial management may The proportion of firms citing taxation as a major adversely affect firms’ tax burden. Bhutanese firms are less constraint is high, although less than in other coun- likely than their regional peers to prepare externally audited tries. High tax rates were considered a major business financial statements, with microenterprises extremely obstacle by 15 percent of Bhutanese firms. However, unlikely to do so. Tax data collected by Department of firms around the world routinely complain about high Revenue and Customs (DRC) indicate that, in 2015, only tax rates. For instance, 26 percent and 30 percent of 8.6 percent of all BIT registered payers submitted books of businesses in South Asia and in all countries, respectively, account. Firms with audited statements are 6 percent less identify tax rates as a major or severe constraint. likely to perceive tax rates as the top constraint, even after accounting for firm size, sector, and location (Figure 25-D). While profit tax rates in Bhutan are higher than in many countries in the region, the overall tax burden Poor accounting practices reflect the recent adop- in Bhutan is low. Bhutan’s tax regime imposes a 30 per- tion of official accounting standards and failures to cent tax on net profit, but does not tax labor or other con- build firm capacities. The lack of accounting standards tributions.55 The overall burden of taxation in Bhutan is limits transparency and inhibits firms’ access to capital mar- lower than that in India and across South Asia countries kets. Until 2012, Bhutan did not have official accounting (Figure 25-A). For a typical LLC, the time to pay taxes has standards and businesses generally follow the Generally also dropped over the past 10 years. In 2017, the time to pay Accepted Accounting Principles (GAAP) and, in some taxes was 85 hours per year, which is one-third of the aver- cases, the Indian Accounting Standards (http://business age time required for firms across South Asia (Figure 25-B). bhutan.bt/10933-2/). Consequently, accounting principles WBES data further suggest that firms faced fewer tax and methods practiced lacked uniformity, and disclosures of financial reports were inadequate (AASBB 2015). 55. The legislative framework for Bhutan’s tax system is provided by the Income Tax Act 2001 as well as by the Sales Tax, Customs, and Excise Tax of 2000 and its corresponding rules. For businesses, the principal taxes include a business income tax (BIT) or corporate income 56. The DRC estimates that, as of 2015, 11,571 businesses were tax tax (CIT), a personal income tax, a property transfer tax, and the sales exempt, accounting for 45 percent of all BIT units (DRC 2016). tax for selected domestic goods and services. CIT is a corporate tax, 57. The DRC maintains two methods to collect BIT. Taxes are levied at the rate of 30 percent on net profit, on those entities registered computed based on tax rules when the taxpaying entity maintains and as a company under the 2001 Companies Act. BIT is similarly levied submits books of accounts during the time of filing taxes. However, at 30 percent on unincorporated businesses operating with a license for firms without bookkeeping, the DRC uses an estimated assessment or permit issued by relevant government authorities. The category method, usually based on any information available to the department, includes sole proprietorships and partnerships with sizes ranging from taxpayers, or third parties. The DRC itself recognizes that this method micro to large businesses (DRC 2016). See Annex 3.6 for more detail. of tax assessment and collection are highly criticized (DRC 2016). Investment Climate Assessment of Bhutan 39 A. Tax Rates (LLCs), 2017 B. Time to Pay Taxes (LLCs, Hours/Year), 2017 Bhutan 34% 1% Bhutan 274 85 13% 7% 17% 243 South Asia South Asia 284 India 25% 21% 16% India 241 China 8% 49% 7% China 259 3% Thailand 264 Thailand 22% 5% 266 29% 4% 435 Bangladesh Bangladesh Nepal 408 Nepal 18% 11% 339 Maldives 0 Maldives 13% 8% 9% 406 0% 10% 20% 30% 40% 50% 60% 70% 0 100 200 300 400 500 Profit Labor & contributions Other 2006 2017 C. Annual Frequency of Meetings with Tax Officials D. Determinants of Tax as Biggest Obstacle micro(<=5) small(5−20) medium(20−99) Other manufacturing Tourism Other services Thimphu/Paro Phuentsholing 0 2 4 6 8 Gelephu/Sarpang Frequency of inspections/requirement for meeting by tax officials −1 −.5 0 .5 Bhutan 2009 Bhutan 2015 Costa Rica 2010 Note: Coefficient plots with 95% CI when regressing an India 2014 indicator of finance as the top constraint, on size, sector Note: Excludes outside values and regional dummies. Large firms, Food manufacturing, and Samdrup Jongkhar as base. Figure 25:  Tax Rates and Tax Administration Source: Tax rates and time to pay taxes come from the Doing Business database. Frequency of tax official visists is estimated from WBES 2015. 40 Investment Climate Assessment of Bhutan Chapter 3 The Way Forward Summary Improving the competitiveness of Bhutan’s private sector will require a mixture of both crosscutting and sector-specific reforms: Crosscutting Reforms. Reforms that reduce uncertainty for lenders and risk for cred- itors, enhance asset collateralizability, and increase financial awareness can increase firms’ access to finance. The access of firms to skilled labor can be improved by relax- ing barriers to skilled migration, providing vocational training, and addressing the attractiveness of private-sector compensation. Greater access to external markets can be achieved by improving border processing, upgrading infrastructure, and promoting FDI. Competition can be enhanced by rationalizing the role of state-owned enter- prises, instituting a competition policy and public-private dialogue, and adjusting pub- lic procurement. The perceived burden of taxation can be reduced through revisions to licensing and incorporation procedures and by improving accounting standards. Sector-Specific Reforms: To increase the benefits of tourism, policies should be revised to reflect the changing nature of flows and the changing preferences of tourists. The development of the ICT sector can be facilitated through improving Internet connectivity and by developing sector-specific channels to attract foreign expertise and investment. To develop agribusiness, the RGoB should rationalize the current program of subsidies and other interventions, develop supporting infrastructure, and fully implement the Brand Bhutan strategy. Finally, to enhance the economic spillovers of hydropower investments, the participation of local firms and workers in project construction should be increased. 3.1 Introduction The achievement of sustained economic growth will rest on the devel- opment of product lines which can leverage the country’s institutional assets while not being constrained by its natural endowments. Bhu- tan’s natural endowments—its small size, mountainous topography, and land- locked location—hinder the ability of manufacturing firms to achieve increases in productivity through exploiting economies of scale. On the other hand, the country’s institutional characteristics—good governance, low corruption, civil stability, an English-speaking workforce, and cheap and reliable ­ electricity— reduce risks ordinarily associated with private investment. In addition, Bhutan’s 41 commitment to GNH principles can help the country’s in various sectors; difficulties experienced by firms in hiring products command a premium among environmentally skilled labor; factors inhibiting the integration of produc- conscious consumers in high-value markets. Thus, while ers with external markets; activities of government-­ linked Bhutan’s potential to develop profitable industries centered entities that discourage competition; and regulations that on the export of basic goods is limited, industries focused discourage licensing, incorporation, and tax compliance on the export of services—such as tourism and ICT—and (Section 3.2). Sector-specific reforms, on the other hand, of premium niche products have substantial potential. should update policies affecting the tourism sector to reflect the changing pattern of tourist flows and the changing The ability of the private sector to take advantage preferences of tourists; address factors that undermine the of Bhutan’s latent potential in tradable services and viability of investments in the ICT sector; promote invest- premium niche products is currently inhibited by ments that enable access to high-value markets for agri- various input and product market imperfections. business products; and maximize the positive economic Bhutan’s private-sector development is constrained both by spillovers of hydropower investments (Section 3.3). crosscutting factors and policies affecting specific key indus- tries. The growth of firms across the economy is stunted by a limited supply of and demand for financial products; by 3.2 Crosscutting Reform immigration restrictions and public-sector compensation Recommendations policies that reduce the supply of skilled labor; by trans- A prioritized yet multifaceted reform program will port and logistics deficiencies that inhibit access to external facilitate private-sector development. Analysis of markets; by unfair competition from public-sector entities; the perceptions of firm managers and complementary and by accounting practices that unnecessarily increase data sources indicates that the growth of Bhutan’s pri- the burden of taxation. The growth of Bhutan’s tourism vate sector is inhibited by multiple factors, including industry is specifically inhibited by deficiencies in the qual- insufficient access to finance; limited access to skilled ity and scope of accommodation, food, and tour services; labor; restricted access to external markets; and factors the growth of the ICT industry is inhibited by a failure to restricting competition. To alleviate these constraints and capitalize on regional pools of skilled labor, by connectivity promote the development of the private sector, certain costs, and a lack of promotion; while the growth of agri- reforms should be prioritized. Specifically: business is inhibited by counterproductive public invest- »» Access to Finance: To improve the access of ments, inadequate trade infrastructure, and shortcomings firms to finance, the RGoB should address defi- in branding and marketing. Finally, the impact of Bhutan’s ciencies in the supply of and demand for financial hydropower industry on the wider economy is inhibited by products by reforming the credit information sys- the limited integration of local firms and workers in project tem, credit registry, restructuring and insolvency construction activities. regime, and banking regulations and by providing financial literacy training (Subsection 3.2.1). A reform program that combines crosscutting and »» Access to Skilled Labor: To enable private- sector-specific measures will promote broad-based sector firms to access essential skills, the RGoB economic development. With a robust institutional should provide vocational training to the adult framework, Bhutan has an advantage over many of its population; adjust public-sector compensation peers in the region and beyond in being able to enhance and recruitment policies to improve the relative private-sector development by making relatively minor attractiveness of private-sector employment; and adjustments to policy and public investments. However, to relax restrictions on the recruitment of skilled fully achieve Bhutan’s economic potential, the RGoB will expatriates (Subsection 3.2.2). need to undertake reforms that are both crosscutting and »» Access to External Markets: To address Bhu- sector specific. Crosscutting reforms should address the tan’s poor integration with foreign investors and limited access to finance experienced by micro­enterprises markets, the RGoB should support the upgrading 42 Investment Climate Assessment of Bhutan of firms’ marketing capabilities; reduce the costs lending and increase the supply of finance. Plans that border processing, infrastructure gaps, and the exist to expand coverage of the CIB to include loans made logistical sector impose on trade; and take addi- by MFIs (including REDCL), as well as information from tional measures to attract FDI (Subsection 3.2.3). insurance companies. Bhutan’s two utility regulators have »» Competition: To enhance competition, the RGoB issued directives to utility providers to provide informa- should review SOE activities to ensure that private- tion to the CIB. The CIB system has been upgraded to sector development is not being curtailed; introduce accept and incorporate this new information into the a new competition policy and establish a mechanism credit reports for all users. To further this process, an out- for public-private dialogue; and revise public pro- reach exercise is needed to show the banks how these new curement processes to provide incentives for firms to information sources can be integrated into their credit acquire new capabilities (Subsection 3.2.4). assessment processes to enable better lending decisions »» Taxation: To reduce the burden of regulation and and increase the supply of credit. Finally, to ensure its increase compliance with tax policies, the RGoB commercial sustainability, the CIB should develop a stra- should revise licensing and incorporation proce- tegic business plan, undertake a pricing review, and adopt dures, provide training on taxation and account- corporate governance structures. ing standards, harmonize databases, and improve coordination between agencies (Subsection 3.2.5). Approve and Implement New Insolvency Bill A new restructuring and insolvency regime will provide better protections for creditors and bor- 3.2.1  Access to Finance rowers and facilitate efficient debt recovery. A new Further reforms are needed to enhance the supply Insolvency Bill has been drafted by the RGoB to replace of and demand for financial products. To increase the the current Bankruptcy Act and certain sections of the supply of finance, the RGoB should reduce uncertainty Companies Act. The new Insolvency Bill introduces a for lenders; reduce creditor risk; and adjust regulations new restructuring and insolvency system aligned with to increase financial competition (Subsection 3.2.1.1). best practices that will improve both the reorganization To increase the demand for finance, the RGoB should and the liquidation of distressed companies and small enhance potential borrowers’ ability to use assets as col- businesses. The Bill has been approved by the Cabinet lateral and bolster financial literacy (Subsection 3.2.1.2). and rapid passage through Parliament will be an impor- tant step to better pricing creditor risk; preserving jobs 3.2.1.1 Supply Side and supply chains; promoting entrepreneurship; and Improving the Movable Property and Immovable improving economic efficiency by reallocating productive Property Security Act (MIPA), the credit information assets from insolvent to solvent firms. The RGoB should systems, and insolvency procedures should increase further review and amend the Land Act to further reduce the supply of finance. The RGoB should prioritize the costs and uncertainty for creditors seeking to recover reforms that broaden and deepen the MIPA and expand outstanding debts through the judicial process; explore the CIB, as well as the passage of the new Insolvency the feasibility of establishing a commercial court; and Bill. Other actions that the RGoB may undertake include build the capacity of insolvency professionals (Murga- increasing interbank competition by reforming the role troyd 2016, 41). of the BDBL and promoting the expansion of nonbank financial institutions by easing requirements for microfi- Increase Financial Competition nance institutions and reducing the risks of e-banking. Reforms of the role of the BDBL can increase inter- bank competition and expand the scope of financial Deepen and Broaden Credit Information Systems products available. To increase the supply of credit to Deepening and broadening credit information agriculture, the RMA should expand BDBL’s license systems will reduce uncertainty associated with to enable it to provide export financing for agricultural Investment Climate Assessment of Bhutan 43 clients (Murgatroyd 2016), such as by providing letters 3.2.1.2 Demand Side of credit and factoring and handling foreign exchange An increase in the realized demand for finance can transactions. To further enhance the availability of credit be achieved by expanding the scope of collateraliz- to farmers, the RGoB should direct BDBL to prioritize able assets. To this end, the RGoB should prioritize pro- group lending to the 37 agricultural cooperatives, all of posed amendments to the MIPA and enhance the Central whom currently have bank accounts and are currently Registry for Secured Transactions (CRST), while pursu- undergoing financial literacy training to bolster credit- ing reforms that will enable the use of crops, crop transac- worthiness (ibid.). To further increase the scope for price tions, and land as collateral. The demand for finance may competition, the RGoB should also require SOEs to reg- be further increased through efforts to address financial ularly obtain competitive bids from multiple banks and illiteracy and to develop cultures of financial responsibility consider distributing funds more widely across the finan- and inclusion within the private sector. cial system (ibid.). Expand Scope of Collateralizable Assets The easing of licensing and reporting requirements An expansion in the scope of movable assets that for MFIs can expand the access of small and/or can be used as collateral can be achieved by Par- remote enterprises to credit. To facilitate the growth liament approving amendments to the MIPA and of MFIs, it is essential that the RMA finalize regulations through an upgrading of the CRST. Proposed amend- for deposit taking MFIs and ease the licensing and opera- ments to the MIPA that will enable all moveable assets tion of nondeposit taking MFIs by reducing the required (such as accounts receivable, inventory, factoring, etc.) to minimum paid-in capital and simplifying and stan- be registered in the CRST and subsequently used as col- dardizing reporting requirements with the Civil Society lateral are currently before Parliament. These should be Organizations (CSO) Act (ibid.). To improve the sustain- approved. Thereafter, the RMA should draft regulations ability and enhance the growth of the microfinance sec- to ensure that collateral requirements are favorable to tor, the RMA should require that information on all MFI, movable asset-based financing in accordance with Basel-II REDCL and BDBL loans, regardless of size, be reported recommendations. To render the CRST easier to use, the to the CIB and that avenues are explored to establish a database’s search functionality should be enhanced. The partial credit guarantee fund (ibid.). RMA should also establish an appropriate corporate gov- ernance structure for the CRST and provide training to Regulatory reforms that focus on reducing risks for financial institutions on the development of new lending customers can encourage the growth of e-banking. products against movable assets. To resolve outstanding issues concerning the security of and responsibility for mobile transactions, the Bhu- The volume of agricultural finance may be tan Information, Communications and Media Act increased by empowering farmers to use crops and 2006 (BICMA) should be amended to enable the issu- crop transactions as capital. A substantial volume ance of e-money. In addition, the Ministry of Informa- of Bhutan’s produce is currently exported and a net- tion and Communications (MoIC) should amend the work of warehouse facilities exists to collect crops prior ­ Governance Master Plan to address outstanding reg- e-­ to export. Adoption of legislation and accompanying ulatory gaps pertaining to privacy, data protection, and regulations to enable the use of warehouse receipts as service provider and user responsibilities. To further facil- collateral could potentially increase the volume of agri- itate the growth of mobile banking, the RMA should cultural credit (ibid.). The development of crop insurance adopt e-money regulations that accommodate bank- and mechanisms, a commodities exchange, and the adoption nonbank systems; create a gateway for e-money interop- of accompanying regulations to permit the use of associ- erability among banks and mobile operators; and incor- ated instruments as credit may also serve as instruments porate a framework for combatting financial terrorism for increasing the access of farmers to credit over the into the country’s anti-money laundering regime (ibid.). medium term (ibid.). 44 Investment Climate Assessment of Bhutan Reforms of the management of property records lines provided for CSIs and rural enterprises, now man- will facilitate the use of land as collateral. Elec- aged by BDBL and REDCL, have suffered from slow dis- tronic input and search capabilities should be integrated bursement due to capacity and geographical constraints. into the National Land Commission electronic property However, implementation is also affected by unclear pol- and land registration system and real estate valuation icy objectives and inconsistencies in eligibility conditions. services should be developed. The National Land Com- Similarly, past programs, such as the Entrepreneurship mission should undertake measures to link the Thromde Development Program (EDP), were considered ineffec- Land Section’s property records with the corresponding tive at improving lender viability. Both types of programs property titles and land information from the land com- suffer from poor targeting resulting from a lack of under- mission’s registries by upgrading the current platform standing of the demand for finance by CSI and rural for urban and rural titles and connecting it with the geo- enterprises. Going forward, rigorous results tracking is spatial information contained in the Arc GIS database. needed to assess effectiveness and provide evidence to Finally, the unified system should be linked to municipal- improve programmatic design (see Box 1). ities to ensure that citizens and businesses can take full advantage of the upgraded system. 3.2.2  Access to Skilled Labor Increase Financial Literacy Alleviating skill shortages will be essential to A multifaceted financial literacy program can bolstering economic growth, particularly in the increase the use of financial products among dif- tradable services sector. While Bhutan has made sig- ferent segments of the population. To inform the nificant strides in increasing school enrollment over the design of tools to increase financial literacy among past decade, such improvements address the prevailing entrepreneurs and other segments of the population, the skill shortage only gradually. Thus, to limit the negative RGoB and its development partners should comprehen- economic impact of skill shortages, the RGoB should sively survey financial literacy and identify a focal agency. act to ensure a greater availability of skills over the short Options for financial literacy initiatives include focus- term by developing channels for skilled migration while ing training on financial managers and entrepreneurs; also investing in building the skills of the adult population expanding MFI village-based financial literacy initiatives; (Subsection 3.2.2.1). To increase the access of private- upgrading bookkeeping modules provided to members sector firms to skilled graduates, the RGoB should also take of agricultural cooperatives to enable the production of actions to improve the relative attractiveness of private- annual balance sheets and income statements that may sector compensation packages (Subsection 3.2.2.2). be used to support loan applications; incorporating mod- ules on financial literacy into the high school education 3.2.2.1 Skill Gaps system; and creating incentives to provide financial con- Skill shortages may be alleviated by rationalizing sulting services to firms and entrepreneurs (ibid.). The effi- rules for hiring foreign workers and by providing cacy of entrepreneurship training programs in increasing vocational training. Durably resolving skill shortages financial literacy and usage should be evaluated to iden- requires an upskilling of the domestic workforce, which tify adjustments that may improve such programs. is gradually being achieved through increases in school enrollment. However, the failure to resolve skill short- The efficiency of priority lending programs can ages in the short term may critically handicap emerg- be enhanced through better defining targets and ing industries of strategic economic significance, such as developing a more rigorous monitoring and evalua- ICT and tourism. To gain a foothold in these sectors, the tion framework. To bridge financing gaps for MSMEs RGoB should reform labor and immigration regulations and the agriculture sector, the RGoB has introduced var- to enable the recruitment of skilled foreign workers and ious concessional lending programs, some of which are should develop vocational training programs and schol- coupled with entrepreneurship training. Priority credit arships for executive education. Investment Climate Assessment of Bhutan 45 Box 1: Evidence from Entrepreneurship Training in South Africa While economic research has established the importance of entrepre- this that “business training requires an incubation period of sev- neurial skill as a determinant of productivity, the impacts of business eral months for firms to apply and test their new knowledge before training programs on the profits of small firms in developing countries improvements in firm outcomes are realized. have been disappointing. The results of a recent experimental study are notable, therefore, not only because they demonstrate that train- Interestingly, the study finds differences in the effects of the two train- ing programs—if sufficiently intensive—can increase profits, but also ing programs. Entrepreneurs receiving marketing training became because they indicate that achieving such impacts requires matching better at receiving feedback from business partners and custom- different types of training to firms with different characteristics. ers and increased profits by focusing on increasing sales, investing in stock and materials, and hiring more employees. Entrepreneurs The study focused on 852 small firms in Cape Town, South Africa. receiving finance training, on the other hand, increased profits by Entrepreneurs leading a randomly selected subsample of these firms reducing costs and better managing firm finances, resulting in sig- were provided with 10 weeks of intensive training on either market- nificantly higher levels of firm efficiency. ing or finance delivered by a local business development and training organization. The study used a novel electronic survey tool to mea- The two types of training had varying effects on the entrepreneurs sure key outcomes, such as firm behaviors, sales, costs, and profits, at involved. Those with less exposure to different business contexts ben- six months and then again at 12 months after the training. efited significantly more from the marketing training, while those with broad exposure did not appear to benefit from that training. On The study finds that, over the course of a year, both programs cre- the other hand, finance training benefited more established firms, ated significant statistical and qualitative increases in firm profits of but newer firms benefited little. between 41 and 61 percent. However, only modest impacts were detected six months after the training. The authors surmise from Source: Anderson, Chandy, and Zia 2016. Rationalize Restrictions on Migrant Labor can improve firm-level productivity and increase The rationalization of rules on hiring foreign work- wages. The RGoB and its development partners should ers will enable firms to fill skill shortages. Address- increase the provision and quality thereof of vocational ing the skills shortage in the near term will necessitate training to the adult population. Based on employers’ reforms to remove barriers to the recruitment of skilled perception on skill deficits, the content of training should foreign labor. The RGoB may consider the creation of a focus on core technical skills such as computer literacy separate channel for skilled temporary migration (similar and soft skills such as leadership and teamwork (World to the H-1B program in the United States) to both enable Bank 2016a). To ensure the effectiveness of these initia- control over the volume of immigration (a goal which tives, it is important that impacts on skill attainment and is achieved by current policy) and to ensure that flows employment outcomes are rigorously evaluated and that of unskilled migration do not crowd out flows of skilled variations in programmatic design and implementation migration (which is not achieved by current policy). Com- are continuously tested to enable ongoing improvements plementary reforms that might be considered include the (Box 1). elimination of the negative list of occupations in which foreign employment is precluded; the standardization of Scholarships for intensive business education can approval requirements across all countries of origin; and improve the capacity of private-sector executives the introduction of decentralized approval procedures. to develop the soft skills of their workers.58 In many By easing the extent to which firms may use foreign sectors, managerial capacity and firm-level training are a workers to fill prevailing skill shortages, such reforms can key determinant of the level of soft skills within a firm. To increase the productivity of Bhutanese firms and thereby improve employment prospects of Bhutanese workers. 58. Entrepreneurship training is not discussed given mixed evidence about its effectiveness. A variety of programs exist to provide incen- Upskill the Domestic Labor Force tives for capacity upgrading, such as the Entrepreneurship Develop- ment Program and matching grants provided for the CSI sector. The Increased vocational training and a focus on build- RGoB needs to rigorously monitor and evaluate these initiatives and ing technical and soft skills of the labor force experiment with targeted training. 46 Investment Climate Assessment of Bhutan assist managers in building the skills required to instill cul- increases of public-sector wages to less than or equal to tures of teamwork and professionalism, the RGoB should those of the private sector, thereby enabling the private sec- develop a scholarship program that enables well-qualified tor to become increasingly competitive in base pay (World managers, business executives, and young business pro- Bank 2016a). Second, the RGoB should develop income fessionals to pursue intensive executive education abroad. support measures for unemployed private-­ sector workers Currently, a total of 921 students are undergoing tertiary and active labor market programs—such as retraining and education on scholarship, of which 242 students grad- job search assistance—to ameliorate the negative impacts uated in 2016 (Bhutan MoLHR 2015a). However, very of shocks and vulnerabilities associated with private sec- few of these are in business. Creating an avenue by which tor employment (ibid.). By adopting these twin policies of Bhutanese business professionals can gain an interna- moderating public-sector wage increases and developing tional standard executive education will, in addition to a “flexicurity” system, the attractiveness of private-sector helping build cultures of managerial excellence among employment for skilled workers should improve over time. Bhutanese firms, further the development of linkages with export markets. An alignment of pension systems, provision of man- dated benefits by private-sector employers, and a 3.2.2.2  Attractiveness of Private-Sector Work reduction in benefits for public-sector workers will Adjustments to public-sector compensation address the imbalance in total compensation. The packages and recruitment procedures will enable generous pensions paid to public-sector workers account for ­private-sector firms to attract talented graduates. a substantial portion of the differential in total compensation. Currently, private-sector firms in Bhutan struggle to To improve the attractiveness of private-sector jobs without attract talented graduates, who are enticed by more creating a tax wedge, the RGoB may promote voluntary lucrative jobs in the public sector. Ensuring that the pri- participation in a defined contribution scheme by match- vate sector can attract the best and brightest workers will ing contributions made by private-sector workers (World require measures to address the relative attractiveness of Bank 2016a). In conjunction, the generosity of the defined private-sector jobs. Specific actions include moderating benefit scheme offered by the public sector should be para- increases in public-sector wages, bolstering social protec- metrically adjusted to reduce the risk of future deficits. Even tion for private-sector workers, and ensuring the equal- though the equality of employment benefits is mandated by ity access between public- and private-sector workers to law (ibid.), a relatively small proportion of Bhutan’s private- fringe benefits. In addition, the RGoB might consider sector workers have access to fringe benefits such as gratu- adjusting how public-sector workers are recruited by plac- ities, provident fund payments, overtime, paid annual, sick, ing a greater emphasis on private-sector work experience. maternity/paternity, and casual leave, and compensation for work accidents. To redress this imbalance, the RGoB should undertake public awareness campaigns to apprise workers Realign Public- and Private-Sector Compensation of their rights and employers of their responsibilities, while Moderation of public-sector wage increases and bolstering enforcement (ibid.). Finally, improving the relative the development of ‘flexicurity’ policies for private-­ attractiveness of private-sector employment may also neces- sector workers will improve the relative attractive- sitate reducing certain fringe benefits offered to public-sector ness of private-sector jobs. Jobs in Bhutan’s public workers but which are not legally mandated, such as subsi- sector generally offer better total compensation and are dized housing (ibid.). The development of a national social more secure. While Bhutan’s employment protection leg- protection system as described above could help provide islation provides flexibility to employers, it also creates a political space for such reforms. degree of risk for workers that—absent a robust social protection system—reduces the attractiveness of private- sector jobs. Improving the competitiveness of the private Reform Public-Sector Recruitment sector will require the RGoB to take measures to address Changes to civil service recruitment practices this imbalance. First, the RGoB should moderate future can render private-sector employment a more Investment Climate Assessment of Bhutan 47 attractive option for graduates. The Bhutanese civil contracts, and an unfamiliarity with standards and qual- service administers a rigorous examination to select the ity certification. To increase the access of Bhutanese most qualified candidates for employment (World Bank firms to new markets, the RGoB should promote the 2016a). The examination emphasizes academic achieve- use of online business platforms to enable access to ments, technical knowledge, analytical ability, and flu- ­ e-commerce, increase awareness of the importance of ency in English and Dzongkha, among other criteria, but quality standards and certifications, reinforce the Brand does not place any value on private-sector work experi- Bhutan strategy, and develop a strategy to leverage duty- ence (ibid.). Due to this failure to consider private-sector free and quota-free access to European, South Asian, and employment as a qualification for the civil service, those U.S. markets. who seek a career in the civil service are encouraged to focus on preparing for the next exam rather than using Promote the Use of Online Business Platforms the intervening period to gain work experience (ibid.). The creation of online platforms to match local Reforming the civil service recruitment process to enable firms with export partners and other e-commerce candidates to be rewarded for having gained private- initiatives can enable firms to overcome Bhutan’s sector work experience would immediately increase the high transport costs. Micro and small firms, which attractiveness of private-sector employment for gradu- typically face a high fixed cost to export, have been ates and thereby the supply of skilled workers available to shown to benefit from online platforms for commerce.59 the sector, while also potentially increasing the quality of The Internet is a particularly important tool for firms in civil service recruits over time (ibid.). small countries, given the difficulties firms in such coun- tries face in achieving economies of scale when serving only domestic markets.60 Estonia provides an example of 3.2.3  Access to External Markets a small country that has embraced e-commerce as its key Achieving greater access to high-value export development strategy (see Box 2). markets will require improved marketing, more efficient border processing and transportation Bhutan will need to strengthen its logistics infrastructure, and increased flows of FDI. In order infrastructure, including e-payment systems, to enable Bhutanese firms greater access to external mar- and encourage pioneer investors to develop kets, the RGoB should support the upgrading of firms’ ­e-­commerce.61 Except for online sales of air tickets and a marketing capabilities, such as e-commerce, quality certi- small number of online shopping portals (e.g., http://shop. fication, and branding (Subsection 3.2.3.1); address pre- bt/), there is limited e-commerce in Bhutan. A key barrier vailing constraints on trade imposed by border processing, to e-commerce in Bhutan has been the lack, until recently, customs regulation, infrastructure gaps, and the underde- of supporting infrastructure. There were no options for velopment of the logistics sector (Subsection 3.2.3.2); and Bhutanese merchants to receive payments online prior to remove barriers to FDI (Subsection 3.2.3.3). the launch of BoB’s e-payment gateway in 2015. At pres- ent, few banks allow Internet transactions and the RGoB 3.2.3.1 Marketing Support to improve the capabilities of Bhutanese firms to export can enable the realization of firms’ 59. Many exporting firms on eBay have fewer than 10 employees ambition to reach higher value markets. An unusu- (Kelly et al. 2017). Research by eBay (2013) finds, for example, that Jordanian businesses using eBay Marketplace to export reached on ally large share of Bhutanese firms relies on intermedi- average 28 different markets, whereas traditional Jordanian exporters aries for exports (Subsection 1.2.4), which is a symptom only reached 3 markets on average (eBay 2013, 32). 60. For example, the share of sales to other EU countries in total of a lack of experience in accessing foreign markets. eBay sales is negatively correlated with the size of GDP. In general, Key informants at commercial banks suggest that many the benefits of e-commerce are highest for the smaller and less devel- oped countries in the region (Kelly et al. 2017). firms demonstrate a lack of marketing skills, a lack of 61. This discussion draws on an e-trade readiness assessment by understanding and use of trade finance and commercial UNCTAD (2017). 48 Investment Climate Assessment of Bhutan Improve the Quality Standards and Certifications Box 2: E-commerce Development in Estonia Framework Estonia is one of the world’s leaders in e-commerce. In 2016, over A communication strategy to increase awareness 50 percent of the country’s population were e-commerce users, of the importance of quality standards and cer- spending around $389 USD on average. With the industry grow- ing at a rate of 40 percent per annum, the penetration and num- tifications will help firms expand their market bers are expected to continue to rise. opportunities. Effective adoption of quality standards will require an assessment of target export sectors and The Estonian government has been facilitating the growth of markets to prioritize investments in the national quality ­ e-commerce since it regained its independence in 1991, when the government prioritized the development of ICT. Recently, the gov- infrastructure. Currently, the share of Bhutanese firms ernment created a first-of-its-kind e-residence program with the meeting international standards is low, partly due to a aim of further growing e-commerce. This program allows any- lack of awareness on the demand side. As a first step, the one in the world to create a business that will utilize and develop government should invest in a communication strategy e-services in Estonia. As e-residents generally require local bank- ­ ing and accounting services, the establishment of e-businesses by to explain and highlight the benefits of standards and ­ e-residents generally results in broad economic spillovers. quality certification in gaining access to new markets (ICA Costa Rica 2002). For example, Colombia’s Qual- The rise of e-commerce has had positive impacts on Estonia. ity and Environmental Management Program was key to Firstly, with 97 percent of banking transactions done using e-bank- ing services and given the convenience associated with online shop- increasing SME certification (World Bank 2007). ping, it has made citizen’s lives a lot easier. Secondly, Estonia is reaping the benefits of being recognized as the world’s leader in 3.2.3.2  Border Performance, Infrastructure, e-commerce, with tens of thousands of new e-residents. Thirdly, e-commerce is driving the country’s economic growth. Estonia’s and Logistics experience shows that in the digital age, being a small country is Reforms to border and customs procedures, invest- not an impediment to development. ments in infrastructure, and support for the devel- opment of the logistics sector can help improve Source: The Economist (2013). export performance. Firm-level data and benchmarking of Bhutan’s performance in trade logistics indicate that will need to further develop payment solutions to enable several connectivity constraints inhibit the country’s export firms to receive payments. To fill in the gaps in human performance. In order to address these, the RGoB should: capital, the RGoB needs to place a greater emphasis on introduce risk-based inspections and improve coordina- ICT training in the education system. In the short term, tion with other international border agencies by aligning the RGoB can also support the development of an online customs legislation and practices with the Revised Kyoto platform to match Bhutanese firms with potential export Convention (RKC) standards; expand and improve the cur- partners (as with Japan’s Trade Tie-Up Promotion Pro- rent transport and logistics infrastructure and diversify the gram). The RGoB might also consider adopting elements transport corridors to reduce current dependency on India; of an initiative deployed by the Republic of Korea which phase in the Bangladesh, Bhutan, India, and Nepal Motor supported the growth of rural e-commerce by developing Vehicles Agreement (BBIN MVA); and support the devel- a reliable nationwide distribution channel through its post opment of private-public partnerships in infrastructure. (UNCTAD 2015).62 office service ­ Introduce Risk-Based Inspections and Increase 62. Korea’s rural project could be benchmarked not just for the Border Coordination promotion of commerce abroad, but also in the context of RGoB’s e-government initiatives. While the project has been created to bridge Introducing risk-based inspections and clearances the digital divide between rural and urban areas, the e ­ -commerce and strengthening coordination with India will system is available to provide incentives to residents of rural areas to participate in the training programs that impart basic Internet skills. allow for more efficient processing of shipments. E-commerce channels developed by the Korean project have made The risk-based management approach targets a balance great contributions to the income growth of rural areas and to the capacity required to utilize the e-government systems. between ensuring compliance and minimizing disruptions Investment Climate Assessment of Bhutan 49 and trade costs, as it allows customs to assign its resources that transit between Phuentsholing and Kolkata. Inter- to high-risk areas and to increase the efficiency of the national border-agency cooperation makes cross-­ border clearance procedures for low-risk cargo (WCO 2011). trade and logistics more efficient and less costly, as it One option is for the DRC to move from a semiauto- simplifies document preparation, harmonizes physical mated clearance process system to a fully automated sys- inspections, reduces administration costs, and decreases tem that allows creation of a database of information on staff needs (UNCTAD 2011).67 risks. This would lead to a lower rate of physical inspec- tions of cargo traffic and enable more efficient clearances The RGoB should provide adequate access to con- for import and export based on traders’ history, thus vertible currency and ensure that tax rebates for reducing congestion and inefficiencies at Phuentsholing imports of semifinished goods manufactured in (Bhutan, MoEA 2012).63 More broadly, the RGoB should India are correctly implemented (Bhutan, MoEA align customs legislation and practices with the RKC 2012). Inefficiencies in refunding taxes have a distortion- standards,64 which entail making customs actions pre- ary effect on market prices, competition, and economic dictable and transparent, standardizing and simplifying growth. The RGoB could allow credit to be carried for- procedures and documents, using risk management and ward and offset against future tax liabilities, including audit-based controls, and coordinating interventions with income tax. This measure would avoid creating barriers other border agencies.65 for imports. Improved border coordination and automation of Support the Development of Infrastructure customs procedures will reduce trade costs and and Logistics facilitate customs clearance of Bhutanese prod- By expanding existing transport and logistics infra- ucts. Traders in Bangladesh benefited from the intro- structure, Bhutan can reduce its dependency on duction of an automated customs clearance system at existing transport corridors. To reduce dependence Chittagong port, reducing a customs clearance process on Kolkata, the MoEA should fast-track a bilateral tran- of 42 steps to just 5, reducing costs of doing business sit agreement with Bangladesh and work with the private by 70 percent, and reducing custom processing time by sector to identify and assess viable alternative corridors, 80 percent (World Bank 2009; DataSoft 2010).66 In addi- such as Bangladesh’s Chittatong and Mongla ports. The tion to creating a national single-window system, Bhu- MoEA should encourage the development of industrial tan could establish joint border facilities with India to and logistic clusters along existing and planned corridors reduce border queues and clearance times for products (Bhutan, MoEA 2012; Rahman and Rahman 2016).68 The RGoB should focus on completing the southern east- 63. For instance, Zambia introduced a risk management system in west highway, which will reduce unnecessary delays and 2015 that determines the degree of intervention of consignments boost tourism (Galay 2014). The RGoB must also ensure according to their risk profile, resulting in minimal intervention of at least 59 percent of cargo intervened between June and August 2015 that the newly planned dry port facilities near Phuent­ (IFC 2016). sholing are constructed on time given the current bottle- 64. The RKC provides a harmonized blueprint for modern, simpli- necks caused by the lack of appropriate customs facilities fied, and efficient customs procedures. 65. For example, after Japan signed the RKC in 2001, release times and multiplication of clearance sites. The viability of were reduced by the introduction of several customs procedures and techniques; in 2009, the average release time for sea cargoes with pre-arrival information was 60 percent shorter than for those without 67. For example, Germany and Poland jointly operate the Ludwigs- pre-arrival information (Yasui 2010). dorf border crossing (customs office, inspection area, parking lots, 66. Colombia introduced a national single-window system, Venta- storage, and other facilities), located in German territory. Zambia nilla Única de Comercio Exterior (VUCE) in 2005, which stream- and Zimbabwe cooperated on the implementation of the Chirundu lined more than 135 different import procedures into one, reduced Border Post, which reduced the time trucks spent at the border from cargo inspection times from three days to one, and contributed to four days to one (Zambia, MoCTI 2011). a 40 percent reduction in direct costs of exporters and importers 68. For example, Kosovo reduced the time and cost of documentary (MinCIT 2014). In Costa Rica, the implementation of streamlined and border compliance by implementing the Albania-Kosovo Transit export permit procedures through a single-window system increased Corridor and upgrading its automated customs system (World Bank the number of exporters by 22.4 percent (World Bank 2016d, 80) 2016b, 37). 50 Investment Climate Assessment of Bhutan a railroad connection between Phuentsholing and the Thimphu Parking, and the Thimphu Tech Park. New Indian railway network should also be analyzed as this PPP projects in the transport, energy, urban infrastruc- would enhance the dry port’s potential (Kunaka 2014). ture, tourism, healthcare, and education sectors have great potential (Ernst & Young 2014). For example, the The elimination of cross-loading requirements and National Highways Authority of India was established the provision of training for logistics professionals though a combination of public resources and standard- can bolster Bhutan’s logistics sector while reduc- ized PPP ­ concession schemes (India, PPIAF 2011). Some ing trade costs. The RGoB should seek to phase in the projects that may not be commercially viable for inves- Bangladesh, Bhutan, India, and Nepal Motor Vehicles tors in the short term may be economically viable and of Agreement, which enables vehicles to enter any of the social interest in the long term. To finance these types of four countries without transshipment of goods at the bor- projects (i.e., construction of a low-volume road network der from one country’s trucks to another’s (Mitra 2016; to connect an isolated region), the MoF should develop The Hans India 2017). The RGoB must negotiate provi- appropriate procedures and guidelines to establish a Via- sions that ensure that bad practices, such as the unofficial bility Gap Fund (VGF) targeting specific key constraints ban of Bhutanese-plated trucks in Indian markets, are to PPP project development (Bhutan, RGoB 2016; ICA ended.69 The RGoB should also phase in the introduc- Nepal 2012, 8; ADB 2016, 14).71 tion of the BBIM MVA with the planned completion of new road infrastructure (Galay 2014), so as not to col- Continued investments in airport infrastructure lapse existing networks.70 The MoEA should also design and deregulation in the airline sector can help and offer a logistics training program that combines con- improve the potential for multimodal ground-to-air ceptual and practical notions (i.e., distribution channels, logistics.72 Despite improvements of the road network, methods of payment, and logistics systems management) Bhutan’s mountainous terrain continues to impose travel (Bhutan, MoEA 2012, 50). The MoLHR and MoEA times and costs that discourage tourists from visiting loca- should further make vocational training for drivers and tions beyond the western regions and renders the exports other manual intensive handling labor a priority, as the of goods such as perishable produce infeasible. Improv- BBIN MVA will introduce strong competition from ing connectivity will require Bhutan to further increase Indian trucking companies. the efficiency of its air transport. To achieve this, the RGoB may consider further investments in the regulatory The development of a Viability Gap Fund can facil- capacity of the Bhutan Civil Aviation Authority (BCAA) itate private-public partnerships to finance the and in the operational capacity of the Department of Air construction and maintenance of road infrastruc- Transport (DOAT). ture. The Ministry of Finance (MoF) should encourage PPPs through its newly established Public Private Part- 3.2.3.3  Foreign Direct Investment nership Agency (P3A) and PPP policy (Bhutan, RGoB Bhutan should use specific strategies to attract 2016). To date, only a few PPPs have been implemented investors to niche sectors that can leverage the in Bhutan: the Dagachhu Hydro Power Plant, the country’s unique institutional features. Bhutan has natural constraints in attracting private-sector investment due to its landlocked nature, small domestic market, and 69. The RGoB, with the Indian government, should address par- ticularly the interference with the Bhutanese trucking and trading industries. Further, the RGoB should seek a reciprocal transport agreement enforced with the Indian trucking syndicate that allows 71. For example, Mexico’s National Infrastructure Fund (FONADIN) backhauling by Bhutanese trucks from Assam and West Bengal. provides grants to make PPPs financially viable. It does not obtain 70. For example, to facilitate cross-country trade and reduce border any annual funding from the treasury, receives revenues from existing corruption, Albania, Bosnia and Herzegovina, Bulgaria, Croatia, projects, and offers reimbursable and nonreimbursable support. Macedonia, Moldova, Romania, and Serbia and Montenegro From 2010 to 2012, each dollar of FONADIN subsidy generated $7 adopted the Trade and Transport Facilitation in Southeast Europe of private investment (ADB 2016). Program, which generated economies of scale in the production of 72. This section draws heavily on the air transport sector assessment marketable goods and services (WB IEG 2007). by the ADB (2016). Investment Climate Assessment of Bhutan 51 long distance to global and regional markets. At the same dedicated investment promotion unit to match industry time, Bhutan possesses unique advantages over its neigh- and educational providers.75 Finally, the RGoB should bors, including carbon neutrality, limited corruption, civil reduce the time it takes to register a property to create a stability, low electricity prices, unique cultural values, and more positive environment for prospective investors, par- a high quality of life. An efficient FDI policy framework ticularly in the agribusiness sector. can help Bhutan navigate its disadvantages to better attract and retain FDI. While foreign investors interested 3.2.4 Competition in coming to Bhutan have received dedicated promotion Rationalizing the role of state-owned enterprises, services in some cases, Bhutan does not have a strategy passing a robust competition policy, establishing to proactively target potential investors. RGoB should mechanisms for public-private dialogue, and revis- promote new FDI through a well-formulated promotion ing procurement rules will facilitate the growth strategy, targeting niche markets in key sectors like med- of the private sector. To reduce the adverse effect of ical, educational tourism, and niche agricultural prod- SOEs on private investment, the RGoB should carefully ucts.73 In the short term, the RGoB should present and evaluate the merits of intervention (Subsection 3.2.4.1). promote investment opportunities directly to existing net- The RGoB should also introduce a new competition law works of investors. In the medium term, the RGoB can and invest in the necessary enforcement capacity (Subsec- assess the need to create a stand-alone investment promo- tion 3.2.4.2). To address the perception of policy capture, tion unit with dedicated staff to conduct outreach.74 the RGoB should create a robust private-public policy dialogue platform to provide equal access to policy mak- To further increase inflows of the FDI, the RGoB ers (Subsection 3.2.4.3). Finally, revisions to public pro- should revise existing sectoral barriers to entry curement policies and practices can help further promote and relax de facto and de jure restrictions on regis- private-sector development (Subsection 3.2.4.4). tering property and employing high-skilled foreign labor. Equity restrictions like the minimum investment 3.2.4.1 Role of State-Owned Enterprises threshold in the hotel sector inhibit desirable investments Rationalization of the activities of state-owned in the country. To attract high-value, low-impact tour- enterprises will limit the extent to which efforts to ism, the RGoB should introduce alternative incentives to overcome market failures inadvertently crowd out encourage home-stay tours in rural destinations. In addi- private-sector development. DHI currently provides tion, immigration rules should be consistently enforced essential public goods and enables economies of scale in in accordance with the FDI policy. Moreover, the RGoB several sectors. PPP investments in the Thimphu Tech- should avoid inflexible regulations on the foreign-to-­ park, for instance, provided essential infrastructure to local employment ratio given the extent to which foreign kick-start the first foreign investments in the ICT sector workers in new sectors are essential for knowledge spill- (Subsection 1.4.3). However, in activities such as small-­ overs. The RGoB should facilitate learning and train- scale mining and manufacturing, the RGoB should iden- ing for high-skill sectors through the establishment of a tify the market failures that DHI can help correct and scale back interventions that are not well justified. For 73. Bangladesh and the Indian state of Orissa have excellent expe- example, if the concerns are to maintain strict environ- rience in promoting agribusiness investment. Given their proximity, Bhutan should consider familiarizing themselves with their invest- mental quality, resources could be reallocated to improve ment promotion efforts. The World Bank Group’s Agribusiness the capacity of the Department of Natural Resources to Investor Targeting Toolkit (World Bank Group 2014) also provides a useful step-by-step guide in the design and conduct of outreach cam- monitor and enforce environmental standards. In the ISP paigns aimed at investors, along with many practical tools for project teams to use in developing outreach plans. 74. For example, New Zealand, a small and geographically isolated 75. For example, Costa Rica’s IPA, CINDE, surveys foreign investors’ country, established New Zealand Trade and Enterprise to target skill demands and works with academia to design and implement investment into the government’s priority growth sectors, to develop training programs and to inform students of highly demanded career a global network of investors, and to attract and retain smart FDI in paths; since 2005, CINDE has trained more than 10,000 workers in greenfield and brownfield projects (UNCTAD 2013). high-value skills (UNCTAD 2014). 52 Investment Climate Assessment of Bhutan market, the government could evaluate whether allowing enhance coordination in the short term without requiring new private entrants would help bring down the cost of substantial budgetary outlays.77 broadband Internet access. 3.2.4.4 Public Procurement 3.2.4.2 Competition Policy A national e-procurement implementation strategy The creation of a new legal framework to prevent can reduce costs and delays, maximize efficiency, anticompetitive practices, monopolies, and car- increase transparency, and boost the participation tels can help improve economic efficiency and the of SMEs. E-procurement can help reduce the cost of competitiveness of the private sector. Bhutan has accessing public procurement opportunities, especially adopted a National Competition Policy that requires all for smaller enterprises.78 Bhutan has started building a relevant government agencies to carry out competition comprehensive end-to-end e-GP system. However, the impact assessments of new and existing laws. However, lack of a national e-GP implementation policy and strat- the RGoB should also introduce a competition law and egy increases the risk that the e-GP system will not be build enforcement capacity and understanding of the law delivered on time and on budget. It is recommended that (UNCTAD 2015). Kenya may provide a potential model. a national e-GP implementation policy and strategy be Kenya’s Competition Authority, for example, raised prepared. The national policy should include stakeholder awareness and understanding of its new competition law training and a phased, time-bound action plan to move through a successful advocacy campaign; the compliance to a 100 percent electronic system. In addition, this mea- effects of the advocacy campaign avoided a 20 percent sure should be complemented with a properly defined increase in the cost of certain private healthcare provid- market analysis policy and bidder debriefing in the public ers (World Bank 2016c). procurement network (World Bank 2017b). The RGoB should also make sure that the bidding evaluation criteria 3.2.4.3 Policy Feedback incentivizes businesses, especially SMEs, to improve their Establishing a mechanism for public-private dia- capabilities. To do so, the RGoB must include a firm’s logue will reduce the perception of undue influence skill composition in the bidding criteria, and it should also of SOEs or large private players. In intervening in the divide larger contracts into smaller batches or establish economy, the government’s objectives have principally incentives aimed at facilitating SME access, so as not to aimed to correct market failures and support public goods systematically exclude smaller businesses.79 creation. However, a lack of dialogue with the private sector has resulted in some failures to incorporate feed- 3.2.5 Taxation back from businesses about the on-the-ground impact of Revisions to licensing and incorporation proce- polices and created perceptions of inequalities in access dures, the provision of training on taxation and to policy makers. To address these issues, Bhutan would accounting standards, and the harmonization benefit from establishing a formal private-public dialogue of government databases can increase tax com- platform.76 Bhutan has a difficult balancing act to main- pliance and reduce regulatory burdens. Bhutan tain a healthy level of market competition while allowing firms to reach the economies of scale needed to compete successfully on international markets. Ensuring equal 77. For example, Peru implemented a program of “Mesas Ejecu- tivas,” which consists of weekly temporary public-private working access to policy dialogue is a first critical step to main- groups focused on solving sector-specific bottlenecks; these “Mesas tain this balance. Introducing an online platform could Ejecutivas” were implemented in sectors such as forestry, aquacul- ture, logistics, textiles, gastronomy, and high-impact entrepreneurship (Ministerio de la Producción del Peru 2016). 78. For example, 10 years after Chile introduced its ChileCompra portal, the share of contracts awarded to SMEs rose from 24 percent 76. Usually, PPDs are mechanisms that go beyond coordina- to 44 percent (World Bank 2016c). tion, in that they help building trust, sharing knowledge, making 79. For example, in Angola, Côte d’Ivoire, the Dominican Republic, evidence-based decisions, and fostering transparency, to name a few ­ India, and Morocco around 20 percent of the total value of govern- benefits. ment contracts is allocated to SMEs (World Bank 2016c). Investment Climate Assessment of Bhutan 53 has one of the highest levels of institutional quality in the overhaul of its Companies Act back in 2004, focus- the South Asia region. However, suboptimal coordina- ing on simplifying administrative requirements, creating tion among regulatory agencies reduces the quality of transparent company structures, boosting competitive- government-to-business services. Moreover, weaknesses ­ ness through accountability and corporate governance, in accounting standards, creditors’ rights, and corporate and contributing to greater shared prosperity (World governance have a negative impact on taxation revenues, Bank 2016d, 69). transparency, access to capital, and risk taking. To promote the development of the private sector while increasing By streamlining the existing licensing procedures taxation revenues, the RGoB should take steps to increase for businesses holding multiple licenses, taxation the awareness of private sector actors of taxation policy revenues can be increased. The MoEA and the DRC and accounting standards (Subsection 3.2.5.1). Taxation should work on streamlining the existing licensing proce- revenues can be further increased and incentives for firm dures, as one business can hold up to 21 licenses, which productivity enhanced through revision of licensing and makes it confusing to file tax returns and to keep track of incorporation procedures and increased data ­ sharing existing businesses (Bhutan, RAA 2016, 33). The newly between government agencies (Subsection 3.2.5.2). introduced government-to-business (G2B) online license portal is a good step in the right direction. However, the 3.2.5.1 Taxation MoEA should identify and eliminate redundant licenses.81 The provision of targeted training and communi- cations campaigns on taxes and accounting stan- The increased use of ICT to harmonize govern- dards can improve compliance with tax regulation. ment processes and facilitate data sharing among Small businesses’ biggest obstacle to paying taxes is government agencies can improve the RGoB’s unfamiliarity with accounting practices. This result reso- ability to design policy and deliver efficient nates with the MoLHR’s assessment that accounting and ­government-to-business services. A key step is to finance are the most important skill gap in the produc- complete the integration of the Revenue Administration tion sector (Bhutan, MoLHR 2016, 91). To successfully Management Information System (RAMIS) with MoEA’s mainstream the adoption of accounting standards, the electronic business registration system. As of 2016, RGoB should carry out a communication campaign on RAMIS had been integrated with the Bank of Bhutan tax compliance and offer adequate training programs for for online payments and with the Public Expenditure SMEs (Bhutan, MoEA 2012).80 The widespread imple- Management System (PEMS) for online filing of Tax mentation of bookkeeping among firms would reduce Deducted at Source (TDS). To follow through with the subjective tax assessments and improve compliance with e-Government Master Plan, the RGoB should integrate tax regulation. RAMIS with other relevant agencies and systems, move toward a unique business identification system through a 3.2.5.2 Licensing and Incorporation centralized database (Bhutan, RAA 2016, 21) and add a Amendments to the Companies Act can ensure license registration module to RAMIS that can be used adequate oversight of firms’ practices without on a real-time basis by the Regional Trade and Industry restricting boards’ flexibility in commercial deci- Offices (RTIO) and the Regional Revenue and Customs sion making. The Companies Act sets the rules on busi- Offices (RRCO) (Bhutan, RAA 2016). Such a measure ness ownership, incorporation, management, insolvency, would generate trustworthy data on business status and and court challenges. Therefore, the amendment should address the current liquidation and reorganization 81. For example, Lao PDR made starting a business faster by imple- framework gap. For example, India started working on menting simplified procedures for obtaining a license and a registered company seal (World Bank 2016d). A randomized controlled trial in Guatemala found that letters containing deterrent messages calling 80. It has been shown that teaching “rule of thumb” accounting nondeclaration of taxes either an intentional choice or a violation of concepts to microentrepreneurs can be more effective than teaching social norms among the rest of the population that did pay taxes was a traditional approach to accounting (Xu and Zia 2012). effective in increasing payment rates (Kettle et al. 2016). 54 Investment Climate Assessment of Bhutan timely registration of licenses with the RRCOs (Bhutan, storage facilities; and undertake targeted FDI promo- RAA 2016, 34). By effectively adopting an integrated tion (Subsection 3.3.2). approach to the existing and planned information sys- »» Agribusiness: To grow Bhutan’s agribusiness tems, the RGoB would mitigate inefficiencies, minimize sector, the RGoB should reform public investments the risk of technology obsolescence, and improve interac- to minimize adverse effects on the private sector; tions with businesses (Bhutan, MoIC 2014, 37).82 promote markets for high-value niche products by encouraging the development of export infra- 3.3 Sector- structure; and fully implement the “Brand Bhu- Specific Reform tan” strategy (Subsection 3.3.3). »» Hydropower: To ensure the benefits of hydro- Recommendations power generation for the rest of the economy, the Addressing sector-specific constraints through RGoB should explore mechanisms to promote the targeted reforms will ensure the growth of Bhu- involvement of local firms (Subsection 3.3.4). tan’s leading industries. The performance of the hydropower, tourism, ICT, and agribusiness sectors will The following sections provide further details on these have a major effect on the future of Bhutan’s economy. sector-specific policy recommendations. While each sector is growing rapidly, they also all face industry-specific constraints that either threaten to inhibit 3.3.1 Tourism future growth or curtail spillover benefits for the wider By addressing shortcomings in the quality and economy. To alleviate these constraints, certain reforms scope of tourist services, Bhutan can enhance the and investments should be prioritized. Specifically: value of its tourism brand.83 Bhutan’s tourism sec- »» Tourism: Limited accessibility, high seasonality, tor currently suffers from extreme seasonality, limited lack of product development, ineffective market- geographic reach, low quality services, and insufficient ing, and the dual tariff system are starting to neg- marketing. Bhutan could increase tourism revenue with- atively affect the sustainability of Bhutan’s tourism out incurring adverse impacts by utilizing existing excess industry. To address these issues, the RGoB should capacity and broadening itineraries across the coun- support the building of capacity by tourist service try. To diversify flows temporally, geographically, and providers; provide incentives for operators to pro- demographically, the RGoB and tourist service provid- mote new packages during the lean season and ers should work together to promote lean season arrivals outside the Western Circuit; and use social media and develop alternative activities, while introducing a fee and other innovative strategies to develop new system for regional arrivals (Subsection 3.3.1.2). Finally, markets (Subsection 3.3.1). the RGoB and service providers should strengthen pol- »» ICT: To promote the development of Bhutan’s icy coordination and destination marketing by develop- nascent ICT sector, the RGoB should invest in ing new structures for public-private dialogue and joint enhancing the speed, reliability, and cost-effectiveness investments (Subsection 3.3.1.3). of high-speed Internet connectivity; explore the fea- sibility of high-skilled migrant worker programs for the ICT sector; encourage the development of data 82. For instance, Sri Lanka, a lower-middle-income country like 83. A properly planned and executed tourism policy, related strategy Bhutan, provides more than 65 online services through basic phone and coordinated actions could have major positive impacts on calls and has developed an inclusive e-government strategy to cope Bhutan’s people and landscapes, by giving cultural and environmen- with its literacy gap (UN 2014, 2016). The Philippines rolled out a tal assets greater economic value, stimulating private investment one-stop shop, the Integrated Business Registration System, which and job creation, helping to preserve the country’s primary tourism integrates business registration, tax payments and payroll related pay- assets, and providing rural residents with socioeconomic incentives ments, thus converting a 34-day, 16-step process to start a business to remain in or return to rural villages, which underpin Bhutanese into an 8-day, 6-step process (Philippines, NCCP 2015). culture and traditional ways of life. Investment Climate Assessment of Bhutan 55 3.3.1.1 Price and Quality four-season travel destination, the RGoB and tour opera- Adjustment in incentives, technical assistance, and tors should identify summer and winter festivals and sum- marketing support can address service shortcom- mer and winter sporting events—such as biking, trekking, ings that undermine tourist satisfaction. Potential kayaking, archery—that can provide experiences which measures that may be adopted include: (i) a review and differ from existing offerings. revision of when and how hotels are paid by operators for bookings; (ii) a review and revision of the hotel rating By diversifying tourist activities and enabling cus- system, so outdated hotels would be required to invest in tomization of itineraries, Bhutan can appeal to renovating properties to maintain their three-star rating; the younger generation of tourists and ensure the (iii) improvement of access to financing and tax incen- sustainability of flows. Historically, the so-called baby tives for renovations; (iv) provision of technical assistance boom generation has made up the bulk of tourists in Bhu- and incentives for use of locally produced furniture and tan. However, as that generation ages, the demographic décor; (v) streamlining of the work permitting process for make-up of tourists is shifting to younger generations foreign chefs; (vi) creation of a culinary school in Bhutan; with different tastes and preferences. Developing a tour- (vii) creation and promotion of a consumer-driven online ism product that will appeal to the younger demographic review and rating system for hotels, restaurants, and tour will require innovation in and the diversification of activ- operators; and (viii) reduction or elimination of tariffs on ity offerings, such as by offering greater opportunities to imported wine and other spirits. engage in adventure-related outdoor activities (mountain biking, rafting, trekking, etc.) and cultural immersion 3.3.1.2 Diversification of Flows and by increasing opportunities to develop customized By providing incentives to operators, the tempo- vacations that can be booked locally. Through challenge ral and geographic diversification of tourist flows grants, technical assistance, cooperative marketing cam- can be diversified. By geographically and temporally paigns, and/or tax incentives, the RGoB may consider diversifying flows, the economic impact of tourism can supporting the development of more activity-oriented be broadened across the population. Despite investments programs and opportunities for cultural emersion (for to improve access to central, eastern, and southern Bhu- example, river rafting, trekking, homestays, artisans in tan, the potential offered by these regions is untapped. To action, etc.). promote tourism in the areas, the RGoB should consider establishing a public-private Rural Tourism Develop- The growth in the number of regional tourists vis- ment Task Force, which will be responsible for drafting a iting Bhutan can be managed through a new fee strategy to expand and market travel beyond the Western regime and through the creation of facilities for Circuit. Through tax exemptions, technical assistance, low-spending tourists near the border. The large challenge grants, airfare discounts or subsidies, and/or increase in flows of tourists from neighboring countries targeted market support, the RGoB should also create not subject to the MDPP has reduced the average reve- circuit development and marketing incentives to promote nue generated by tourists while threatening to affect neg- rural tourism focused primarily on eastern and southern atively Bhutan’s cultural and environment resources and Bhutan. Finally, and once appropriate regulations for the the experience of higher spending visitors. To address regional market have been developed, the RGoB should this concern, the RGoB should continue its development explore the potential for developing overland tourism of an entrance fee regime for visitors not subject to the routes from India to southern and eastern Bhutan, which MDPP. The entrance fee could potentially take the form may then be marketed to younger demographic segments of a road toll assessed on vehicles entering Bhutan or interested in adventure travel and more activity-oriented a tourist card required to be purchased by foreign visi- pursuits. With the goal of transforming Bhutan into a tors entering overland. The RGoB might also consider 56 Investment Climate Assessment of Bhutan requiring all visitors to popular heritage sites and festivals foreign companies have been attracted to Bhutan’s ICT to pay an entrance fee and/or to hire a guide to accom- sector by the country’s stable business climate, several pany them. To reduce overcrowding at popular sites and investors have been deterred by an unanticipated defi- festivals in the interior, the RGoB may also consider cre- cit in essential skills among the workforce, high Internet ating attractions, accommodations, and visitor services costs, and the slow growth of the sector (Subsection 1.4.3). near the border targeted specifically at low-spending While durably addressing the skills gaps requires educa- visitors. tional reforms, investor concerns can be addressed in the short run by developing targeted incentives for job 3.3.1.3 Marketing and Management training and a specialized channel for migrant labor in Increased dialogue between public- and private- ICT (Subsection 3.3.2.1). To reduce Internet costs for sector entities and coordination of tourism-­ related the sector, the RGoB should pursue establishing a new policies will improve the performance of the sector. gateway with Bangladesh and PPP-based investments to To improve policy coordination, the RGoB might con- improve infrastructure (Subsection 3.3.2.2). Finally, a tar- sider exploring further the separation of promotional and geted investment promotion strategy, revisions of public regulatory functions while also providing more funding procurement rules, and the establishment of an advisory for human resources, marketing and market research. council can also promote the sector (Subsection 3.3.2.3). By improving coordination between private- and 3.3.2.1 Skills public-sector marketing and through utilizing digi- The provision and/or subsidization of training on tal marketing, Bhutan can attract greater volumes soft skills can help address factors constrain- of high-paying tourists. Some tour operators and ing the productivity of ICT firms and heighten the hoteliers want to work more closely with TCB to develop attractiveness of investments in the sector. Con- marketing activities. To facilitate such joint marketing versations with firms in Thimphu Techpark suggest that activities, the RGoB should: (i) evaluate the current mar- Bhutan’s low wages are attractive for investors in the ICT keting strategy and define new approaches for attracting sector, but that this advantage is offset by low productivity. a broader demographic; (ii) develop a framework, crite- In addition to concerns about the availability of middle ria, and process for selecting and prioritizing geograph- management and technical skills, firms also noted deficits ical markets; (iii) overhaul the national tourism website in soft skills—such as punctuality and ­ professionalism— to utilize best practices in destination website design, among employees. Key informants reported that such use, and maintenance; (iv) improve the use of social deficits have imperiled the fulfillment of international media to increase engagement between TCB and travel- supply contracts and negatively affected firms’ reputa- ers; and (v) organize an annual Discover Bhutan Travel tions. While the RGoB has specific policies to subsidize Mart, inviting members of the travel trade to Bhutan for training through MoLHR’s Guarantee Employment pro- familiarization trips and business-to-business networking gram (Bhutan, MoLHR 2014), additional programs may sessions. be devised to provide remedial training in soft skills to employees of ICT and other firms engaged in the export of services, as well as to university students and job seek- 3.3.2 Information and ers. Alternatively, the MoLHR may consider subsidizing Communications Technology firm-level training. To exploit its latent comparative advantage in ICT exports, the RGoB must address skills shortages A specialized channel for high-skilled migration and high Internet costs, as well better market Bhu- can address skill shortages, while providing grad- tan as an ICT investment destination. While several uates from northeast India with an attractive Investment Climate Assessment of Bhutan 57 alternative to India’s business process outsourcing ensure that Bhutan’s nascent ICT industry has the req- (BPO) sector. Firms noted that stringent immigration uisite infrastructure to compete internationally, this new regulations—which apparently contradict the more lenient link should be pursued. RGoB may also wish to explore but unapplied FDI regulations—­ preclude the recruitment the possibility of attracting PPP-based investments in of foreign expatriates to fill critical skill shortages. To relax Internet connectivity. the skills constraint over the short run, the RGoB should establish a specialized channel to allow a limited number 3.3.2.3 Investment Promotion and Product of high-skilled foreign expatriate workers to work in the Development Thimphu Techpark on multi-year contracts. Following Investment promotion and public procurement can the creation of this channel, targeted promotion may be help develop the ICT sector. The Thimphu Techpark undertaken among persons originating from northeast- has served as a proof-of-concept for the feasibility of ern India with training and experience in ICT and/or ICT in Bhutan. However, a critical mass of investments BPO. Currently, many ICT graduates from this area find will be required to ensure the continued development work elsewhere in India (Nandakumar and Arakali 2014; of the nascent industry. Achieving this will require more Lalrampuii 2016), but report instances of discrimination active FDI promotion to build awareness of opportuni- (Abbas and Varma 2014; Das 2014). Given its cultural ties in ICT. Promotion may be particularly focused on similarities with parts of northeastern India, Bhutan may investors already based in the region, given that several represent a more attractive destination for such graduates. firms currently based in the Thimphu Techpark—such as Such a program is not unprecedented, with the Ministry Selsie and Scan Café—opted to relocate from neighbor- of Education recruiting teachers from northeast India to ing countries. In addition to investment promotion, the address a shortage in 2006 (Hindustan Times 2006). RGoB can also use public procurement to stimulate the domestic market for ICT services. Various government 3.3.2.2 Connectivity agencies are in the process of digital transformations. The establishment of a new Internet link with Ban- Procurement rules for the provision of related services gladesh can provide Bhutan with the world-class should be formulated to enable companies based in Bhu- connectivity necessary to support the growth of tan to benefit from these contracts. the ICT sector. Key informants in the Thimphu Tech- park identified the cost—which is reportedly twice as Establishing a panel of advisors can help Bhutan high as in neighboring countries—and speed of Internet take advantage of emerging opportunities in ICT. access as another factor that adversely affects the ICT sec- Key informants report that, due to its abundant electricity, tor in Bhutan. While the competitiveness of the Internet low cost base, temperate climate and physical proximity service provider (ISP) sector has increased in recent years, to the Bangladeshi and Indian markets, Bhutan poten- Bhutan Telecom Ltd. still captures most of the demand, tially possesses a competitive advantage in data storage. including 513 of the country’s 854 leased line subscrib- Given the rapidly developing nature of the sector world- ers and 28,431 of the country’s 28,538 ASDL broadband wide, additional opportunities inevitably exist—or will subscribers as of June 2016 (Bhutan InfoComm and emerge—for which Bhutan is well positioned. To enable Media Authority 2016). As of late 2016, the Department the RGoB to identify such opportunities and develop of IT and Telecom (DIT) was exploring the possibility appropriate strategies, a panel of ICT investors may be of importing 2.5 to 10 Gbps of Internet bandwidth from convened to advise the government. The RGoB may also Bangladesh, which would lower costs by as much as two- leverage the country’s tourism product to attract luminar- thirds and provide alternate redundant connectivity over ies to Bhutan to participate in conferences and meetings and above the existing two gateways (Tshedup 2016). To with appropriate officials and local investors. 58 Investment Climate Assessment of Bhutan 3.3.3 Agribusiness BDBL and other private financial institutions could Increasing investment and productivity in agri- help increase mechanization by developing new business can be achieved by reforming subsidies, loan products. Subsidies provided through the Agri- developing trade infrastructure, and implementing culture Machinery Centre (AMC) incentivize use of the Brand Bhutan strategy. To ameliorate the adverse cooperatives over more entrepreneurial models, which in effect of subsidies and other public interventions on the turn perpetuates a business model unable to maximize agricultural and rural sector, the RGoB should under- productivity.84 Individual ownership, on the other hand, take reforms to optimize incentives for private investment places responsibility for maintenance and income gen- and firm efficiency (Subsection 3.3.3.1). To promote the eration in the hands of one person, facilitating decision development of markets for high-value niche crops and making and innovation. Leasing provides one of the best domestic livestock products, the RGoB should invest in options for the rural poor, who have no collateral and few storage and logistics and market infrastructure (Subsec- assets, to obtain equipment, and in some cases it may be tion 3.3.3.2). Finally, to enable producers and traders to more effective than promoting cooperative ownership. exact full value from Brand Bhutan, it is imperative that Accordingly, the BDBL and other banks should explore the RGoB develop and implement a regulatory frame- mechanisms for providing loans for or leasing agribusi- work, resolve the division of labor between participating ness machinery and equipment to small entrepreneurs. agencies, and communicate with producers about the innovation (Subsection 3.3.3.3). 3.3.3.2 Market Development By investing in storage and logistics, the RGoB can 3.3.3.1 Subsidies and Incentives promote exports of high-value, niche crops. Bhutan By overhauling public investments, the RGoB can possesses several potential niche crops—noncommoditized increase investment and efficiency in agribusiness. products with low volumes of international trade—which Currently, several well-intentioned interventions—such are not currently produced in volumes comparable to com- as megafarms, Farm Shops, and the Agricultural Machin- modities like grains, but which may potentially command ery Center (AMC) and various subsidies—suppress high value in export markets like Bangkok, Singapore, and private-sector investment and promote inefficiency (Sub- Dubai. These products include fresh wild-collected mush- section 1.4.4). The RGoB’s public interventions in agri- rooms (matsutake, morels, chanterelles),85 retail honey, business should be reviewed and reformed to ensure that, crated fruit (mandarins and kiwi fruit), asparagus, pro- wherever possible, market-based solutions are favored, cessed hazelnuts, walnuts, black pepper, Sichuan pepper, and competition and efficiency is promoted. Specifically, retail-packaged cardamom, processed ginger products, and rather than deciding for farmers which crops they should seed potatoes. The RGoB can support the development of grow and where they should buy inputs, MoAF should export markets for these high-value niche products by pro- consider a voucher system, similar to India’s Kisan Credit moting innovations in storage and logistics, for instance by Card, allowing farmers to spend vouchers at any private establishing an export terminal equipped with cold storage provider. The Farm Shops program should develop a and customs and loading facilities at Paro airport.86 Seed clear plan to transition away from its current model and move toward full private ownership. In addition, the 84. According to World Bank (2017), the FAO’s Agriculture Sector Review of Bhutan states that the AMC’s farm mechanization effort retail sale of subsidized food staples by the Farm Shops has been met with limited success, yet more funding is currently should be reexamined to integrate vouchers. The RGoB being put into providing power tillers to small cooperatives formed for that purpose. should also rebalance subsidy programs to support the 85. Owing to the extensive forest cover, the collection of wild-­ marketing side of the value chain—rather than just the growing mushrooms is a very common livelihood in rural Bhutan. 86. The facility at the Lahore airport in Pakistan, from which the production or supply side—to promote market develop- famous Kinnow mandarin is exported, may serve as a good bench- ment and reduce excess production. mark for such a facility. Investment Climate Assessment of Bhutan 59 potato production can be promoted through investments (iii) establish and publish sanctions and penalties for mis- in laboratories and inspection protocols as well as research use of the brand; and (iv) create systems for controlling into new varieties and the development of microtuber pro- the quality of products sold under the brand. duction. In addition, the Bhutan Exporters Association (BEA) may assist by consulting with traders and brokers Better delineation of functions between relevant in the European Union, Canada, and Japan to explore the agencies and enhanced communication strategies feasibility of developing these markets. will enable producers to better exploit the value of Brand Bhutan. While the MoEA holds overall respon- The increasing demand for livestock products in sibility for the brand, the Bhutan Agriculture and Food Bhutan represents an excellent opportunity for Regulatory Authority and the Bhutan Standards Bureau domestic farmers and agribusinesses to expand. will serve an essential role in enforcing standards. To The RGoB should encourage greater replacement of support this, RGoB should ensure the correct structure, imported animal protein products, such as milk, beef, function, capacities, and funding arrangements for the pork, poultry, and honey. Currently, the Department of two agencies and an appropriate degree of separation Livestock funds the development and management of both between their roles and between the regulatory model farms for livestock rearing, processing, and mar- and services functions of the strategy. To build aware- keting, yet these efforts risk suppressing private initiatives. ness of the brand among consumers in target markets, Instead, the RGoB should emphasize linking smaller MoEA should also develop effective communications domestic market hubs and establish market infrastructure strategies to ensure that exporting firms avail themselves in Bhutan’s secondary cities. In addition, separate live- of the benefits of Brand Bhutan and comply with its stock product markets could be created in major urban standards. areas and hub cities to better serve this subsector. The RGoB should encourage investments in abattoirs and 3.3.4 Hydropower create a regulatory framework to support the growth of To increase the benefits of hydropower construc- the post-harvest and marketing aspects of the livestock tion for the broader economy, the RGoB should subsector. ensure the enhanced participation of local firms and workers in hydropower projects. Anecdotal 3.3.3.3 Marketing evidence suggests that hydropower investments have The RGoB should develop and implement a regu- failed to generate the positive spillovers for the wider latory framework for the management of Brand economy—such as enhancement of the technical and ­ Bhutan, including the regulation of quality and managerial capacity of Bhutanese and the employment standards. Brand Bhutan represents a promising means of local labor—that were anticipated. While Bhutanese of leveraging Bhutan’s unique image to promote the firms have landed some civil works subcontracts, Indian country’s products and command premium prices in agencies have taken the lead in planning, designing, and high-value markets. However, further steps are required managing many projects and have handled all major to realize the strategy’s potential. Notably, the Ministry construction and supply contracts (Premkumar 2016). of Economic Affairs must formally launch Brand Bhu- Likewise, construction work for projects is reportedly tan and create a framework for its management. This undertaken mainly by the 60,000 Indian nationals living framework should (i) establish standards for products in Bhutan and the 8,000 to 10,000 workers who cross bearing the Brand Bhutan identity and associated labels; the border every day (Premkumar 2016). To increase the (ii) outline procedures for private-sector use of the brand; benefits of the hydropower projects for Bhutanese firms 60 Investment Climate Assessment of Bhutan and workers, the RGoB should undertake the following appropriate provisions to enable the contracting of Bhu- measures: (i) commission a study of factors inhibiting tanese firms and the employment of Bhutanese workers Bhutanese firms from winning hydropower-related con- where feasible; and (iii) provide training and associated tracts (either outright or on a joint venture basis) and measures to increase the capacity of local firms and Bhutanese workers from being employed on hydropower workers to participate in hydropower projects. projects; (ii) ensure that hydropower agreements include Investment Climate Assessment of Bhutan 61 Women carrying bales of straw in front of Tashichhoedzong, Thimphu, October 2015. Chapter 4 Conclusion Fueled by booms in hydropower and tourism, Bhutan’s economy has been transformed. These changes have brought about rapid income growth and poverty reduction. However, the impact of the transformation on the popu- lation has been muted by a lack of dynamism in the agriculture, manufacturing, and the services sector, which employ the overwhelming majority of the private workforce. Bhutan’s private economy remains dominated by microenterprises that struggle to increase productivity, attract investment, expand employment, and access international markets without assistance from intermediaries. Given its small market and high trade costs, Bhutan’s prospects for achieving inclusive development rely on tradable services and high- value niche products. With its unique package of institutional assets—robust public institutions, civil and political stability, low corruption, a commit- ment to protecting the country’s unique cultural heritage and environment, an English-speaking workforce, and cheap and reliable ­ electricity—Bhutan represents an attractive proposition for investors and can extract a premium for exports marketed to leverage the country’s international reputation. To achieve this, however, Bhutan will need to address constraints that undermine productivity and discourage investments in promising high-value sectors such as ICT, tourism, and agribusiness. Bhutanese firms are constrained by limited access to key inputs and markets. The ability of firms to access credit is inhibited by financial illit- eracy, weak regulation, and limited credit information and by difficulties in collateralizing assets. Limited access to skilled labor—which results from low levels of education, competition with the public sector, and restrictions on employing expatriates—is another key factor inhibiting firms from increasing productivity and investment. Bhutanese firms also face hurdles in accessing external markets, not just due to the country’s adverse geography but also because of deficiencies in infrastructure, an underdeveloped logistics sector, limited foreign investment, and deficits in firm capacities. While Bhutan has robust institutions, the ability of private firms to compete domestically is 63 adversely affected by inequalities in access to policy mak- mechanisms for public-private dialogue, and revising ers, while a lack of knowledge of accounting standards public procurement procedures. undermines the transparency of taxation. Addressing sector-specific constraints is essential Maximizing Bhutan’s development potential will to promoting development in key industries. Bhu- require reforms to address prevailing business con- tan’s tourism industry has grown rapidly in recent years, straints. To improve the access of firms to credit, the but it must evolve further to better distribute economic RGoB should focus on deepening credit information and impacts and minimize adverse cultural and environmental strengthening the legal rights of creditors and borrowers. effects. Bhutan’s ICT industry is still nascent, but it has the Improving firms’ access to skilled labor can be achieved potential to emerge as a key export earner if policy changes by developing channels to facilitate the employment of help address the skill deficits currently facing the industry. skilled expatriates, bringing public-sector compensation The development of high-value niche agricultural prod- packages into line with those offered by the private sector, ucts is likewise in its infancy, but with investments in trade and promoting vocational training. Facilitating greater infrastructure, reform of subsidies, and better marketing, access of the private sector to external markets will the sector can provide broad-based benefits to Bhutan’s require improvements in border processing and transport rural population. Finally, while hydropower has grown to infrastructure, capacity building in quality standards and be the most important industry in Bhutan, ensuring that certification, implementation of the Brand Bhutan strat- the sector helps rather than hinders the wider economy egy, promotion of e-commerce, and a well-targeted pro- will require further efforts to promote the involvement of motion strategy to attract FDI. The RGoB can further local firms and workers in project construction. Table 11 encourage the development of the private sector by ratio- summarizes the main policy recommendations to support nalizing the role of state-owned enterprises, establishing private-sector development in Bhutan. Table 11: Summary of Policy Recommendations Policy Area Recommendations Timeline Crosscutting Recommendations Access to Priority Actions: Finance Expand scope of collateralizable assets. Short Deepen and broaden credit information. Approve and implement new insolvency bill. Medium Reduce risks of e-banking for customers. Other Actions: Improve management of property records to facilitate collateralization of land. Short Expand BDBL’s scope to provide export financing for agriculture and group lending to cooperatives. Encourage growth of microfinance institutions by rationalizing licensing and reporting requirements. Medium Provide targeted financial literacy training to financial providers and users. Improve monitoring and evaluation of priority lending programs. Short Access to Priority Actions: Labor Introduce dedicated channel for skilled migration. Short Provide vocational training to adult labor force. Realign public compensation packages with private sector. Medium Other Actions: Offer scholarships for intensive business education. Medium Reward private-sector experience in public-sector recruitment. 64 Investment Climate Assessment of Bhutan Policy Area Recommendations Timeline Crosscutting Recommendations Access to Priority Actions: Markets Promote use of e-commerce platforms. Short Increase awareness and use of quality standards and certifications. Develop and implement investment promotion strategy. Introduce risk-based border inspections and coordinate border procedures. Medium Other Actions: Develop logistics skills for industry professionals. Medium Phase in the Bangladesh, Bhutan, India, and Nepal Motor Vehicles Agreement. Improve transport and logistics infrastructure. Medium–Long Improve regulatory and operational functions of airports through skills upgrading. Diversify transport corridors. Long Competition Priority Actions: Create a public-private dialogue platform to provide equal access to policy feedback. Short Monitor anti-competitive practices and effect of SOEs on private investment. Other Actions: Introduce a national e-procurement strategy to enhance private-sector competitiveness. Medium Create a legal framework to prevent anti-competitive practices, monopolies, and cartels. Long Taxation Priority Actions: Increase awareness of taxation policy and accounting standards. Short Other Actions: Amend the Companies Act. Short Streamline licensing procedures. Medium Sector-Specific Recommendations Tourism Build capacity of three-star accommodation and restaurant providers. Short Support development of programs to geographically and temporally diversify flows. ICT Develop sector-specific high-skilled migration channel. Upgrade skills of existing and prospective ICT workers. Short Develop and implement sector-specific investment promotion strategy. Upgrade Internet infrastructure. Medium Agribusiness Develop regulations, oversight roles, and communication strategy for Brand Bhutan. 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Typically, data are nationally repre- sentative of formal (registered) private firms with five or more employees. This is the case for the 2009 survey round in Bhutan. In the Bhutan 2015 round, however, the survey was expanded to include micro-firms, i.e., those with fewer than five employees. In addition, the sample contains panel data following 110 establishments interviewed in 2009. Bhutan 2015 data, collected between April 2015 and January 2016, were drawn primarily from the Department of Revenue and Custom’s taxpayer database. This database contains a full list of businesses registered for operating licenses as well as for a Corporate Income Tax (CIT) or Business Income Tax (BIT)’s ID. In addition, the list of 250 firms surveyed in 2009 was included to form the panel firms. A random subset of 6,000 businesses from this list was then used for verification. During the verification process, most BIT records were found to be out of date, duplicates, or other­ wise ineligible for the survey. To compensate for the poor quality of the BIT list, fresh BIT establishments were enumerated during the physical verification process and made eligible for the survey. The resulting list of eligible establishments used as the sample frame consisted of 1,833 firms (see Table 12 for the distribution of the frame). 73 Table 12: Bhutan ES Sample Frame Food & Other Other Beverages Manufacturing Tourism Services Thimphu-Paro   0—Micro (1–4) 4 29 139 665 1148 1—Small (5–19) 2 25 66 130 2—Medium (20–99) 0 7 21 44 3—Large (100+) 0 2 3 11 Phuentsholing 0—Micro (1–4) 3 22 27 120 310 1—Small (5–19) 4 14 7 49 2—Medium (20–99) 6 15 13 19 3—Large (100+) 0 8 0 3 Gelephu 0—Micro (1–4) 4 4 12 58 100 1—Small (5–19) 0 3 2 10 2—Medium (20–99) 0 5 0 2 3—Large (100+) 0 0 0 0 Samdrup Jongkhar 0—Micro (1–4) 1 11 47 165 275 1—Small (5–19) 0 13 12 20 2—Medium (20–99) 0 3 0 2 3—Large (100+) 0 1 0 0 Grand Total 24 162 349 1298 1833 From this frame, the sample was selected using than in the construction and agriculture sectors. Regional stratified random sampling. Three levels of stratifica- stratification was defined in four regions: Thimphu-Paro, tion were used in Bhutan: type of industry, firm size, and Phuntsholing, Gelephu, and Samdrup Jongkhar. geographic region. The universe was stratified into four sectors: Food and Beverages, Other Manufacturing, Tour- The resulting sample includes 367 businesses rep- ism, and Other Services. Size stratification was defined resentative of all registered firms operating in the following the standardized definition: micro (fewer than nonagricultural economy in the four regions cov- five employees), small (5 to 19 employees), medium (20 ered (see Table 13 for the distribution of the achieved to 99 employees), and large (more than 99 employees). sample). The stratification of the sample allows statisti- For stratification purposes, an employee was defined as a cally significant inferences regarding the effects of the permanent full-time worker. This definition of the labor investment climate across four regions, four broad sec- force was appropriate because seasonal/casual/part-time tors, and four firm-size categories. employment is not a common practice in Bhutan, other 74 Investment Climate Assessment of Bhutan Table 13: ES Achieved Sample Food & Other Other Beverages Manufacturing Tourism Services Thimphu–Paro   0—Micro (1–4)  1   9 13  33 177 1—Small (5–19)  2  21 25  22 2—Medium (20–99)  0   4 15  23 3—Large (100+)  0   1  3   5 Phuentsholing 0—Micro (1–4)  3  14  2   7  85 1—Small (5–19)  2  11  5   6 2—Medium (20–99)  5   7  8  11 3—Large (100+)  0   3  0   1 Gelephu 0—Micro (1–4)  4   4  4   7  38 1—Small (5–19)  0   2  2  10 2—Medium (20–99)  0   4  0   1 3—Large (100+)  0   0  0   0 Samdrup Jongkhar 0—Micro (1–4)  1  11  4  18  67 1—Small (5–19)  0  12 10   6 2—Medium (20–99)  0   2  0   2 3—Large (100+)  0   1  0   0 Grand Total 18 106 91 152 367 Investment Climate Assessment of Bhutan 75 Kids running on the street, Thimphu, September 2015. Annex 2 Bhutan Licensing Regimes and Estimated Size of Private Sector In Bhutan, the regulatory framework governing firm registration is comparatively complex. Limited liability companies (LLCs) are required to register with the Registrar of Companies. This remains a very small seg- ment of the private sector. Sole proprietors form by far the largest segment of domestic firms in Bhutan, and the main forms of legal registration for them require registering for an operating license with line departments at the Min- istry of Economic Affairs and registering for a Taxpayer Number (TPN) from the Department of Revenue and Customs. Operating licenses are managed by different departments at MoEA depending on their indicated sector and size. Table 14 summarizes the different licensing requirements for firms by legal status, size, and sector. Table 14: Business Registration Framework Size (self-declared initial fixed Sector investments) Type of License Licensing Agency For Companies All Sectors All Sizes Limited-Liability Legal Registrar of Companies Status (Department of Industry, MoEA) For Sole Proprietors/Partnerships Manufacturing, Medium and Large Business License Department of Industry, MoEA Construction & Services (Investment > 1 Mil Nu) (except wholesale/retail Cottage and Small Businesses Business License Department of Cottage and Small trade) Industry (DCSI), MoEA (Investment < 1 Mil Nu) Retail Micro Microtrade Registration Department of Trade, MoEA (Investment < 1 Mil Nu) Certificate Small, Medium, Large Retail Trade License (Investment > 1 Mil Nu) Wholesale All Sizes Wholesale Trade License Source: https://bhutan.eregulations.org; conversations with MoEA staff. 77 The differing licensing schemes are intended to The number of businesses as indicated by the num- provide smaller firms with simplified registration ber of operational TPNs provides a more accurate processes and better incentives. For example, the picture of the size of the private sector. Bhutan micro-trade registration certificate is renewable without requires firms wishing to renew their licenses to register fees while providing businesses with tax exemption ben- with the DRC. This applies for even the smallest traders efits. Registering with DCSI allows firms to access pri- under the micro-trade certificate scheme. In practice, the ority finance from the Rural Enterprise Development number of licenses exceeds the number of tax numbers, Corporation.87 and tax data are thus more likely to provide the true num- ber of existing businesses. This is so for several reasons: However, the system’s several shortcomings »» The DRC does not have a mechanism to enforce emerge in practice. One key shortcoming is a lack of TPN registration by all licensed businesses. harmonized definitions on firm size between licensing »» MoEA departments responsible for approving schemes and financing schemes. Further, the current operating licenses keep track of license renewals, firm size definition is based on initial investments in fixed but beyond licensing, they do not have a mecha- assets, which is self-declared by firms at registration and nism to track firms’ operational status. In contrast, in practice is decided at the discretion of the licensing firms report their operating status in their filings official without any uniform verification process. This with the DRC. lack of verification potentially creates misleading infor- »» Both tax return data and fieldwork to form the ES mation on the overall firm-size distribution. Further reg- sampling suggested that businesses, to keep their ulatory inconsistencies and/or redundancies undermine licenses, maintain tax filings with DRC even when Bhutan’s ability to monitor its private-sector activities not operational. efficiently. For example, currently cottage (micro-) and »» Finally, a business can have multiple licenses but small firms experience no difference in benefits, render- files for only one TPN. ing the distinction irrelevant. For non-LLCs, MoEA also does not require them to report changes in size, economic Our best estimate of the current number of exist- activity, or operating status. ing businesses in Bhutan is around 28,000. The DRC maintains information on the status of firms based 2.1 Estimated Size of the on their tax filing records (Figure 26). First, nonexisting Enterprise Sector businesses that do not keep contact with the DRC will have their TPNs deactivated. Among active accounts, Since coordination among these agencies remains businesses that are not tax exempt must file taxes annu- limited, estimates of the size of the private sector ally, thus reporting on their operational status. In 2016, in Bhutan vary widely. The Bureau of Statistics pub- 19,287 businesses submitted filings to the DRC elec- lishes annual reports on the size of the private sectors, tronically, of which about 23.12 percent were nonoper- based on the number of licenses as indicated by the cor- ational. The operational status of the remaining 17,620 responding line departments. For example, in 2014, the active TPNs, the holders of which either filed taxes total reported number of firms in all sectors except min- non-­ electronically or were tax exempt (mostly micro-­ ing was 69,847 firms. These figures do not reflect firm businesses), is unknown. Nevertheless, assuming the same exits, however, and hence substantially overestimate the rate of operations for 2016 of around 77 percent, our number of existing businesses in the country. best estimate on the number of operating BIT payers is around 28,374. Given the minimal number of LLCs and publicly traded companies, the true population of regis- 87. Previously the Business Opportunity and Information Center. tered firms in Bhutan is likely close to this number. 78 Investment Climate Assessment of Bhutan 838 13,546 operational non- filers, assuming 23.12% rate of non-operational 17,620 28,374 37,745 36,907 4,459 operating BIT TPNs 23.12% non- 19,287 operational 14,828 All firms Active in database (Among active TPNs: Among filers: filers vs. non-filers operational status Total BIT registered TPNs Active registered TPNs De-activated TPNs BIT filers BIT non-filers Operation filers Non-operational filers Figure 26:  Number of BIT Firms by Status in DRC Tax Database, 2016 Source: Information from conversations with MoEA and DRC staff. 2.2 Extent of Informality Bhutan is also likely to be negligible. Besides the licensing schemes discussed above, rural businesses and Formality is a multifaceted concept. At the firm businesses with investment below Nu 100,000 (about level, it can include various forms of legal registration US$1,560) are not required to register.88 According to (trade license, tax identification number), membership MoEA staff, for other businesses, the cost of being for- in business associations and the chamber of commerce, mal—in terms of both tax burdens and registration to the use of formal finance, the degree of information costs—are sufficiently low that almost all businesses with technology used by the firm, and the business practices a permanent outlet would have some form of licens- and record keeping that a firm does. ing. The ratio of registered firm per employed person (28,000/339,568, i.e., 1 registered firm per every 12 Based on WBES 2015 data, the vast majority of employed persons) appears in line with this assessment.89 firms are formal based on the criteria of having a business license or paying some taxes. If defined as Informality defined by a firm’s registration and tax being an LLC while not registered with the company reg- status is rare, but informality in terms of employ- istrar, informality is somewhat more common (at 12 per- ment is common. Based on the WBES 2015, in aggre- cent). However, this definition is not very informative, as gate, 50 percent of all full-time workers in the formal a mere 1.59 percent of all firms are LLCs. The limitation (registered) sector are employed with a temporary con- of the WBES, of course, is that the sample frame is based tract. This definition will exclude one-person companies on the list of licensed companies and taxpayers, hence by without employees and hence underestimates those work- definitions we cannot observe firms outside this system. ing in, for example, household enterprises. Existing household data also do not allow for estimating the extent of business informality in Bhutan. 88. Throughout the report, we use the 2015 official exchange rate of Nu 64.15 to US$1 to convert nominal values. 89. The Gallup World Poll survey in 2016, for example, suggests that Defining formality as meaning registered for an the percentage of Bhutanese adult population owning a business is operating license, the share of informal firms in 9 percent (see Annex 3, Section 3.5, for more detail). Investment Climate Assessment of Bhutan 79 Based on household surveys and a broader definition of Table 15: Share of informality, informal employment is even more prevalent. Informal Firms in Bhutan Based on the 2014 labor force data (World Bank 2016a) Informality Source/ and ILO definition of informality, the rate of informal Definition Share Year employment in 2014 is 79.8 percent. Expectedly, it is a Firm-level: (% of all phenomenon more common among those with less edu- firms) cation and in poorer households (World Bank 2016a).90 Being a LLC and not 12.10% WBES registered with the 2015 company registrar Operating without a 0% WBES license 2015 Not paying taxes 2.20% WBES 2015 Employee level: (% of total employment) Informal employment 79.80% LFS 2014 defined following ILO 79% LFS 2007 (2013) as those employed 90. This definition encompasses all workers who work as casual but not in regular wage/ paid employees, contract/piece paid workers, own-account workers, salaried work or high-end and family workers. In addition, regular paid employees without a self-employment90 contract of employment and/or access to any kind of fringe benefits (gratuity, provident fund payments, overtime payments, annual Employees with a 50% WBES payments, sick leave, casual leave, maternity/paternity leave, or temporary (as opposed 2015 compensation for injury, disability or death due to work accidents or to permanent) contract occupational disease) are also counted as informally employed. 80 Investment Climate Assessment of Bhutan Annex 3 Additional Tables and Figures Measures of Labor 3.1  Productivity Value added per worker is a basic measure of labor productivity. We measure, per equivalent full-time worker, the value of goods and services that the firms produce, less the cost of raw materials and intermediate inputs. Labor pro- ductivity can be affected by differences in technology, organizational struc- ture, or quality of the firm’s human resources that enable it to produce more output with the same labor and other resources. Productivity is also higher in firms that use capital more intensively. A better measure of efficiency is total factor productivity (TFP), which accounts for the use of capital, but missing data on capital means that TFP cannot be estimated for the majority of firms 8 6 Log value added per FT employee 4 BWA CRI MUS LSO Bhutan2015 2 LAO IND NPL 0 −2 4 6 8 10 12 Log GDPPC Figure 27:  Correlation of Income and Labor Productivity 81 Table 16: Median Labor Productivity (Value Added per Full-Time Worker) by Industry in Bhutan ISIC Sector Name 2009 2015 10 Mining of coal and lignite; extraction of peat 60.05 15 Manufacture of food products and beverages 5.66 1.45 17 Manufacture of textiles 2.12 0.01 18 Manufacture of wearing apparel; dressing and dyeing of fur 0.68 20 Manufacture of wood and of products of wood and cork, except furniture; manufacture of 1.86 1.47 articles of straw and plaiting materials 21 Manufacture of paper and paper products 4.16 1.52 22 Publishing, printing, and reproduction of recorded media 1.60 1.49 24 Manufacture of chemicals and chemical products 10.07 25 Manufacture of rubber and plastics products 2.57 20.12 26 Manufacture of other nonmetallic mineral products 27.59 4.42 27 Manufacture of basic metals 17.51 3.12 28 Manufacture of fabricated metal products, except machinery and equipment 0.86 6.05 31 Manufacture of electrical machinery and apparatus n.e.c. 38.78 11.09 32 Manufacture of radio, television, and communication equipment and apparatus 356.72 36 Manufacture of furniture; manufacturing n.e.c. 2.16 8.11 37 Recycling 0.32 45 Construction 6.76 17.76 50 Sale, maintenance, and repair of motor vehicles and motorcycles; retail sale of automotive 2.35 2.66 fuel 51 Wholesale trade and commission trade, except of motor vehicles and motorcycles 11.77 101.09 52 Retail trade, except of motor vehicles and motorcycles; repair of personal and household 5.75 23.44 goods 55 Hotels and restaurants 5.67 2.73 60 Land transport; transport via pipelines 1.49 14.07 62 Air transport 92.36 63 Supporting and auxiliary transport activities; activities of travel agencies 5.66 20.68 64 Post and telecommunications 6.89 5.91 72 Computer and related activities 4.81 9.15 74 Other business activities 3.59 Note: Value added is measured in thousand US$, in 2010 prices. in Bhutan’s dataset. Consequently, we use value added is that high productivity measures might reflect higher per worker as the only measure of firm productivity. One prices due to conditions such as higher demand or mark- key caveat of productivity measures using revenue (as ups by firms with market power opposed to the amount of physical outputs and inputs) 82 Investment Climate Assessment of Bhutan 3.2  Price Levels 2.5 2 1.5 Manufacturing Construction 1 Wholesale & retail trade Hotels & restaurants 0.5 Transport, storage & communication 0 2007 2008 2009 2010 2011 2012 2013 Figure 28:  Price Levels Relative to 2000 Note: Price levels are calculated as the ratio between GDP by economic activity in current and constant LCU. Data are from the national accounts series published by the NSB at http://www.nsb.gov.bt/xl/?dir=SUBJECTS/NATIONAL%20ACCOUNTS/ Annual%20National%20Accounts 125 120 115 110 105 100 95 90 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Manufacturing Transport & storage Figure 29:  Producer Price Index Note: Based on PPI data published by NSB at http://www.nsb.gov.bt/xl/?dir=SUBJECTS/PRODUCERS%20PRICE%20 INDEX Investment Climate Assessment of Bhutan 83 Under these assumptions, a model on the determinants 3.3 Determinants of of labor productivity can be estimated in a regression of Labor Productivity (log) labor productivity on capital intensity and employ- and Employment ment, and other firm characteristics. The results are Growth presented below. The estimated positive coefficients on log(employment) in the manufacturing sector indicates Assume a Cobb-Douglas production function of the potential increasing returns to scale in this sector. (This is form Y = K aLb, where a + b = u, so that output per because the estimated coefficient on labor, (u – 1), gives worker can be written as a function of capital intensity an indication on economies of scale. A positive coeffi- and employment: cient indicates increasing returns to scale as this implies: a + b > 1). log Y = a log(K ) + (b – 1)logL = a log K + (u – 1)logL L L Table 17: Determinants of Labor Productivity Variables (1) (2) (3) (4) (5) (6) (7) (8) Employment (natural log) 0.0930 –0.0198 0.151* 0.361** –0.0748 0.0811 –0.0336 0.271 (0.0863) (0.0972) (0.0903) (0.142) (0.0984) (0.0869) (0.102) (0.212) Capital labor ratio (natural log) 0.412*** 0.400*** (0.0724) (0.0954) Phuentsholing –0.494 –0.471* –0.531 0.753* –0.281 –0.672* –0.370 0.713 (0.317) (0.240) (0.328) (0.423) (0.312) (0.368) (0.320) (0.512) Gelephu/Sarpang –1.165*** –0.967** –1.079*** 0.102 –1.044*** –1.130*** –0.885** 0.238 (0.386) (0.416) (0.407) (0.733) (0.383) (0.382) (0.413) (0.842) Samdrup Jongkhar –0.634 –0.534 –0.579 0.610 –0.660* –0.593 –0.505 0.233 (0.388) (0.349) (0.367) (0.530) (0.361) (0.391) (0.343) (0.633) Foreign-owned –0.851** –1.168** –0.713 0.242 –1.150*** –0.922** –1.253*** –0.356 (0.426) (0.463) (0.459) (1.539) (0.365) (0.433) (0.415) (1.879) Limited liability company (llc) 0.306 0.242 0.343 0.152 0.185 0.263 0.160 0.283 (0.387) (0.429) (0.417) (0.453) (0.414) (0.396) (0.456) (0.627) Other legal status 0.107 –0.0481 0.0865 –0.0461 0.159 0.107 0.0447 0.00707 (0.363) (0.299) (0.335) (0.557) (0.346) (0.354) (0.297) (0.540) Age 0.0163 –0.00160 0.0374 0.0768 0.0274 0.0181 0.0232 0.0821 (0.0238) (0.0329) (0.0277) (0.0560) (0.0238) (0.0235) (0.0345) (0.0754) Non-food manufacturing 1.892*** 1.142** 1.823*** –0.157 1.658*** 1.865*** 0.979** –0.232 (0.349) (0.500) (0.389) (0.469) (0.356) (0.348) (0.496) (0.525) Tourism services 3.379*** 2.790*** 3.486*** 3.333*** 3.292*** 2.738*** (0.268) (0.348) (0.417) (0.252) (0.273) (0.437) Other services 4.233*** 3.619*** 4.266*** 4.119*** 4.198*** 3.573*** (0.201) (0.384) (0.298) (0.194) (0.202) (0.422) Owner’s age 0.0126 0.0107 (0.00940) (0.00950) Owner’s education: some 0.330 0.141 secondary (0.218) (0.219) 84 Investment Climate Assessment of Bhutan Variables (1) (2) (3) (4) (5) (6) (7) (8) Owner’s education: 1.113*** 0.683** post-secondary (0.334) (0.333) Owner born outside bhutan 0.133 0.195 (0.284) (0.339) Manager’s experience –0.0233* –0.0126 0.0256 (0.0121) (0.0144) (0.0349) Female manager –0.241 0.0273 (0.257) (0.255) Share of skilled labor 0.00865* 0.00734* –0.00881 (0.00483) (0.00416) (0.00815) Have formal training –0.370 –0.215 –0.233 (0.273) (0.264) (0.592) Have internationally 0.621 0.423 –0.390 recognized quality certificate (0.532) (0.608) (0.672) Invested in it 0.821** 0.526* 0.102 (0.328) (0.302) (0.502) Regulatory time tax 0.00353 0.00213 0.00399 (0.00303) (0.00310) (0.00568) Observations 334 319 332 78 331 334 314 75 R-squared 0.911 0.923 0.915 0.829 0.916 0.911 0.927 0.831 Note: Robust standard errors in parentheses: ***p < 0.01, **p < 0.05, *p < 0.1. Labor productivity is measured as log value added per worker. Skilled labor includes those with at least a high school education. Table 18: Determinants of Employment Growth Variables (1) (2) (3) (4) (6) (7) Sales growth (log scale) 0.205*** 0.201*** 0.163*** 0.195** 0.191*** 0.163*** (0.0563) (0.0570) (0.0483) (0.0801) (0.0528) (0.0534) Small (5–20) 0.120 0.135 0.150* 0.242 0.102 0.101 (0.0768) (0.0818) (0.0767) (0.152) (0.0835) (0.0832) Medium (20–99) 0.275*** 0.323*** 0.272*** 0.387* 0.302*** 0.301*** (0.0773) (0.0863) (0.0911) (0.214) (0.0942) (0.0950) Large (100+) 0.185 0.232 0.125 1.077*** 0.161 0.195 (0.151) (0.163) (0.166) (0.206) (0.177) (0.166) Non-food manufacturing –0.146 –0.0983 –0.181 –0.113 –0.00453 0.0297 (0.113) (0.133) (0.119) (0.142) (0.140) (0.135) Tourism services –0.180 –0.145 –0.313** –0.0774 –0.0157 (0.124) (0.142) (0.127) (0.126) (0.109) Other services –0.0442 –0.00184 –0.115 0.0838 0.147 (0.0904) (0.114) (0.103) (0.120) (0.112) Investment Climate Assessment of Bhutan 85 Variables (1) (2) (3) (4) (6) (7) Phuentsholing 0.0627 0.0748 0.0960 0.124 0.0145 0.00921 (0.0852) (0.103) (0.0933) (0.148) (0.101) (0.103) Gelephu/Sarpang 0.115 0.0908 0.0986 –0.0420 0.100 0.0843 (0.0815) (0.0756) (0.0624) (0.107) (0.0792) (0.0802) Samdrup Jongkhar 0.00587 –0.0124 0.0247 0.608*** –0.0251 –0.0386 (0.0804) (0.0824) (0.0786) (0.166) (0.0862) (0.0861) Foreign owned 0.396** 0.450** 0.365** 1.275** 0.388* 0.383* (0.187) (0.219) (0.174) (0.629) (0.219) (0.222) Owner’s age –6.69e-05 9.88e-05 –0.000156 –0.000513 –0.00112 (0.00216) (0.00204) (0.00352) (0.00224) (0.00218) Owner’s education: some –0.0412 –0.0138 0.189 –0.00530 –0.0118 secondary (0.0784) (0.0653) (0.165) (0.0762) (0.0768) Owner’s education: –0.136* –0.00930 0.189 –0.0808 –0.0773 post-secondary (0.0741) (0.0858) (0.128) (0.0893) (0.0872) Owner born outside Bhutan –0.0429 0.0265 –0.194 –0.0540 –0.0454 (0.0994) (0.0817) (0.324) (0.101) (0.103) Manager’s experience –0.000721 (0.00318) Female manager 0.202*** (0.0627) Share of skilled labor –0.00381 (0.00280) Have formal training 0.141** (0.0611) Capital labor ratio (natural log) –0.0504* (0.0293) Access to finance is major or –0.204* –0.318** severe obstacle (0.105) (0.144) Access to finance * sales growth 0.250 (0.173) Observations 293 279 277 74 272 272 R–squared 0.301 0.307 0.398 0.677 0.338 0.356 Note: Robust standard errors in parentheses: ***p < 0.01, **p < 0.05, *p < 0.1. The dependent variable is employment growth, calculated as the log of (employment in 2014/employment in 2012). Skilled labor includes those with at least high school education. Other controls not reported: legal status, age, age squared. 86 Investment Climate Assessment of Bhutan Table 19: Drivers of Expansion Plans Reason for Expansion (%) Increased Demand Total Number of Firms for Goods and Product Easy Access to Other with Expansion Plan Services Diversification Credit Facilities Reasons 2,335 74% 4%  1% 21% Main Reasons for Not Expanding (%) Total Number of Lack of Demand Firms without Plans for Goods & Other for Expansion Market Competition Services Credit Constraints Reasons 3,542 48% 5% 40%  6% Source: Establishment Census 2016. 3.4 Physical and Human Capital Table 20: Quality and Investments in Physical and Human Capital Invested in Invested in High School Mgr. Years of Provides Median Capital Fixed Assets Fixed Assets Educated Experience Formal Intensity (Mfg.) (Mfg.) (All) Workers (Avg.) Training Bhutan 2009 46% 52% 16 23% Bhutan 2015  2.93 43% 40% 28% 12 26% Botswana 2010 10.68 66% 68% 37% 18 52% Costa Rica 2010 17.98 61% 60% 38% 20 55% India 2014  7.42 26% 25% 51% 11 36% Lao PDR 2016  5.85 17% 17% 20% 15  7% Lesotho 2016  0.83 27% 27% 69% 10 31% Mauritius 2009  9.27 63% 52% 17 26% Nepal 2013  8.59 35% 28% 24% 16 32% Note: Capital intensity (total fixed assets per equivalent FT employee), measured in thousand US$ per FT worker, is available for manufacturing sector only. Since investment data are subject to high levels of measurement errors, we report the share of firms reporting any positive investments in fixed assets. Investment Climate Assessment of Bhutan 87 3.5 Labor Regulations and Perception on Labor Constraints in Bhutan Table 21: Labor Regulations in Bhutan and South Asia Minimum Wage Ratio of Fixed-Term Maximum Maximum Applicable Minimum Contracts Length of Length of Fixed- to Worker Wage to Prohibited for Single Fixed- Term Contracts Assumed in Value Added Economy Permanent Tasks Term Contract (Incl. Renewals) Case Study per Worker Afghanistan No No limit No limit 0 0 Bhutan No No limit No limit $58.2/month 0.2 Maldives No 24 months 24 months 0 0 Nepal Yes No limit No limit $93.5/month 0.9 Sri Lanka No No limit No limit $78.5/month 0.2 India: Delhi No No limit No limit $180.7/month 0.9 Pakistan: Lahore Yes 9 months 9 months $121.9/month 0.6 Bangladesh: Chittagong No No limit No limit 0 0 Bangladesh: Dhaka No No limit No limit 0 0 India: Mumbai No No limit No limit $136.1/month 0.7 Pakistan: Karachi Yes 9 months 9 months $121.9/month 0.6 Source: World Bank (2016d). Table 22: Firm’s Perception of Different Labor Constraints At Least Moderate Employment Salary Restrictiveness of Undereducated Obstacle Protection Costs Immigration Rules Workforce All 11% 22% 17% 20% Food & beverages  0% 51% 13%  3% Other manufacturing 11% 27% 25% 31% Tourism 14% 33% 17% 24% Services  9% 16% 17% 17% Micro  9% 19% 12% 19% Small 13% 29% 22% 23% Medium 21% 32% 49% 28% Large 16% 47% 54% 19% Without temporary workers  9% 14% 13% 16% With temporary workers 16% 44% 28% 30% Without foreign workers 12% 24% 10% 23% With foreign workers  8% 19% 34% 14% Source: World Bank (2016a). 88 Investment Climate Assessment of Bhutan 3.6 Main Corporate and Business Taxes Bhutan Table 23: Main Corporate and Business Taxes in Bhutan Main Corporate Taxes Statutory Rate Tax Base Corporate income tax (CIT) 30% Net profit Business income tax (BIT) 30% Net profit Tax rate for foreign companies 30% Net profit Capital gains taxation Taxes on capital gains are levied on the actual or presumptive net income of corporations and enterprises. Main allowable deductions and Income Tax Deductions: (i) Direct costs associated with the operation of the business that tax credits may be directly attributed to the generation of income shall be allowed as deductions; (ii) Wage, salary, and bonus paid to the employees shall be deductible as per the limits and rules prescribed by the Ministry.  Other Taxes Statutory Rate Tax Base Property tax Varies from BTN 500 to 25,000 Size of building/ land Business license BTN 75 Per unit Vehicle tax BTN 6,000 (fees and charges) + BTN 7,000 (motor vehicle tax) Fixed fee Stamp duty BTN 10 Property transfer tax 5% Withholding taxes Dividends: 10% Interest: 5% Royalties: 5% Double taxation treaties Bhutan is a signatory of the SAARC Agreement on Avoidance of Double and Mutual Administrative Assistance on Tax Matters, which includes India, Bangladesh, Maldives, Nepal, Pakistan, and Sri Lanka. Source: Department of Revenue and Custom, Ministry of Finance; Doing Business 2017. Investment Climate Assessment of Bhutan 89 Woman weaving a kira, Koma Village, April 2014.