Bhutans Trade and Exchange Rate Policies

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Bhutans Trade and Exchange Rate Policies

Table of Contents

Introduction
Bhutans current trade problems and exchange rate policies
Areas of Improvement
Conclusion
Bibliography
Footnotes

Introduction

Bhutan is a landlocked country located in Southern Asia, between China and India. Presently, it is classified as one of the Least Developed Countries (LDC). Close connections with India were conditioned by the 1949 treaty allowing Delhi to influence over Bhutans foreign relations. The aftermath of the treaty is Indias ensuring of Bhutans security from Chinese intervention. As for Bhutans relationships with China, they remain tense because of territory issues. The two countries share 270 km of disputable border. Therefore, the protection from Chinese military aggression is still Bhutans high priority. The aforementioned facts explain why Bhutan trades with India and does not trade with China. Consequently, a free trade regime was developed between Bhutan and India as a result of the India-Bhutan Friendship Treaty of 2007.¹

Bhutans pattern of trade is conditioned by its geographical location, which predetermines climate and nature. Bhutan has a resource-based economy that is abundant with alloys of iron. More than 50% of its land is located at a 3000-meter height above sea level, and 20% is covered with ice. Only a small amount of land is allowed for cultivation.² It is difficult to construct or reprocess the hydroelectric plants because steep mountains dominate the country, which makes the building of roads complicated, dangerous, and expensive. In other words, Bhutans geopolitical position imposes a limitation on the countrys economic progress.

On the other hand, a vast network of rapid rivers allows for the development of hydroelectricity, where the countrys comparative advantage lies. Since Bhutan is a small country, its domestic demand for electricity is low; thus, it has a surplus of power generation that is exported to India.³ To build more hydropower plants in Bhutan, the country imports diesel, parts of hydraulic turbines, including petrol, wood charcoal, coke, machinery, electrical apparatus, and vehicles from India.⁴ As Bhutan produces more hydropower plants, its hydroelectric industry has the potential to become bigger and decrease its average costs. With more export of hydroelectricity to India, Bhutan will be able to reduce its trade account deficit in the future.

Bhutans current trade problems and exchange rate policies

According to the Bhutan Development Update 2018, there are four major challenges Bhutans economy is facing today. First, delays in hydropower construction will decrease exports and revenues. As it has already been mentioned before, Bhutan remains dependent on the hydropower sector. However, the completion of Punatsangchhu hydropower station has been delayed several times because of adverse weather events, which allegedly might result in the decrease of revenues by 0.5-1.0 percent of GDP. Secondly, lack of donor financing can constrain government spending and negatively affect future growth and development. Finally, adverse weather events could negatively affect the economy through hydropower and agriculture. Being landlocked, remoteness from major markets, a considerable distance from the coast, and the lack in good roads and air transportation are deemed as minor barriers, though they have a negative impact on Bhutans development. They can explain why Bhutan imports refined petroleum, cars, and whatever equipment needed for the production of electricity.⁵

Another limitation is imposed by Bhutans government itself, which endeavors to preserve the countrys pristine nature and does not encourage industrial development. Vague local policies and strict regulations tend to impede foreign investment. It is necessary to keep developing diplomatic and economic ties with Bangladesh, thus reducing the geopolitical reliance on India. Though these ties may be based on a series of trade propositions and balancing acts, they will allow Bhutan to seek access to the sea and improve their transit conditions.

As for exchange rate policies, they have two major characteristics according to Galey. First of all, Bhutanese currency Ngultrum is pegged at par with the Indian Rupee. Although it could be pegged to some other currency, the exchange regime with India has been maintained for more than thirty years. Ngultrum has no independent exchange rate against other major currencies of the world. Another trait is the circulation of Indian Rupee alongside Ngultrum. In terms of circulation the rupee can be called a subsidiary currency. By far, pegging proved as a beneficial policy for Bhutan as it is a small economy with small or no influence in the international trade. Circulation of two currencies allows for the unconstrained exchange of workers between Bhutan and India as well as free trade. Moreover, fixed exchange rates reduce transaction costs, taking into account, that India is the main trading partner.

Areas of Improvement

Considering the aforementioned, the following policies could be suggested. Firstly, it is necessary to consider a cautionary example of other developing countries, which have placed themselves into a vicious circle of international trade and debt. A necessary discretion here is that business and direct foreign investments are not capable of solving the countrys problems. Thus, the best course of action would be to hold to the countrys protectionist politics in terms of free trade and try to avoid dependence on international trade organizations. The country is a member of the South Asian Free Trade Area, and negotiations on the free trade agreement within the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) and accession to the World Trade Organization (WTO) are ongoing.⁶ Only the ability to evolve from within can provide sustainable and balanced development of the countrys economy. What Bhutan can do is create infrastructure and provide a high-skilled workforce. The integration into the global economy through trade should be careful, directed, and controlled not to harm Bhutans identity, which manifests in preserving the centuries-old traditions and nature.

Secondly, it is rather dangerous to rely only on the export of hydroelectricity. Ecological damage caused by hydroelectric power stations might exceed the profit and not justify the country leaders high ambitions in hydropower area. It is vital to take into consideration the countrys values and willingness to preserve the unique ecosystem. This view suggests the development of alternative sources of income.

Conclusion

Bhutans trade pattern and underlying factors, as well as the main trade problems and opportunities, have been discussed. There are some serious risks for Bhutanese economy. In general, a favorable forecast could be made for this developing country. Still, several conditions are to be met, such as the adherence to its authentic course, careful integration into the worlds economy, and more protectionist policies regarding integration in international finance. Alongside, several issues should be addressed to make the difference for the country, such as investment in human resources, which requires a retreat from the strict cultural regulations. Should these suggestions be implemented, they would change Bhutans economic position in the international arena for the better.

Bibliography

Bhutan-India Trade Relations. Royal Bhutanese Embassy.

Bhutan. International Hydropower Association.

Bhutan. OEC.

Bhutan Development Update. November 2018. World Bank.

Galey, Karma. An analysis of pegged exchange rate between Bhutan and India (2003).

Royal Monetary Authority of Bhutan. Annual Report 2018. Royal Monetary Authority.

The World Factbook: Bhutan. Central Intelligence Agency. Web.

Footnotes

Bhutan-India Trade Relations, Royal Bhutanese Embassy, Web.
The World Factbook: Bhutan, Central Intelligence Agency, Web.
Bhutan, International Hydropower Association, Web.
Bhutan, OEC, Web.
Royal Monetary Authority of Bhutan, Annual Report 2018, Royal Monetary Authority, Web.
Karma Galey, An analysis of pegged exchange rate between Bhutan and India, Web.
The World Factbook: Bhutan.