The state’s dominance of the economy has not only constrained private sector development but also distorted the market, according to the World Bank.
A working paper of the World Bank, ‘Bhutan Development Report-A Path to Inclusive and Sustainable Development,’ states that due to Bhutan’s small domestic market, sparse population, and high transportation costs, the risks associated with private investment are comparatively higher.
For this reason, it stated that public investment in commercially oriented government-linked companies- with full or partial public ownership-has played a key role in Bhutan’s development.
“State dominance of the economy has led to a lack of competition,” the report states. The state enterprises, according to the World Bank operate in commercial sectors such as manufacturing, energy, natural resources, finance, communication, aviation, trading, and real estate sectors. “The strong linkages that exist between policy makers and managers of SOEs inhibit a level playing field and may discourage private investment,” the report states.
Due of the sheer size of some SOEs, it enjoy access to policy makers and discourages private investments and limit competition.For example, the mandated role of DHI in providing feedback to the Ministry of Finance creates a de jure conflict of interest that may discourage private investment. In addition, the existence of large SOEs in commercial sectors with preferential access to policy makers distorts the market.
The World Bank also states that Bhutan is not an attractive destination as a manufacturing or services hub because of its small population and logistical challenges in accessing external markets (including India), high cost and low internet connectivity, and an appreciated exchange rate.
Bhutan’s history of isolation, according to the World Bank report, has also hindered the incorporation of local producers into global value chains and resulted in minimal flows of non-hydro foreign direct investment (FDI).
After 2010, net FDI inflows kept declining and were lower than the averages of South Asia and middle-income countries.
It was also highlighted that dominance of state-led hydropower in the economy has resulted in macroeconomic volatility and vulnerability. The massive scale of hydropower projects relative to the small size of the economy generates large fluctuations in aggregate demand. Delay of a mega-hydropower project, reduces the GDP growth rate by 3–4 percentage points.
Three hydropower projects currently under construction have a cost amounting to 190 percent of the country’s GDP.
However, the World Bank states that efforts have been made to improve the investment climate and strengthen investment in infrastructure to crowd in the private sector.
In recent years, key reforms, such as the new licensing policy, digitisation efforts to simplify the process of registering properties, and revisions of FDI rules and regulations, have improved the regulatory environment.
The government has also implemented reforms in several areas to improve access to finance, especially for cottage and small industries.
While Bhutanese traders enjoy low tariff barriers and increasingly efficient customs facilities, the costs of transporting goods to and from external markets are aggravated by deficiencies in infrastructure quality and logistics.
Inflows of foreign investment, according to the World Bank, can enable access to external markets, technologies, and managerial processes. But this too, suffered shortage of skilled labor, and ad hoc nature of incentive packages. “The limited use of quality certification by Bhutanese firms also inhibits access to external markets, particularly for high-value products.”