Investment Climate Assessment of Bhutan Removing Constraints To Private Sector Development To Enable the Creation of More And Better Jobs Thimphu, September 22, 2017 MASSIMILIANO SANTINI

Constraints to Private Sector Development Access to Finance Agenda Economic Overview Constraints to Private Sector Development Access to Finance Access to Skilled Labor Access to Markets Policy Recommendations

making impressive inroads to poverty reduction Bhutan experienced rapid economic growth and structural transformation, making impressive inroads to poverty reduction Clear trends of diversification away from agriculture GDP per capita doubled to USD 2,500 between 2000 and 2015 Poverty rate fell to 2 percent in 2015

Characteristics of Businesses Changes in Employment Composition About 28,000 businesses operate in the private sector, mainly microenterprises. Agriculture still employ the majority of active force. Characteristics of Businesses Changes in Employment Composition Source: WBES 2015

Entry of Licensed Businesses Business and Employment Informality Economic growth has fueled business entry and expansion. Business informality is rare, although employment informality is common. Entry of Licensed Businesses Business and Employment Informality CAGR = 8.5% Source: NBS, 2015; MoEA.

Overall improvement in labor productivity, even if the absolute value remains low almost doubled Businesses in the top quartile exhibit higher labor productivity than their regional peers Source: WBES 2015

However, much of this productivity gain has been driven by increased prices and profitability in (non-tradable) services very low Low productivity growth in manufacturing shows the difficulties to overcome Bhutan’s high trade costs and economies of scale constraints to compete internationally Source: WBES 2015

Constraints to Private Sector Development Access to Finance Agenda Economic Overview Constraints to Private Sector Development Access to Finance Access to Skilled Labor Access to Markets Policy Recommendations

Insufficient finance constrains the private sector to make productive investments, especially for micro enterprises Source: WBES 2015

In fact, micro enterprises appear especially constrained, evidenced by low usage of financial products and higher capital profitability Source: WBES 2015

Value of Collateral Needed for Loan Access to Finance is restricted by factors that discourage lenders and borrowers from supplying and demanding credit, respectively Lending interest rate Value of Collateral Needed for Loan (% of loan amount) Supply side: high interest rates, but also limited product development Demand side side: high collateral needed, but also lack of financial literacy supply side

Constraints to Private Sector Development Access to Finance Agenda Economic Overview Constraints to Private Sector Development Access to Finance Access to Skilled Labor Access to Markets Policy Recommendations

Low levels of education, competition with public sector, and restrictions on employing expatriates, generate limited ACCESS TO SKILLED LABOUR by firms Competition for Labor between Public and Private sectors (% workers receiving key benefits) Generous public sector compensation packages discourage recent graduates from seeking private-sector jobs

The scarcity of skills in Bhutan constrains the competitiveness of manufacturing, even though labor costs are low Median wages in manufacturing declined between 2009 and 2015, and the productivity of manufacturing fell even further As worker skills are a key determinant of productivity in manufacturing, low level of productivity shows the economic cost imposed by the shortage of skills for manufacturing

Constraints to Private Sector Development Access to Finance Agenda Economic Overview Constraints to Private Sector Development Access to Finance Access to Skilled Labor Access to Markets Policy Recommendations

In addition to geographical constraints and poor infrastructure, access to external markets has been limited by a logistics sector that is still underdeveloped

Foreign investment has been constrained by policy and lack of complementary inputs, such as skilled labor and high quality infrastructure low Sectoral regulatory barriers and lack of investment promotion strategy limit FDI entry Skills shortages and access to high quality ICT infrastructure hamper expansion of firms already established in the country

Constraints to Private Sector Development Access to Finance Agenda Economic Overview Constraints to Private Sector Development Access to Finance Access to Skilled Labor Access to Markets Policy Recommendations

Bhutan’s prospect for achieving inclusive development rely on treadable services and high-value niche products Bhutan needs to rely on external markets to sustain its gains in productive private employment growth Expansion of markets in tradeable services and the rise of consumer consciousness in high-value markets provide opportunities for Bhutan to diversify its economy, leveraging on Bhutan’s unique institutional assets: Robust public institutions Civil and political stability Low corruption Unique cultural heritage and environment English-speaking workforce Cheap and reliable electricity Maximizing Bhutan’s development potential will require crosscutting reforms to address prevailing business constraints, and sector-specific reforms in key industries

Crosscutting recommendations in ACCESS TO FINANCE Priority Actions: Expand scope of collateralizable assets. Deepen and broaden credit information. Approve and implement New Insolvency Bill. Reduce risks of e-banking for customers. Other Actions: Improve management of property records to facilitate collateralization of land. 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. Provide targeted financial literacy training to financial providers and users. Improve monitoring and evaluation of priority lending programs.

Crosscutting recommendations in ACCESS TO SKILLED LABOUR Priority Actions: Introduce dedicated channel for skilled migration. Provide effective vocational and soft skills training to adult labor force. Realign public compensation packages with private sector. Other Actions: Offer scholarships for intensive business education. Reward private-sector experience in public-sector recruitment.

Crosscutting recommendations in ACCESS TO EXTERNAL MARKETS Priority Actions: Promote use of e-commerce platforms. Increase awareness and use of quality standards and certifications. Develop and implement investment promotion strategy targeting key markets. Introduce risk-based border inspections and coordinate border procedures. Other Actions: Improve transport and logistics infrastructure. Diversify transport corridors. Develop logistics skills for industry professionals. Improve regulatory and operational functions of airports through skills upgrading. Phase in the Bangladesh, Bhutan, India, and Nepal Motor Vehicles Agreement.

Sector-specific recommendations in TOURISM, ICT, and AGRIBUSINESS Build capacity of three-star accommodation and restaurant providers. Support development of programs to geographically and temporally diversify flows. ICT Develop sector-specific high-skilled migration channel. Develop and implement sector-specific investment promotion strategy. Upgrade Internet infrastructure. Upgrade skills of existing and prospective ICT workers. Agribusiness Develop regulations, oversight roles, and communication strategy for Brand Bhutan. Promote storage and logistics investments to facilitate exports of high-value products. Reform subsidies and interventions to optimize incentives for private investment.

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