A Stabilization Fund to stabilize Bhutan’s Economy

This fund is also expected to prevent Rupee and Credit crises in the long term
In an effort to avoid financial problems like the rupee and credit crises in the future, the government is planning to set up a stabilization fund for Bhutan in the 11th five year plan.

A government report titled, ‘The Recommendations on Establishment of Stabilization Fund’ recommends the setting up of such a fund based in Bhutan’s own needs and also based on examples of the funds success in other countries.

The report drafted by a high level committee comprising the Gross National Happiness Commission (GNHC) Secretary Karma Tshiteem, Ministry of Economic Affairs Secretary Dasho Sonam Tshering and Finance Secretary Lam Dorji was submitted to the cabinet last week.

The committee started studying the feasibility of a stabilization fund in July 2012 after an executive order was given by the cabinet. The GNHC was responsible for the overall coordination of the study.

“In an economic forum organized by the GNHC along with experts from UNDSA and also involving Jospeh Stiglitz, one recommendation that featured very clearly was that Bhutan should consider the establishment  of a stabilization fund,” said Nyingtob Pema Norbu, planning officer with the GNHC.

The recommendation was made in light of the ongoing rupee shortage and credit crunch. Another major reason for the fund according to the report is that Bhutan will have surplus revenue once the 10,000 MW projects are constructed and that revenue can go into this fund. The report projects that towards the end of the 11th plan itself three projects would be coming on line giving a surplus of a few billions.

 

Why Bhutan should have the fund?

The report mentions several grounds or reasons as why Bhutan should have a stabilization fund. The committee also closely studied international practices and experiences in having such a fund.

One objective of the stabilization fund is to stabilize and synchronize inflow and outflow mismatches.

“There was a perception that the due to massive inflows from sources like hydropower exports and construction and grants there was excess liquidity in the system leading to excessive credit creation which translated mainly into imports,” said Nyingtob.

Bhutan also faces sever volatility in rupee inflow and outflows. The inflow happened when hydropower revenue came in and the outflow peaked when the hydro loans had to be serviced.

The fund could be used to absorb the excess liquidity and rupee surplus when the revenue comes in and then be used to ensure that there is no shortage when it is time for an outflow. It can, therefore, balance credit creation and also insure there is no rupee shortage.

Another objective is to insure inter-generational equity whereby all the resources available are not just finished in this generation but also left for future generations. The idea here is create long term savings vehicle and invest in foreign markets and also domestically.

The fund is also aimed at stabilizing the government’s stream of fiscal revenue. The study found that in the wake of the global financial crisis, a lot of the countries that had a stabilization fund or sovereign wealth fund could access such savings to give fiscal stimulus packages to keep the GDP growth rate afloat. In Bhutan’s case the fund would enable the government to give stimulus packages to encourage the economy.

One objective of the fund is to also avoid the ‘Dutch Diseases’ that affects countries who are excessively dependant on natural resources. The Dutch Diseases is named after Netherlands but affected multiple countries like Russia, Indonesia, Philippines, Nigeria, Canada, etc when they experienced in boom in natural resource production or prices. This meant that there was a lot of foreign cash inflow leading to the strengthening of their currencies which in turn led to their manufacturing sector becoming less competitive as their exports became more expensive.

“In Bhutan’s case the ‘Dutch Diseases’ will not affect the currency as there is no exchange rate but it will increase the buying power of people leading to an increase in the demand and price of non tradable goods and services putting and upward pressure on prices like land, rent, housing, restaurant services, etc,” said Nyingtob.

This will increase the demand in these non tradable goods and services shifting the labor and focus there and making it difficult for developing country like Bhutan to diversify its economy into other productive areas.

In order to avoid the Dutch Diseases the stabilization fund will streamline some of the inflows and invest them in economic diversification programs and in promoting private sector development. “One model could be equity financing whereby a entrepreneur may have a good project but no financing, so the fund could buy some of his equity (shares) and provide funding and enable him to buy back his equity a few years down the line,” said Nyingtob.

The stabilization fund can also give a high rate of return for the country with some existing funds getting returns of nine percent to even much higher returns on highly secure and liquid investments.  The motivating factor for many international funds for such high return investments was the low returns on US Treasury Bills.

Stabilization funds are also used in stabilizing the exchange rate. In the case of Chile where the main export is copper their system does not allow the excess inflow to enter the financial system when the demand for copper increases.

 

The Chile and Botswana example

The report has also studied stabilization funds in Chile and Botswana who like Bhutan are mainly dependant on natural resources for a bulk of their income and are developing countries. These countries were chosen due to their similarities with Bhutan and also their performance. Chile is also the best performer in South America while Botswana is the best performer in Africa. Both countries had also grappled with the Dutch diseases before setting up the fund.

“What we learnt from Chile is that you don’t need to have surplus to set up a stabilization fund. Even before the surplus Chile went ahead and set up the legal and institutional framework, human resource requirements and got the Act passed in parliament,” said Nyingtob.

He said it was also strategic since there were no funds there was no political opposition to the law.

Once the surplus revenue flows in everybody has to abide by it.

“For Bhutan the idea is go ahead and explore the institutional and legal framework for such a fund and it would be ready by the time the surplus from 10,000 MW projects start coming in.” said Nyingtob.

In most countries the stabilization fund is managed by the Central Bank who in turn oversees a group of fund managers. The Central bank in turn is accountable to the Ministry of Finance through the legal rules.

In Bhutan’s case the proposal is to keep a similar arrangement, with the management of Stabilization fund staying with the Central Bank as an autonomous body who in turn will be accountable to the Ministry of Finance for inflows and outflow through rules and procedures.

The stabilization fund is also expected to create a new level of fiscal discipline for Bhutan. In Botswana there is a fiscal rule whereby once the foreign exchange reserves exceed a threshold the excess money is transferred to the stabilization fund but in a case where the reserves are low then the fund flows back from the stabilization fund.

Chile has a very systematic system of budget allocation rules for money to go into and out of the fund. In their case since their main export is copper the price of copper is predicted in the future. If the current prices are higher than the excess money is put into the fund. In case the future prices are much higher than current prices then money is taken from the fund.

In Bhutan’s case the Stabilization fund could also have the purpose of meeting the growing Current Account Deficit which is total monetary deficit in services and goods combined. It can also be used to ensure adequate rupee reserves.

The GNHC has already received positive feedback from the Asian Development Bank on the initiative.

With the draft report submitted to the cabinet the committee is expecting future directions to institute the institutional and legal framework in keeping with Bhutan’s own unique characteristics.

“The hallmark of a good stabilization fund is that it has to be a dynamic process. In the developing stages of a country’s economy it is used for socio-economic development and as the country’s economy matures the fund is used to ensure macro-economic stability in the economy,” said Nyingtob.

Once the go ahead is given Bhutan will get support from UNDSA to set up and legal and institutional frameworks and also seek contact with other stabilization funds around the world. There would be extensive brainstorming working with local and foreign experts.

The full legal and institutional structure is expected to be ready within the 11th plan and it is expected to kick off with the surplus billions that are expected to flow in the last years of the 11th plan as some projects come online.

The Prime Minister in his State of the Nation address on 9th July 2012 said, “Recognizing the rupee shortage to be a continuing problem, the Royal Government has recently approved the establishment of a High Level Committee to study the feasibility of a stabilization fund for Bhutan.”