Pilot Investment Climate Assessment - World Bank · Bhutan Challenges and Opportunities for Private...

Pilot Investment ClimateAssessment

Bhutan

Challenges and Opportunities

for Private Sector Development

in Bhutan

June 2002

33690

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Acknowledgments vi

Acronyms and Abbreviations vii

Executive Summary viii

1 The Survey 1

How the Survey Was Conducted 2

Profile of the Companies Surveyed 2

Geographic Coverage of the Survey 4

A Private Sector Perspective 5

2 The Context for Private 6

Macroeconomic Overview 7

Overview of the Private Sector 8

Financial Sector 13

Privatization 15

Trade Regime 16

Foreign Investment 17

Infrastructure 17

Labor and Employment 17

3 Cross-Cutting Issues 21

Biggest Business Problems for the Private Sector 22

Labor Issues 23

Technology Issues 29

Financial Sector Issues 32

Land Issues 38

Auditing, Accounting, and Taxation Issues 39

Infrastructure Issues 41

Regulatory Environment 43

Trade Regime 45

Institutional Issues 46

Benchmarking the Business Environment 48

Alternative Development Tracks 49

Privatization 51

4 Agroprocessing 54

Present Situation 55

Costs and Competitiveness 58

Impediments to Growth 63

Potential 66

Recommendations for the Sector 68

5 Wood and Wood-Based Industries 71




Potential 85


6 Tourism 90





7 Information Technology 105


Opportunities 108

The Way Forward 110

8 Foreign Direct Investment 112

Need for Foreign Direct Investment in the Priority Sectors 113

Present Constraints to Foreign Direct Investment 114

Proposed Regime for Foreign Direct Investment 116

Remaining Issues 119

9 Conclusions and Recommendations 121

Governance and Regulation 122

Contents ii

Labor, Skills, and Employment 123

Finance 124

Competitiveness and Technology 125

Infrastructure 127

Public-Private Dialogue 128

Challenges and Opportunities in the Priority Sectors 128

A Vision for the Development of the Private Sector 130

Main Recommendations 131

Appendixes 133

1 Registered Companies in Bhutan, 2001 135

2 Tax Regime and Trade Policies 139

3 Quantity and Value of Cash Crops in Bhutan,1995–98 142

4 Tourism Data and Analysis 143

Boxes

2.1 The Bhutanese Power Sector’s EnormousPotential 8

2.2 Bhutan’s Biggest Companies 10

2.3 Bhutan’s Five-Year Development Plans 19

3.1 Matching Grant Schemes to Aid Technology Transfer 32

3.2 Recommended Actions for Improving Auditing and Accounting 40

3.3 Yangphel Handicrafts—a Nontraditional Niche Business 51

3.4 The Challenges of Developing Niche Markets 52

4.1 The Importance of Location 62

4.2 Effects of Poor Management on Bhutan’s Market Potential 65

4.3 Penetrating Niche Markets through Innovation and Proactive Relationships 67

5.1 Supply and Demand for Government-Trained Woodworkers 74

5.2 A Small Firm’s Difficulties in Sourcing New Machinery 83

6.1 Public-Private Cooperation in Marketing Tourism 98

Figures

2.1 Economic Contribution of the Power Sector,Bhutan, 1991–2000 7

2.2 New Businesses Licensed, Bhutan, 1987–97 8

2.3 Enterprises by Type of Ownership, Bhutan,1995 and 1997 9

2.4 Enterprises by Size, Bhutan, 1997 10

2.5 Enterprises by Sector, Bhutan, 1994 and 1997 11

2.6 Enterprises by Sector and Region, Bhutan, 1997 12

2.7 Employment by Sector, Bhutan, 1999 12

2.8 Employment and Value Added by Sector, Bhutan, 1997 13

2.9 Bank Lending by Sector, Bhutan, 1988 and 1999 14

4.1 Labor Productivity in Agroprocessing, Selected Countries 62

6.1 Tourist Arrivals, Bhutan, 1985–2000 92

6.2 Tourist Arrivals by Month, Bhutan, 1998–2000 99

6.3 Organogram of the Bhutan Department ofTourism 101

6.4 Proposed Organogram of the Bhutan Department of Tourism 102

Tables

1 Biggest Business Problems for Bhutanese Firms x

1.1 Firms Surveyed by Size of Employment 3

1.2 Firms Surveyed by Sector, Location, and Size of Employment 3

Contents iii

1.3 Annual Growth in Employment in the Firms Surveyed, by Sector 4

1.4 Employment and Share of Nonnationals in the Labor Force of the Firms Surveyed, byLocation 4

2.1 New Businesses Licensed by Sector, Bhutan, 1987–97 9

2.2 Public Ownership Share in Listed Companies, Bhutan 15

2.3 School-Leavers Joining the Bhutanese Labor Force, 2000–10 18

3.1 Biggest Business Problems for Bhutanese Firms 23

3.2 Average Monthly Salary by Location andNationality, Bhutan in Ngultrum 25

3.3 Average Annual Value Added per Worker by Share of Indians in Workforce, Bhutan 25

3.4 Share of Indian and Bhutanese WorkersEmployed, by Location and Job Category, Bhutan 26

3.5 Training by Bhutanese Firms 27

3.6 Reasons Cited by Bhutanese Firms for Not Providing Training 28

3.7 Interest Rates and Collateral Ratios, Bhutan and Nepal 34

3.8 Firms’ Access to Credit, Bhutan and Nepal 34

3.9 Bhutanese Firms’ Experience with Nonpayment and Enforcement 35

3.10 Firms Investing in Recent Periods, Bhutan and Nepal 37

3.11 Average Share of Financing from DifferentSources for Most Recent Investment by Bhutanese Firms 38

3.12 Electricity Prices for Industrial Customersin Selected South Asian Countries 43

3.13 Bhutanese Firms’ Ratings of the Government 44

3.14 Bhutan’s Trade with India and the Rest of the World, 1996–99 45

3.15 Firms Perceiving Laws as Unpredictableand Government as Unhelpful, Selected Regions 48

3.16 Firms Perceiving Regulation as a Moderate or Major Constraint, Selected Regions 49

3.17 Firms Perceiving the Quality of Public Services as a Moderate or Major Constraint, Selected Regions 50

4.1 Early Entrants in Agroprocessing Categories Typical in Developing Countries 56

4.2 Agroprocessing Firms in the Survey, byCharacteristics 58

4.3 Price Competitiveness of Agricultural RawMaterials, Bhutan 59

4.4 Can Bhutan Compete in Agroprocessing? 61

5.1 Disposal of Timber by the Bhutan ForestryDevelopment Corporation, 1998–2000 73

5.2 Timber Prices, Selected Markets 76

5.3 Labor Output and Costs in Typical Firms inWood-Based Industries, Selected Countries 76

5.4 Comparative Timber Yields 77

5.5 Value of Wood Exports by Type of Product,Ghana, 1999–2000 78

5.6 Price Paid for a Typical Timber Lot in Bhutan and Its Actual Value to the Sawmill 79

5.7 Time Required to Transfer Technology toBhutanese Firms in the Wood Sector 82

6.1 Employment in the Tourism Sector, Bhutan 93

6.2 Tourist Arrivals and Gross Earnings andGovernment Revenue from Tourism, Bhutan, 1990–2000 94

6.3 Cost of a Seven-Day Tourism Package, Selected Countries, 2001 96

6.4 Breakdown of the Cost of a Seven-Day Visit to Bhutan, 2001 96

Contents iv

6.5 Overseas Travel Agents Serving BhutaneseTourism, by Location 97

7.1 Average Monthly Earnings for Sales and Office Workers, by Nationality and Location, Bhutan 109

7.2 Monthly Fees for Leased Lines, SelectedCountries 109

A2.1 New Personal Income Tax Rates Effective as of 2001 139

A3.1 Quantity and Value of Cash Crops in Bhutan, 1995–98 142

A4.1 Tourist Arrivals by Tour Operator and Month, Bhutan, 2000 143

A4.2 Tourist Arrivals by Month, Bhutan, 1984–2000 146

A4.3 Tourist Arrivals by Economy of Origin, Bhutan, 1995–2000 147

A4.4 SWOT Analysis of the Bhutanese TourismSector 148

A4.5 Results of Pilot Visitor Survey, Bhutan, 2001 149

Contents v

Acknowledgments vi

This report was undertaken on a fully collaborativebasis by the Bhutan Ministry of Trade and Industry, the Bhutan Chamber of Commerce and Industry, theUnited Nations Development Programme, and theWorld Bank. The World Bank team consisted of SimonBell (task leader), John Nasir, Asya Akhlaque, AndrewProctor (Foreign Investment Advisory Service), andconsultants Gerald Tyler, Christopher Oates (gener-ously financed by the United Nations DevelopmentProgramme), and Cian O’Carroll. Representativesfrom the Ministry of Trade and Industry who were in-volved in the survey included Sonam Wangdi (directorof the Policy Planning Department), Karma Tsering(Policy Planning Department), Tshewang Dorji (PolicyPlanning Department), and Jambay Yeshi (Depart-ment of Industry). The representative from the BhutanChamber of Commerce and Industry was TashiTshering.

The survey work was supported by a team of fouraccountants—Nim Sherpa (Sherpa Consultancies)and Alok K. Mitra, Jayanta Banik, and Ujjwal KumarBasu (N.C. Mitra and Co., Calcutta, India). The workof the mission was ably assisted by Dawa Sherpafrom Sherpa Consultancies. Initial background workon the survey was done by Karma Tshiteem andTshewang Norbu (from the Bhutan Ministry ofFinance) as interns with the World Bank. The survey

data were entered into a Microsoft Access data file bya Bhutanese firm, Visual Information Technology, re-cruited for this purpose.

The survey team benefited greatly from two con-sultative sessions at the end of the mission. One waswith the Higher-Level Committee on Private SectorDevelopment, recently constituted by the governmentof Bhutan under the leadership of the secretary of fi-nance to address issues relating to private sector de-velopment. The second was with working-level repre-sentatives of the Ministry of Trade and Industry andthe Bhutan Chamber of Commerce and Industry.

The survey team would like to register its deep ap-preciation to the nearly 100 firms that gave freely oftheir time and insight during the survey. This reportwould not have been possible without their excellentcooperation and the important information that theywillingly provided.

The report was peer reviewed by Benoit Blarel(International Finance Corporation) and Geeta Batra(World Bank). Marilou Uy was responsible for over-sight of the report as the sector director for privatesector finance and the country director for Bhutan atthe World Bank. Mieko Nishimizu, as vice president forthe World Bank’s South Asia Region, had ultimateoversight.

Acronyms and Abbreviations vii

Danida Danish International DevelopmentAgency

FOB free on boardGDP gross domestic productkbps kilobits per secondNu ngultrumR&D research and development

Rs rupeesSAARC South Asian Association for Regional

CooperationUNESCO United Nations Educational, Scientific,

and Cultural OrganizationUNICEF United Nations Children’s FundWTO World Trade Organization

Currency equivalents

Bhutan currency unit = ngultrum (Nu)Nu 1 = US$0.02083

US$1 = Nu 48.00(December 2001)

Fiscal year

1 January–31 December

Bhutan has a new, small, and relatively undevelopedprivate sector. But the government sees it as the en-gine of Bhutan’s future growth and, even more impor-tant, as a growing source of employment for the rap-idly increasing number of Bhutanese leaving schooland entering the workforce. With the looming problemof unemployment and the limited scope for expandingthe public sector, the private sector is receiving closerattention. Unleashing its growth potential will requireidentifying and acting on the key constraints to its de-velopment—the main challenge of Bhutan’s Ninth Five-Year Development Plan (2002–07).

A Small But Growing Private SectorBefore Bhutan opened its economy in the 1960s, pri-vate sector activity was limited to agriculture andsome trading. Since then the economy has beentransformed, with rapid growth in urban centers, theestablishment of basic infrastructure, and the devel-opment of an important hydropower sector. In the1990s national income growth averaged around 6percent a year, driven by revenues from hydropower.

The economic growth has, in turn, fostered the de-velopment of the private sector. By the end of 2000 thegovernment had issued more than 9,000 industrial li-censes and almost 12,000 trading licenses and hadregistered 124 companies operating in a wide rangeof activities—mining, light manufacturing (such as fruitprocessing), power-intensive industries (cement,ferro-alloys, calcium carbide), service industries sup-porting tourism, sawmilling and other wood process-ing industries, and fast-growing service industries insuch areas as transport and construction (spurredlargely by the government’s construction activitiesand the development of the Tala hydropower project).

A handful of medium-size companies dominatethe private sector, reflecting its embryonic state andthe small size of the economy. But most enterprises inBhutan are very small, with fewer than 10 employees.Indeed, around 85 percent of firms are classified as

cottage or mini enterprises (with invested capital ofless than $10,500). The country has only about 100companies of any size, with the largest employingfewer than 540 workers.

Creating Employment—a Critical Role for the Private SectorEmployment data are weak in Bhutan, but it is esti-mated that around 60,000 people are employed in theformal sector. Of these, around 22,000 are employedin public sector institutions (including 14,258 in thecivil service), suggesting that the private sector ac-counts for around 60 percent of all formal sector jobs.But many of these private sector jobs are held by non-Bhutanese workers. Of the 60,000 formal sector jobs,about half are thought to be held by nonnationals.Since nonnationals are likely to hold a very small shareof the jobs in public sector institutions, most of these30,000 nonnational workers are employed in the pri-vate sector.

Rural-urban migration has not yet become a bigsource of urban unemployment in Bhutan; most of therural population remains in rural areas (though this is likely to change in time). But good progress inachieving education goals means that a growing num-ber of educated Bhutanese are seeking urban employ-ment. In the past most of those leaving school were ab-sorbed into the civil service, the preferred employer formost Bhutanese. But the government has nearlyreached the saturation point, and the civil service is notexpected to grow much beyond its current size.

This saturation has occurred just as Bhutan’s in-vestments in education are beginning to pay off. In2001–10 the education system is expected to pro-duce around 90,000 school-leavers and graduates.Indeed, the number leaving school and entering theworkforce is projected to increase exponentially eachyear. With formal sector employment only 60,000today, creating another 90,000 jobs poses a formida-ble challenge.

Executive Summary viii

The government has long been the main engine ofeconomic growth in Bhutan. But it recognizes that thismust change, with the private sector gradually takingon an increasingly important role in driving growth anddevelopment. Nowhere is this more true than in em-ployment generation. The government has made de-veloping a dynamic private sector that can create em-ployment opportunities a central aim of the NinthFive-Year Development Plan. But absorbing the largenumber of school-leavers into the private sector willnot be easy.

Advantages and Disadvantages for PrivateSector DevelopmentLike all countries, Bhutan has a unique set of advan-tages and disadvantages for developing the privatesector. To promote private sector employment, thegovernment should seek to build on the advantageswhile attempting to lessen the disadvantages as muchas possible. And while this may seem painfully obvi-ous, it is extremely important that the government notdiminish any potential advantage or add to the disad-vantages that the private sector faces. The task thatthe private sector confronts in tackling the growingyouth unemployment is so formidable that it will needall the resources and support available.

Several factors create important advantages forprivate businesses in Bhutan:

• Relatively free access to the large Indian marketunder current trade arrangements, though this advantage will gradually lessen as India liberal-izes trade in line with World Trade Organizationrequirements.

• Access to cheap skilled and unskilled labor fromIndia, providing a considerable cost advantage inlabor-intensive production.

• Extremely stable labor relations (no company inthe survey reported disruptive union activity or aloss of workdays because of strikes).

• Flexible labor regulations, with very little restriction

on the ability to hire and fire workers or determinewages.

• Low electricity prices, at a fifth to a half the costsin competing economies in the region. While elec-tricity subsidies are likely to be removed in themedium term, electricity prices will remain rela-tively low, conferring a considerable advantage inpower-intensive industrial activities.

• Political stability.• A clean, efficient, and corruption-free government.

Businesses in Bhutan face an equally impressiveset of disadvantages:

• A lack of entrepreneurial talent due to the new-ness of most private sector activities in Bhutan.

• Bhutan’s remote and landlocked location.• An extremely small domestic market of only

around 800,000 people (compensating for this,however, is the preferential access to the Indianmarket of more than 1 billion people).

• A lack of skilled Bhutanese workers and an ap-parent unwillingness of Bhutanese workers to un-dertake menial or unskilled work (more than com-pensated for by a plentiful supply of low-costskilled and unskilled Indian workers).

• A rudimentary and uncompetitive financial systemoffering only basic financial services and those ata fairly high cost.

• Road transport that is slow and regularly dis-rupted by monsoons and landslides, and airtransport that is costly and erratic. The transportproblems create cost disadvantages for manybusiness activities, particularly in the more remotecentral and northern parts of the country.

• Extremely limited links with outside markets as a re-sult of the dominant trading relationship with India(with trade in electricity, the main export, dominatedby government-to-government deals) and the al-most total absence of foreign direct investment (aconscious policy choice by the government).

Executive Summary ix

Bhutan’s advantages are considerable comparedwith those of many countries in the region. Some,such as cheap electricity and preferential access tothe Indian market, are likely to decline in time. Butevery effort should be made to retain all other advan-tages for private sector activity.

Countering the disadvantages will prove difficult insome cases—Bhutan will always remain landlocked,for example. But some can be lessened through pol-icy choices of the government—such as by graduallyraising the skill levels of Bhutanese workers, promot-ing competition in the financial sector, graduallyimproving the transport infrastructure, and develop-ing external links through more diversified trade and greater foreign direct investment. While actionmay prove costly or complex, action is nonethelesspossible.

Biggest Constraints to Doing Business—Results of the Private Sector SurveySeveral of the disadvantages came out clearly in theprivate sector survey in Bhutan. Conducted in 2001,the survey had several aims. The main goal was tocollect better information on the private sector and itsperceived constraints, to help formulate private sectorpolicy for the Ninth Five-Year Plan. The survey cov-ered 10 main areas: training, technology, infrastruc-ture, entrepreneurship, firm data, investor confidence,labor market issues, business support services, tradeand exports, and financial markets and contractualrelations.

The survey also asked firms to identify their threebiggest business problems and rank them by impor-tance. The results clearly show that the main problemsfaced by private firms in Bhutan relate to labor—and,most important, to skilled labor (table 1). Among thenearly 100 firms surveyed, 20 percent cited skilledlabor as their number one constraint to doing busi-ness, and many others cited it among their top three.In addition to a shortage of skilled labor, firms ex-pressed concerns about labor policy and about the

future direction of policy relating to the employment ofnonnational labor, both skilled and unskilled.

Firms identified the bureaucratic burden imposedby the government and other regulatory concerns astheir next biggest constraint. This issue encompassesa broad range of concerns, including labor policy (abig concern), tax policy, and access to land. This re-sult is an interesting one, given the general perceptionthat the government is friendly to business and sup-portive of private sector activities.

Ranking next were lack of demand, financial sec-tor problems (including access to finance and itscost), and problems with infrastructure.

Shortage of Skilled LaborBhutan has made remarkable progress in raising theeducation and skill levels of Bhutanese workers. Yetthe skills and experience that the private sector needs

Executive Summary x

Firms citingas number Weighted

Problem one problem indexa

Skilled labor 20 0.51

Bureaucratic burden 16 0.38

Lack of demand 17 0.36

Credit and finance 16 0.30

Infrastructure 8 0.20

Business support services 1 0.06

Import regime 0 0.05

Foreign exchange regulations 1 0.03

Note: The table groups related problems. For example, allissues relating to government regulations—such as laborlaw, tax policy, regulations on obtaining land—are groupedunder bureaucratic burden. Similarly, lack of demand in-cludes competition from imports.

a. The weighting was calculated by assigning a numberone ranking a weight of 3, a number two ranking a weightof 2, and a number three ranking a weight of 1.

Source: World Bank private sector survey, Bhutan, 2001.

Table 1 Biggest Business Problems for Bhutanese Firms

are still in short supply. One reason is that the govern-ment has absorbed most skilled and educated work-ers. Another is that most educated Bhutanese have astrong preference for working in the public rather thanthe private sector. But this situation is slowly changingas the government absorbs fewer and fewer school-leavers and graduates.

Clearly, the private sector ought to employBhutanese workers when their skills and experiencematch those sought. But it is also important to recog-nize the considerable advantages offered by thecountry’s ready access to a large pool of skilled, ex-perienced, and relatively low-cost workers in India. Itsaccess to unskilled workers in India offers similaradvantages. Most companies complained that Bhu-tanese would not perform the menial tasks and dirty,repetitive, and backbreaking work that nonnationalworkers undertake on roadworks, construction sites,and production lines—and certainly not for the samewages.

The truth is that the increasing number of school-leavers and new graduates entering the workforce willhave neither the skills and experience to undertakethe skilled jobs (at least not initially) nor the willingnessto take on the unskilled jobs now performed by non-nationals. So mandating reductions in the use of non-national labor does not appear to be an effective wayto promote the private sector or to generate the em-ployment for which Bhutanese are most suited.Instead, the challenge is to create employment thatmatches the qualifications of school-leavers while atthe same time adjusting the school system and voca-tional training to better match the skills needed by theprivate sector.

Indeed, if the objective is to build on Bhutan’sstrengths and reduce its weaknesses, the focusshould not be on excluding nonnational workers, whoconfer a considerable cost advantage. Instead, itshould be on increasing the productivity of Bhutaneseworkers through a mix of management training,worker training, and technology transfer.

Yet training emerged as a serious weakness in thesurvey. Virtually no firms reported undertaking any se-rious staff training—despite their complaints about alack of skills—and only 3 percent of the firms’ em-ployees had received training in the previous 12months. Given the links between worker training,worker productivity, and firm growth, putting in placeincentives for firms to provide more training is critical.These incentives could include levies on indus-tries to support training, greater transparency inthe tax regulations on writing off training expenses,and matching grant schemes and access to retiredexecutives to assist in training.

Bureaucratic Burden—Opaque Policies and RegulationsA surprising 26 percent of firms perceived the gov-ernment as unpredictable and believed that this un-predictability adversely affected their business. And56 percent feared that the government would makepolicy changes without consultation, again with ad-verse effects on their business.

Policy changes introduced without consultationcan have pernicious effects on the private sector.Consider the export ban imposed on logs in 1999, fol-lowed in 2000 by the export ban on semifinishedwood products. Companies that had invested in semi-finished processing after the log ban was imposedwere severely penalized by the sudden imposition ayear later of the ban on semifinished products.

But the main concerns relating to government pol-icy tended to be about lack of transparency. Many en-terprises did not have a clear understanding of the taxpolicy on training expenses, for example. The tax au-thorities review training deductions case by case anddo not necessarily limit them to 2 percent of profits, asmany companies assumed. But case-by-case reviewin cases like this injects into business exactly the ele-ment of uncertainty that most good firms dislike.

Indeed, the survey team found many examples ofdiscretionary or ad hoc treatment of important busi-

Executive Summary xi

ness issues and a lack of transparent guidance onmatters critical to firms. This situation is not surprisinggiven the small size and short history of the privatesector in Bhutan. Business activities have traditionallygrown around personal relationships and ad hocarrangements, a system that has served Bhutan rea-sonably well. But as the private sector grows andbusiness becomes more complex, it is critical thatbusiness policies and regulations become clear andsystematic.

Many firms complained about a lack of clarity inpolicies relating to the employment of nonnationals,the tax treatment of deductible expenses, the licens-ing of businesses in Phuentsholing, the tax auditing of companies, and a range of other issues. Leavingthese policies opaque creates room for rent seekingpractices to creep into an otherwise clean and well-managed system of governance. Addressing these is-sues now would reduce the potential for corruptionand impose order and discipline on private sector ac-tivities. Indeed, the government is well aware of theseissues and has made much progress in formulating abody of law that clarifies legal rights and obligations.

A lack of clarity and systematic practices is notonly an issue in the public sector. The private sectortoo suffers from this problem. Firms lack good infor-mation systems, particularly robust and believablefinancial data—a weakness that opens the door tocorruption and other bad business practices. A sys-tematic approach to auditing and accounting not onlyclarifies a company’s true financial position for the taxauthorities; it also serves as a useful management toolfor guiding its operations.

Lack of Demand—and Its Roots in Technology WeaknessesFirms’ third biggest concern, lack of demand, pre-sents something of a puzzle. Demand is clearly not aconstraint for an efficient business in Bhutan: domes-tic demand is growing rapidly as national incomerises, and regional demand for most products from

India is well beyond Bhutan’s production capacity.Thus when most companies complain about lack ofdemand, what they often mean is lack of demand at the price and quality offered. These companiescannot compete with imports or with other domesticproducers.

What does it take to become competitive? Amongthe most important factors is a firm’s ability to obtaintechnology enabling it to conduct its business cost-effectively. Technology, broadly defined, falls intothree main categories: management capability, equip-ment and processes, and marketing and design.

Management capabilities tend to be weak inBhutanese firms. Most managers lack relevant experi-ence and technical qualifications. About half have abackground in the civil service, and only a small share(less than 13 percent) have had any work experiencewith a foreign firm (and those mainly in India). All thisresults in weak management practices. Managersoften do not know what skills to employ to supporttheir business activities, do not value worker training,and lack familiarity with best practices and with thetechnologies required for their operations.

Equipment and processes are also weak. Mostcompanies operate with outdated and ineffectiveequipment from India. Indeed, the equipment is oftenoutdated even by Indian standards. If firms are to be-come competitive and to grow, they need to acquirethe best equipment available internationally. Thatprobably means leapfrogging the simpler technolo-gies now available from India.

Bhutanese firms have poor marketing and designtechnologies largely because they have such few con-tacts with external buyers and markets. Bhutan’s abil-ity to enter small, profitable niche markets in agropro-cessing, wood products, and even tourism will dependcrucially on its ability to design products that meetspecific demands (in Europe or North America, for ex-ample) and to package food products attractively.

Addressing these weaknesses in technology is noeasy matter. The task of finding, acquiring, and ab-

Executive Summary xii

sorbing technology is difficult and expensive, and themechanisms that help firms do this are poorly devel-oped in Bhutan. The country lacks networks of suppli-ers or international buyers to teach firms about newtechnologies. It has few consultants or technical ex-perts, and Bhutan’s isolation makes it difficult to findthem abroad. And foreign direct investment, one ofthe most powerful ways of transferring technology, isalmost nonexistent in Bhutan.

Strengthening and supporting learning mecha-nisms is thus critical. Establishing matching grantschemes, making visas for technical experts easier toobtain, providing tax incentives for technical improve-ments, and, most important, liberalizing foreign directinvestment could all help firms improve their tech-nology, raise their productivity, and increase theircompetitiveness.

Constraints Imposed by the FinancialSystemFirms in Bhutan complained about many aspects of the financial system, and many of their concernsappear to be valid. Among the most common com-plaints was the high and inflexible cost of finance.With real interest rates at 7–10 percent, the cost of capital is exceedingly high in Bhutan, posing aserious constraint on any policy aimed at promot-ing greater capital intensity and mechanization ofproduction.

A large share of companies (around 43 percent)reported being credit constrained—that is, wanting toborrow more at current interest rates. Around 30 per-cent had no bank credit. This partly reflects a lack offinancial sophistication among firms, with some notwanting to carry any debt. But it also reflects a lack ofsophistication among banks, which, despite havingsubstantial liquid resources, did not (or could not)reach out to private enterprises to help them developbankable projects.

Lack of competition in the financial sector has ledto serious problems—high and inflexible interest

rates, a lack of innovative financial products (such asleasing, venture capital, and factoring services), anda weak payments system. Based almost exclusivelyon paper, the payments system is slow and cumber-some, with fund transfers between branches of thesame bank in different towns taking several weeks toclear. The absence of automated teller machines,wide use of credit cards, and other electronic meansof payment adds to the problem.

Financial sector issues are to receive close an-alysis by the Asian Development Bank in its 2002study of the sector. The study’s recommendationsshould be carefully reviewed for possible speedyimplementation.

Costly and Unreliable TransportFirms had mostly positive perceptions of Bhutan’s in-frastructure, with the one big exception being trans-port. Roads are in poor condition and often cut off bylandslides, making transport costly and unreliable.Thus the cost of transporting timber, for example, canexceed the value of the wood. As a result of the highcosts and poor reliability of road transport, it is almostimpossible for industries heavily dependent on trans-port to be competitive except in the border areas ofBhutan.

Cost and reliability are also serious concerns in airtransport. The high altitudes in the Himalayas dictatethe use of only certain types of aircraft, with limited ca-pacity for cargo. This, combined with difficult flyingconditions, makes air transport expensive and unreli-able. One company complained that raw materialstake three days to travel from the United States toBangkok—but another month to get from Bangkok toParo. Such delays severely undermine the competi-tiveness of companies producing time-sensitivegoods for niche markets. Consider shiitake mush-rooms, which should be in Tokyo markets within 48hours of being picked—a good example of a poten-tially important market that can not be exploited be-cause of by unreliable transport.

Executive Summary xiii

Challenges and Opportunities in the Priority SectorsThe four priority sectors identified by the governmentas potential sources of comparative advantage andemployment growth in Bhutan—agroprocessing,wood-based industries, tourism, and information tech-nology—face the challenges confronting all industriesas well as sector-specific challenges. They also havegood opportunities for growth.

AgroprocessingBhutan’s agroprocessing industry faces many imped-iments. Raw materials are uncompetitive because ofpoor land use, low crop yields, low productivity, andhigh transport costs. Value adding activities are ham-pered by a lack of scale, old technology, bad pack-aging, a lack of branding, and costly freight. Andmanagement lacks the skills and experience to offsetthese higher costs through innovation and marketing.

If the agroprocessing industry could overcomethese impediments to growth, it has potential in twoareas:

• High-value, low-volume products (incense, mush-rooms, essential oils, traditional medicines) inniche markets, based on such competitive advan-tages as Bhutan’s biodiversity, organic produc-tion, and range of microclimates.

• Large-scale businesses with foreign ownership inborder areas, based on the competitive advan-tages of a flexible labor force, a stable politicalenvironment, and competitive infrastructure andusing mainly imported raw materials.

With processed foods the fastest-growing compo-nent of world agricultural and food trade—accountingfor 75 percent of this trade and worth $384 billion in1996—the potential could be enormous.

To exploit this potential, firms will need a timelysupply of competitive, consistent, and high-quality

raw materials; supportive policy on labor, transport,and investment; innovation in products, processes,packaging, and product positioning; and productivityimprovements based on better management, pro-cesses, and labor skills.

Wood-Based IndustriesWood-based industries also face many constraints.Management lacks adequate qualifications and expe-rience, technology levels are low, and labor is un-skilled, resulting in low productivity. The sector has noeconomies of scale, with firms tending to make a di-verse range of products for walk-in clients. The gov-ernment, which buys up to 60 percent of the sector’soutput, drives down quality and margins. The govern-ment has also affected the sector through its policies.In addition to the export ban on semifinished prod-ucts, firms face a requirement to buy timber in auctionlots of mixed species, which means that they cannotget a consistent supply of the type and quality ofwood they need.

The sector has the potential to serve regional mar-kets, particularly Bangladesh, in specialist categoriesnot adequately served by local producers or by thegrowing imports from Europe and Southeast Asia.And the sector could penetrate some niche marketswith easily transported, high-value, low-volume prod-ucts. But realizing this potential will require somechanges. Firms must gain access to single-speciestimber in appropriate sizes and quality. The ban onsemifinished products needs to be relaxed so thatfirms can gain experience and gradually move down-stream to more finished products. Productivity mustbe raised through better management, the use of ap-propriate equipment, and properly trained labor.Firms’ market awareness and marketing skills need tobe improved. And in the medium term Bhutaneseforests should be certified as being sustainably man-aged to provide a selling point for Bhutanese woodproducts.

Executive Summary xiv

TourismThough tourism has grown rapidly over the pastdecade, annual hotel occupancy rates remain low, inpart because the market is highly seasonal, and thereis little repeat tourism. A key issue is the pricing pol-icy, which requires tourists to make sizable upfrontpayments from which the government collects royal-ties, with both determined by the season (peak ornonpeak). Better calibration of these payments—par-ticularly the government royalty—in nonpeak seasonscould encourage a steadier stream of tourists intoBhutan throughout the year.

Tourism marketing is weak. The private sectorlacks resources, and the government plays a passiverole. Moreover, the country is concerned about main-taining a balance between generating revenues andprotecting its cultural heritage. Vacations in Bhutanare relatively expensive, but service is not commen-surate. The service in hotels is usually friendly, but it isof poor quality and amenities are lacking. Part of thereason is that there is little competition to drive upstandards, since tourists must pay before arriving andhave little choice once they enter Bhutan. (Two re-cently approved Singapore-based joint ventures in thehotel industry are likely to influence its development,however.) Moreover, the range of tourism products islimited, though some improvements have recentlybeen introduced. And access to Bhutan, particularlyby air, can be difficult, with the problems exacerbatedby seasonality.

Tourism in Bhutan has much growth potential bothbecause of the country’s competitive advantages andbecause of problems in other potential destinations in the region. Realizing this potential will require de-veloping an unambiguous strategy with appropriatepolicies and regulations, adjusting pricing policy (par-ticularly nonpeak pricing), undertaking more activemarketing (by both firms and the government), im-proving access to Bhutan, addressing seasonality is-sues, developing new products, and improving stan-dards of accommodation and service.

Information TechnologyInformation technology can boost the economy in twoways—as a business tool used in firms and as a trad-able service. The information technology sector inBhutan faces several constraints, however, includingcomparatively high connectivity charges, a lack of in-formation technology professionals (most must comefrom India), undeveloped regulatory and financial sys-tems (online banking is not yet possible, for example),and comparatively high labor costs.

Other developing countries are targeting two mainkinds of opportunities: small niche firms selling suchservices as software development and larger firmsselling data entry or call center services. But Bhutan’sinformation technology sector is still in its infancy, andseveral challenges have to be overcome before it candeliver internationally competitive services. These in-clude increasing the use of information technology in the public and private sectors, developing a pool of skilled information technology workers, introducingappropriate regulations (to support online business,for example), and building a data network.

A Vision for the Development of the Private SectorGiven the constraints and concerns of the private sec-tor in Bhutan, the report recommends a dual- track de-velopment strategy:

• In the border areas—where labor costs are lowerand the cost and reliability of transport are lesspressing constraints—firms can take advantageof the low electricity prices, ease of access toIndian markets (for raw materials and finishedproducts), and stable and low-cost labor force toproduce more cost effectively than equivalent pro-ducers across the border. These advantageswould permit the development of heavy industrywith large inputs of labor and raw materials.

• In central Bhutan—where higher labor and trans-port costs make heavy industry uneconomic—

Executive Summary xv

firms should focus on providing services to the in-dustries along the southern border (such as ac-counting, management, financial, and informationtechnology services), providing other services(transport, tourism, construction), and developingspecialized products for niche markets (mush-rooms, handicrafts, furniture, essential oils, tradi-tional medicines).

This dual-track approach to private sector devel-opment presumes that the government will be able todeal with issues relating to skilled workers, govern-ment regulations, and bureaucracy; promote greatertransfers of technology into Bhutan; address con-straints imposed by the financial sector; and graduallydevelop solutions to the constraints and costs im-posed by the transport infrastructure.

Main RecommendationsRealizing the vision for private sector development willrequire a series of support measures. The main mea-sures recommended in support of private sectordevelopment under the Ninth Five-Year Plan are asfollows:

• Training. Establish a transparent system of tax re-lief and possibly a system of industry levies tosupport radically increased worker and manage-ment training and thus greater productivity.

• Labor. Develop a transparent, time-bound policyfor recruiting nonnational workers to ensure thecontinued cost competitiveness of Bhutaneseindustry.

• Finance. Encourage the development of innova-tive financial instruments and payment meansbased on the Asian Development Bank’s financialsector study—including leasing finance, factoringservices, automated teller machines, and greateruse of credit cards (with lower transaction fees)—

while promoting greater competition in the finan-cial sector and more flexible interest rates.

• Technology. Support technology transfer by im-mediately establishing a matching grant schemeas well as others (such as those relying on retiredexecutives) and by providing incentives such astax breaks for research and development.

• Foreign direct investment. Ensure that the new for-eign direct investment law is finalized and ap-proved in the next session of the National As-sembly and that supporting regulations are put inplace shortly thereafter and actively encourageforeign direct investments that could have a largeimpact in the early phase of implementation.

• Export incentives. Immediately implement a dutydrawback system for imported raw materials usedin producing exports (including exports to India)and begin a dialogue with the banks on providingpre- and postshipment finance to the private sector.

• Policy environment. Within the context of the NinthFive-Year Plan, develop a clear, consistent, andtransparent policy environment for the private sec-tor that takes into account its views, and ensurethat laws and regulations affecting the private sec-tor are clearly and properly codified.

• Auditing and accounting. Gradually expand theauditing net to include a broader group of privatecompanies—both to encourage greater use of fi-nancial information as a management tool and toassist the tax authorities.

• Industrial estates and dry ports. Establish indus-trial estates in strategic locations for the privatesector and dry ports at strategic border locations.

• Dialogue. Bring in experienced professionals fromexternal chambers of commerce and the privatesector to strengthen mechanisms for representingprivate sector interests (such as the BhutanChamber of Commerce and Industry and tradeassociations).

Executive Summary xvi

How the Survey Was Conducted 2

Profile of the Companies Surveyed 2

Geographic Coverage of the Survey 4

A Private Sector Perspective 5

1. The Survey 1

Seven major development challenges were identifiedfor the Bhutan Donors Development Forum held inThimphu in November 2000. Two of these were privatesector development and employment generation.Since the public sector is unlikely to expand in theforeseeable future, these issues become two sides ofthe same coin: employment in Bhutan can only begenerated through growth of the private sector.

Indeed, Bhutan 2020 Vision firmly identifies “theprivate sector as the driving force behind employmentgrowth.” With the private sector still embryonic, it willneed to be considerably strengthened before this vi-sion can be realized.1 A first step in this process is todevelop a better understanding of the private sectorin Bhutan and the key constraints to its growth. A lackof reliable, up-to-date statistics has made this task dif-ficult. Indeed, that is one of the reasons for this reportand the underlying private sector survey. By develop-ing better information on the private sector, the reportis aimed at aiding the government in formulating itsstrategy for supporting the private sector during theperiod of the Ninth Five-Year Development Plan (July2002–June 2007).

How the Survey Was Conducted

Recognizing the lack of knowledge and understand-ing of the private sector, the government of Bhutan re-quested the Ministry of Trade and Industry, the BhutanChamber of Commerce and Industry, and the WorldBank to undertake a survey of the private sector. TheUnited Nations Development Programme providedsupport. The survey was conducted over a three-week period, 18 September–8 October 2001, in fivemajor industrial areas—Thimphu, Paro, Phuentsho-ling, Samtse, and Gomphu. For analysis purposes thefirms were usually grouped in two: Thimpu and Paro in the North and Phuentsholing, Samtse and Gomphuin the South.

The survey instrument covered 10 main areas ofinterest to the private sector: training, technology, in-frastructure, entrepreneurship, firm data, investor con-fidence, labor market issues, business support ser-vices, trade and exports, and financial markets andcontractual relations. The survey was pretested on 12companies in Thimphu and then modified in July2001.

The survey was conducted by four three-memberteams. Each team was led by a specialist in one of thefour sectors designated by the government for in-depth review—tourism, agroprocessing, informationtechnology, and wood and wood-based industries—sectors where Bhutan may well have a comparativeadvantage and believes that it can generate more dy-namic employment. The teams also included a quali-fied chartered accountant and a representative fromthe Ministry of Trade and Industry or the Bhutan Cham-ber of Commerce and Industry.

Profile of the Companies Surveyed

The aim was to cover 100 firms, and ultimately 98firms were interviewed, including in the pretesting ofthe survey instrument in July 2001. The survey wasbased on registered companies operating in theThimphu-Phuentsholing corridor. Emphasis was givento the 124 registered companies (registered under theCompanies Act) rather than the 6,000–7,000 licensedfirms (licensed by the Ministry of Trade and Industry)because registered companies are larger and are re-quired by law to have audited financial statements—an important part of the survey work. Of the 124 reg-istered companies in Bhutan, more than 80 percentoperate in the five towns surveyed (see appendix 1).

Because firms in construction and tourism domi-nate the group of registered companies, not all com-panies in these two sectors were included in the sam-ple frame. Instead, some were replaced with smaller,

21. The Survey

1. The Survey 3

licensed firms operating in the wood, agroprocessing,and information technology sectors, consistent withthe government’s desire to focus the study on thesesectors along with tourism.

The survey includes one firm with foreign owner-ship (20 percent). It also includes 10 firms with at leastsome government ownership. For 6 of these the gov-ernment ownership share was 100 percent; for theothers it ranged from 6 to 80 percent.

Most of the companies surveyed were very small(table 1.1). The largest private firm in the country em-ployed only 532 people. Among the firms surveyed,46 percent had fewer than 10 workers, a size gener-ally classified as microenterprise. As a result, whilethe survey had set out to cover the larger firms inBhutan, it ended up covering a large number ofmedium-size, small, and even micro firms. This re-flects how new and small the private sector is in

Bhutan—and how few large enterprises there are out-side the public sector.

The companies surveyed employed an average of54 workers, and growth in employment averaged 6.8percent a year since they were established (tables 1.2and 1.3). Nonnationals made up a large share of thelabor force in these firms (table 1.4).

Firms EmployeesSector Total Thimphu Phuentsholing Mean Median High/Low

Cementa 10 3 7 103 21 532/5

Chemicalsb 5 0 5 145 157 286/10

Construction 4 4 0 54 45 120/6

Foodc 14 4 10 101 17 364/5

Handicrafts 4 4 0 24 32 60/12

Information technology 11 8 3 13 9 40/4

Metals 4 1 3 40 19 118/3

Textiles 2 0 2 31 38 60/16

Tourism 17 13 4 30 15 150/5

Transport 9 4 5 45 21 190/4

Wood 17 8 9 62 23 373/8

Other 1 1 0 43 43 43/n.a.

Total 98 50 48 54 20 532/3

n.a. Not applicable.a. Includes all cement, tile, blocks, and other construction material.b. Includes chemicals and plastics. c. Includes agricultural processing and food and beverages.Source: World Bank private sector survey, Bhutan, 2001.

Table 1.2 Firms Surveyed by Sector, Location, and Size of Employment

Size (employees) Firms

Micro (10 or fewer) 45

Small (11–50) 26

Medium-size (51–200) 19

Large (201–500) 7

Very large (501 or more) 1


Table 1.1 Firms Surveyed by Size of Employment

The Survey 4

Geographic Coverage of the Survey

Outside of agricultural production, most private sectoractivity occurs in the Thimphu-Paro–Phuentsholingcorridor. Indeed, around 80 percent of registeredcompanies are located in this area. Because of thislarge concentration of formal businesses, the surveyfocused exclusively on this region—for reasons ofcost efficiency as well as logistics (reaching centraland eastern Bhutan generally involves many days ofcar travel). Security problems in the central and east-ern regions of Bhutan were also a consideration. It ishoped that the work of the SNV Netherlands De-velopment Organization in surveying smaller enter-prises in these regions will augment the findings of thesurvey.

As a result of the regional focus of the survey, itdoes not capture potential peculiarities that may existin the other regions. Future private sector surveys willneed to incorporate the views of the private sector inthese regions. While nonagricultural private sector ac-tivity is now concentrated in the west—for reasons re-lating to broader regional development, rural-urbanmigration, and the like—it may become increasingly

Employment growth(percent)

Sector Firms Mean Median

Cement 8 2.6 –0.3

Chemicals 5 4.3 1.9

Construction 3 13.0 11.0

Food 13 5.2 8.3

Handicrafts 3 16.0 23.0

Information technology 11 8.3 6.9

Metals 4 2.7 3.4

Textiles 2 2.3 2.4

Tourism 16 7.9 6.7

Transport 8 8.8 8.4

Wood 8 5.6 0.9

Other 1 18.2 18.2

Manufacturinga 43 5.0 1.9

Servicesb 39 8.9 7.7

Total 82 6.8 6.3

a. Includes cement, chemicals, food, handicrafts, metals,textiles, and wood.b. Includes construction, information technology, tourism,transport, and other.Source: World Bank private sector survey, Bhutan, 2001.

Table 1.3 Annual Growth in Employment in the Firms Surveyed, by Sector

Thimphu Phuentsholing Full sampleServices Manufacturing Services Manufacturing Services Manufacturing

Firms 30 20 12 36 42 56

Employment

Mean 34 23 24 100 32 73

Median 15 15 19 39 16 23

Share of nonnationals (percent)

Mean 13 15 57 59 32 44

Median 3 0 63 70 14 50


Table 1.4 Employment and Share of Nonnationals in the Labor Force of the FirmsSurveyed, by Location

The Survey 5

important to ensure a more balanced development ofprivate sector activities throughout Bhutan.

A Private Sector Perspective

The survey, by its very nature, covers the views, per-ceptions, and concerns of the private sector. InBhutan, as in all countries, the private sector holdsviews that differ from those of the government. Whilethe Ministry of Trade and Industry was involved ingathering the data and information, this report fo-

cuses on the views and concerns of Bhutan’s privatesector—and those need to be balanced against theviews and aspirations of the government of Bhutan.

Notes

1. One indication of just how embryonic the privatesector is: the Bhutan Chamber of Commerce andIndustry was established with the assistance ofthe government.

2. The Context for Private Sector Development 6

Macroeconomic Overview 7

Overview of the Private Sector 8

Financial Sector 13

Privatization 15

Trade Regime 16

Foreign Investment 17

Infrastructure 17

Labor and Employment 17


Macroeconomic Overview

A landlocked Himalayan country, Bhutan was largelycut off from the outside world until the 1960s, with itsdispersed population depending on subsistence agri-culture. Once Bhutan opened up, the country em-barked on a far-reaching development strategy artic-ulated in eight successive five-year plans. Bhutan hasturned in an impressive development performance,with GDP growth averaging more than 6 percent ayear since 1985. In 2000 Bhutan’s GDP was $441 mil-lion, and its per capita gross national income $550.1

Although agriculture continues to account for thelargest share of GDP (36 percent in 1998), natural re-sources have led Bhutan’s rapid growth. Hydropoweraccounts for 11 percent of GDP (figure 2.1). Foreignaid, however, accounts for an even larger share (23percent).

Growth has been driven by the 336-megawattChhukha hydropower project, which has boostedGDP growth directly through power exports to Indiaand indirectly by supporting energy-intensive indus-tries such as cement, ferro-alloys, and calcium car-bide. The hydropower sector has become increas-ingly dominant in the economy, with new power

projects leading to double-digit growth in the con-struction and transport sectors. Generating capacityis set to triple after 2006 with the commissioning of theTala project, but will still reach only about 10 percentof Bhutan’s potential (box 2.1).

Bhutan’s economy is closely linked with that of itssignificantly larger neighbor, India. Bhutan enjoys afree trade agreement with India dating to 1949. Indiaaccounts for more than 80 percent of Bhutan’s trade(more than 90 percent of exports and 70 percent ofimports). India is also Bhutan’s largest foreign donorand greatest source of expatriate labor. It has fi-nanced Bhutan’s major hydropower projects andsome of its large industrial investments. There are norestrictions on trade and payments between the twocountries. Bhutan’s free access to the vast Indian mar-ket and India’s almost unlimited demand for Bhutan’shydropower have boosted its exports. The Bhutanesengultrum (Nu) is pegged at parity to the Indian rupee(Rs), which circulates freely in Bhutan. These linkslimit the independence of Bhutan’s monetary policy,and its interest rates closely follow those in India.

In recent years Bhutan has received around $80million in annual disbursements of concessional assis-tance. Of this, 85 percent takes the form of grant aid,with external borrowings limited by the government’spolicy of using grants in the first instance. The highlyfavorable terms of the aid, combined with its efficient,cost-effective, and transparent use, have enabledBhutan to limit its external debt. The large inflows of re-sources are reflected in a high domestic savings rate(38 percent of GDP), large foreign exchange reserves(around 19 months of import cover), and large foreignassets as a share of total financial assets.

Fiscal policy has remained prudent.2 Bhutan hasa strong record of managing public spending, with theoverall budget (including grants and concessionalcredits) always close to balance. Bhutanese authori-ties have historically avoided borrowing to finance re-current spending. Inflation has remained moderate,

0

10

20

30

40

50

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Share of government revenue

Share of exportsShare of GDP

Per

cent

Figure 2.1 Economic Contribution of thePower Sector, Bhutan, 1991–2000


recorded at 4.5 percent in 2000/01. The exchangerate has been relatively stable, and Bhutan continuesto have a strong positive balance of payments posi-tion. The debt service ratio was estimated at 4.1 per-cent in 2000/01.

Overview of the Private Sector

Commercial activity—as measured by the number ofnew businesses licensed annually—grew steadily inBhutan in 1987–97 (figure 2.2). Annual growth aver-aged around 34 percent over the decade. The servicesector recorded the largest growth, followed by con-struction and then production and manufacturing(table 2.1). The extremely large growth recorded inservices in 1994 was due to changes in classificationthat year.

Private sector development received a big boostbeginning with the Sixth Five-Year Plan (1987–92),when the government began corporatizing govern-ment agencies and divesting equity to the private sec-tor. Private establishments far outnumber both pub-

Bhutan is endowed with enormous hydropower potential.Its potential generation capacity is estimated to be about30,000 megawatts, with more than 16,000 megawatts con-sidered technically and economically viable. The develop-ment of the power sector began in the late 1980s with thecommissioning of the Chukha hydropower project (336megawatts).

Bhutan’s hydropower generation capacity is expectedto grow significantly as new power projects are com-pleted. In the Kurichhu project 45 megawatts were com-missioned in 2001, and the last unit of 15 megawatts wasadded in 2002, bringing the total installed capacity to60 megawatts. The 24-megawatt Basochhu Upper StageProject was commissioned in November 2001, and the 40-megawatt Basochhu Lower Stage Project is targeted forcompletion in early 2005. Bhutan’s generating capacitywill triple in 2006 with the commissioning of the Tala proj-ect (1,020 megawatts), yet still reach only about a tenth ofthe country’s technically viable potential.

The power sector is expected to continue to be themain engine of growth in Bhutan and a significant source

of government revenue and foreign currency earnings.Bhutan still supplies less than 0.5 percent of the powerused in India, which has an enormous market and facesdomestic supply problems. Internal demand in Bhutan willrise substantially with progress in rural electrification (sup-ported by a $10 million loan from the Asian DevelopmentBank).

Despite the enormous potential, the Bhutanesepower sector faces challenges. Development of futureprojects will depend on access to adequate financing.India is likely to be a major source of funding, and its fis-cal situation could prove to be a constraint. More impor-tant, the Bhutanese authorities must find a way to pro-mote domestic employment through the promotion ofpower-intensive industries. Power projects themselvestend to rely on expatriate engineering firms, since localcontracting skills are limited. Still, power projects haveprovided employment for a large number of Bhutanesecontractors in the construction of houses, access roads,and transportation.

Box 2.1 The Bhutanese Power Sector’s Enormous Potential

0

200

400

600

800

1000

1200

1400

1600

1800

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

Figure 2.2 New Businesses Licensed,Bhutan, 1987–97

Table 2.1 New Businesses Licensed by Sector,Bhutan, 1987–97


licly owned and jointly owned establishments (figure2.3), though the public sector continues to dominateemployment.

With the government’s privatization program, pri-vate ownership has been growing in the large public

and jointly owned establishments—such as thePenden Cement Authority, Bhutan Ferro Alloys, andBhutan Board Products (box 2.2). The governmenthas privatized bus services and corporatized postalservices. It also plans to privatize some agriculturalservices, contract out road maintenance, and encour-age private participation in health and education.

But the key power sector remains closed to pri-vate investment. All hydropower projects are fully gov-ernment owned and operated. As a result, this reportdoes not cover the power sector, though it could be-come an important area of private sector developmentthrough privatization.

Profile of Business EstablishmentsBhutan’s economy is dominated by cottage and minienterprises (figure 2.4). The size of establishments isdetermined by their capital investment:

• Cottage, Nu 0.5 million ($10,500) or less.• Small, Nu 0.5 million to 5 million ($105,000).

3169

11 26

4356

5 330

500

1000

1500

2000

2500

3000

3500

4000

4500

19951997

PublicJointPrivate

Figure 2.3 Enterprises by Type ofOwnership, Bhutan, 1995 and 1997

Productionand

Year manufacturing Services Construction Total

1987 17 7 13 37

1988 17 12 74 103

1989 8 4 39 61

1990 14 19 54 87

1991 14 23 51 88

1992 37 40 195 272

1993 30 45 118 193

1994 47 1,297 259 1,603

1995 15 140 127 282

1996 36 180 251 467

1997 33 341 315 689

Total 268 2,118 1,496 3,882


0

25

30

35

Per

cent

OtherMiniCottageSmallMedium-sizeLarge

Note: For definitions of size classifications, see the text.

40

20

15

10

5

Figure 2.4 Enterprises by Size, Bhutan, 1997

Chhukha Hydro Power Corporation (CHPC). Located inChhukha district, the Chhukha hydropower project wascommissioned in 1988 and built with assistance from thegovernment of India (60 percent grant and 40 percentloan). CHPC is the largest corporation in Bhutan, con-tributing 41 percent of the government’s domestic rev-enues in 1999. Its annual sales in 1999 amounted to Nu2,141.65 million ($47.6 million), of which 90 percent camefrom exports to India. It is fully government owned.

Bhutan Carbide and Chemicals Limited (BCCL). BCCLwas established in Chhukha district under a joint venturearrangement between the government and the Tashi Groupof Companies in 1984. Although the government had an 80percent stake, BCCL was managed by its private promot-ers. By the end of the Seventh Five-Year Plan (1992–97) thegovernment had divested its entire holding in the company.In 1998 BCCL had a market capitalization of Nu 375.0 mil-lion ($8.53 million) and annual sales of Nu 583.6 million($13.26 million), almost all from exports to India. BCCL isone of Bhutan’s most profitable companies, declaring divi-dends of more than 100 percent annually since 1997.

Bhutan Board Products Limited (BBPL). Also locatedin Chhukha district, BBPL was established under a joint

venture arrangement between the government and a pri-vate promoter in 1983. Initially the government held 85 per-cent of the company, though it was managed by its pro-moter. Today the government holds a 23.9 percent share.In 1998 the company had a market capitalization of Nu107.5 million ($2.4 million) and sales of Nu 383.8 million($8.7 million), with 95 percent coming from exports to India.

Penden Cement Authority Limited (PCAL). The gov-ernment established PCAL in 1974 and today holds a 42.7percent share. PCAL had a market capitalization of Nu680.0 million ($15.5 million) in 1998. In the same year itssales totaled Nu 564.7 million ($12.8 million), with exportsto India contributing 81 percent. The company is locatedin Samtse district.

Bhutan Ferro Alloys Limited (BFAL). Established in1995, BFAL is one of only three companies operating withforeign investment (Marubeni Japan holds a 20 percentshare). The government has a 25 percent share. BFAL hada market capitalization of Nu 180.0 million ($4.1 million) in1998. Located in Chhukha district, the company has beenfacing problems with landslides and floods caused bymonsoons, particularly in 2000.

Box 2.2 Bhutan’s Biggest Companies


• Medium-size, Nu 5 million to 20 million ($420,000).• Large, Nu 20 million or more.

In 1993 cottage and mini enterprises and the cat-egory other accounted for around 84 percent of es-tablishments. In 1997 this share had increased to 91percent. Large firms accounted for less than 1 per-cent of the total. Only two large projects—in the ce-ment and ferro alloys sector—were developed in the1990s.

By sector, services accounted for 53 percent ofenterprises in 1997, construction for 38 percent, andproduction and manufacturing for only 9 percent (fig-ure 2.5).

There was a strong geographic concentration ofbusiness establishments in region 1, around the capi-tal Thimphu, in 1997—particularly notable in servicesand the category other (figure 2.6). Ranking next wereregions 2, 3, and 4.

At the district level, business establishments areconcentrated mainly in Thimphu, followed byChhukha and Samdrup Jongkha. Medium-size andlarge firms are concentrated in Chhukha district, andcottage enterprises in Thimphu and other districts.Thimphu has the most forest-based, service, and con-struction companies; Chhukha the most agro-based

firms; and Samtse the most mineral-based enter-prises. This distribution of establishments by numberconceals the fact that the biggest firms in Bhutan arelocated mostly in Chhukha district, including BhutanCarbide and Chemicals, Bhutan Ferro Alloys, and theChhukha Hydro Power Corporation.

EmploymentData on employment are scarce and generally of poorquality. But data from the 1999 labor force surveyshow that agriculture provided employment for 75percent of the labor force, the service sector for 12percent, and manufacturing and mining for 5 percent.

Data relating to the private sector are limited tomanufacturing and mining (figure 2.7). In 1997 regis-tered manufacturing and mining firms operating inBhutan employed around 12,600 people. Of these, 47 percent were employed in mineral-based firms, 20 percent in agro-based companies, 18 percent inwood-based enterprises, and the rest in unclassifiedones. Women accounted for 30 percent of the work-force. Excluding the civil service, private companiesemployed the most workers (41 percent), followed bypublicly listed companies (31 percent), public sectorcompanies (15 percent), and jointly owned compa-nies (11 percent). Enterprises in the categories semi-government and other, including electricity, ac-counted for the rest of employment.3

Average wages (including bonus and in-kind pay-ments) were highest in the wood-based firms (Nu11,315, or $257, a month), followed by the categoryother (Nu 10,072, or $229). The total output of manu-facturing and mining establishments in 1997 amountedto Nu 4,920 million ($111.8 million), the cost of produc-tion Nu 2.1 million ($47,000), and the resulting valueadded Nu 2,814 million ($64.0 million). The categoryother had the highest value added as a share of output,97 percent (figure 2.8).

In 1989 only 15 firms employed more than 100people (9 percent of the 168 manufacturing and min-ing companies). In 1997 the number had increased to

0

500

1000

1500

2000

2500

19941997

Production andmanufacturing

Construction Services

Figure 2.5 Enterprises by Sector, Bhutan,1994 and 1997


22 (10 percent of the total of 213).4 Of these 22 firms,10 employed more than 300 people.5

Performance of Listed CompaniesEstablished in 1993, Bhutan’s stock exchange, theRoyal Securities Exchange Board, lists 12 compa-

nies. These are the largest companies in Bhutanother than wholly government-owned firms. Marketcapitalization stood at Nu 1.64 billion ($37.3 million)in December 1998, equivalent to about 10 percent ofGDP. The Penden Cement Authority had the largestmarket capitalization (Nu 680 million, or $15.5 mil-

–100

100

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Note: Region 1 consists of Thimphu, Ha Paro, Wangdue Phodrang, Punakha, and Gasa; region 2, Chhukha and Samtse; region 3, Tsirang, Daga, Sarpang, Zhemgang, Trongsa, and Bumthang; and region 4, Samdrup Jongkha, Pemagatshel, Trashigang, Tashi Yangtse, Mongar, and Lhuntse.

Figure 2.6 Enterprises by Sector and Region, Bhutan, 1997

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Figure 2.7 Employment by Sector, Bhutan, 1999


lion), followed by Bhutan Carbide and Chemicals (Nu375 million, or $8.5 million) and Bhutan Ferro Alloys(Nu 180 million, or $4.1 million). The Druk SatairCompany had the highest return on capital (53 per-cent) in 1998, followed by the State Trading Corpo-ration of Bhutan (48 percent) and Bhutan Carbideand Chemicals (37 percent). Because of the low vol-ume of trading on the stock exchange, market valuesare unreliable indicators of a company’s true value,which is often understated. All but four companiesdeclared dividends in 1998, ranging from 10 percent(Bhutan Board Products) to 150 percent (BhutanCarbide and Chemicals).

Financial Sector

The government plays a dominant role in Bhutan’s fi-nancial sector, holding large ownership shares in allfinancial institutions. There is a clear need for the gov-ernment to divest more of its holdings in these institu-tions and to focus more on banking regulatory issues.Experience elsewhere shows that significant govern-ment ownership hampers competition and growth andweakens the effectiveness of the central bank.

In Bhutan, as in other countries with a short bank-ing history, financial intermediation is rudimentary andlimited to simple deposit and lending schemes. The fi-nancial sector needs to be broadened and deepenedso that it can support broader development throughnew financial products such as lease financing, ven-ture capital, mortgage financing, and factoring ser-vices. Such instruments could help foster new invest-ment opportunities and also help expand borrowingcapacity, which collateral-based lending tends todepress.

Commercial BanksBhutan has two commercial banks—the Bank ofBhutan and Bhutan National Bank. Both are publiclyowned, and there is little competition between them.

The Bank of Bhutan, established in 1968, is theoldest financial institution in the country. With assets ofNu 6,613.3 million (about $150.3 million) in 1999, it isalso the largest commercial bank. It is owned by thegovernment (80 percent) and the State Bank of India(20 percent). Its 25 branches and 3 extension centerscover all 20 districts of Bhutan.

Bhutan National Bank, converted from the UnitTrust of Bhutan in 1997, held assets of Nu 1,292.2

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Employment Value added

Figure 2.8 Employment and Value Added by Sector, Bhutan, 1997


million (about $28.7 million) in 1999. Its largestshareholders are the government and the AsianDevelopment Bank. Citibank was among the largestshareholders until 2001, when it sold its shares backto the government. The bank has four branches.

Nonbank Financial InstitutionsBhutan has two nonbank financial institutions—an in-surance company and a development corporation.The Royal Insurance Corporation of Bhutan, the onlyinstitution offering insurance products, is 41 percentgovernment owned. Its assets in 1998 totaled Nu2,077.9 million ($47.2 million), including Nu 1,304.4million ($29.6 million) in provident funds that havesince been transferred to the newly establishedNational Pension and Provident Fund Bureau. Whilethe corporation enjoys a monopoly in the insurancebusiness, from its inception until 2000 it was preoccu-pied with managing, administering, and investing theGovernment Employees Provident Fund, a defined-contribution scheme that initially covered only publicsector employees but was later extended to formalsector private organizations. The insurance corpora-tion also managed the fund’s real estate assets, in-

cluding construction, rent collection, and propertymaintenance. In June 2000 the fund and the accom-panying responsibilities were taken over by theNational Pension and Provident Fund Bureau. Withthis change, the Royal Insurance Corporation is ex-pected to focus on its core business of insurance, in-troducing a wider range of products and services.

The Bhutan Development Finance Corporation isfully government owned. With assets of Nu 614.7 mil-lion ($14 million) in 1999, it is Bhutan’s smallest finan-cial institution. It focuses on agricultural lending andrural microfinance, though it also lends to small andmedium-size enterprises.

LendingThe financial institutions directed most lending in June2000 to construction (20 percent), followed by trans-port (19.3 percent), manufacturing (19 percent), andtrade and commerce (13.8 percent). Only 5.4 percentwent to agriculture, and most of this (97.8 percent)came from the Bhutan Development FinanceCorporation. The Bank of Bhutan was the largestlender (with 37 percent of the total), followed by theBhutan National Bank (27.6 percent), the Royal

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Figure 2.9 Bank Lending by Sector, Bhutan, 1988and 1999


Insurance Corporation of Bhutan (21.0 percent), andthe Bhutan Development Finance Corporation (13.4percent). Among sectors, manufacturing has seen theslowest growth in bank lending—only 12 percent ayear over the past decade

Bhutan’s financial institutions face problems withexcess liquidity, most of which is redeposited in non-interest-bearing accounts with the Royal MonetaryAuthority (the central bank) or, increasingly, in high-interest-bearing accounts with commercial banks inIndia. The excess liquidity appears to result from alack of investment opportunities in Bhutan, caused inpart by a combination of high interest rates (nominaland real), large collateral requirements, conservativelending practices, and limited financial products onoffer from the banks. Interest rates were deregulatedin 1998, but even in an environment of high excess li-quidity, rates did not fall until September 2000, whenthe Bank of Bhutan lowered its interest rates in alllending categories (except term loans) with the hopeof reducing its excess liquidity. At the same time it re-duced its interest on fixed (time) deposits, but left thesavings deposit rate unchanged. While the privatesector has welcomed this initiative, high excess li-quidity is likely to remain until other factors inhibitinginvestment have been addressed.

Privatization

In the late 1980s the Bhutanese government made a strong commitment to private sector developmentand privatization. It embarked on a series of largeprojects—such as Bhutan Carbide and Chemicals,Bhutan Board Products, and the Gedu WoodManufacturing Corporation—that were beyond the ca-pacity of the private sector. To pave the way for theprivate sector’s entry into large-scale enterprises, thegovernment offered favorable terms, such as man-agement of the company with an investment of only15–20 percent of the equity. These companies (exceptthe Gedu Wood Manufacturing Corporation, whichwas liquidated) are among the largest and most prof-itable private enterprises in Bhutan today.

Since the privatization program began in the1980s, the government has divested a significantshare of its holdings in public enterprises and priva-tized road transport and construction (table 2.2).6 Thegovernment continued to divest its holdings duringthe Eighth Five-Year Plan period (1997–2002), themost recent divestment being the sale of 34 percentof its shares in the Royal Insurance Corporation ofBhutan in October 2000. The pace of privatization anddivestment has been largely dictated by the govern-

Company Inception 1994 2000

Bhutan Board Products Ltd. 85.0 24.9 23.9

Bhutan Carbide and Chemicals Ltd. 80.0 0.0 0.0

Bhutan Ferro Alloys Ltd. 25.0 25.0 25.0

Bhutan National Bank — 67.2 27.0

Bhutan Tourism Corporation Ltd. — 6.7 6.7

Penden Cement Authority Ltd. — 60.7 42.7

State Trading Corporation Bhutan — 51.0 51.0

Royal Insurance Corporation of Bhutana — 61.0 41.0

— data not available.aAs of October 2000, after the government divested 34% of its holdings.

Table 2.2 Public Ownership Share in Listed Companies, Bhutanpercentages


ment’s policy of encouraging and promoting broadparticipation by Bhutanese investors (which results inshares being sold at below-market rates, subject to amaximum ceiling per person and with priority given toindividuals over institutions) and by the private sec-tor’s low absorptive capacity.

The government has also started commercializ-ing—or corporatizing—certain government agencies,such as postal and telecommunications services,forestry (logging) services, and the Department ofPower. Corporatization is seen as a first step towardprivatization. By increasing autonomy, it is expected to result in better performance. But there is littleevidence suggesting that performance will actuallyimprove, since most of these organizations are man-aged and staffed by bureaucrats who, under-standably, have no exposure to a commercial culture.Moreover, most of these corporatized institutions aremonopolies. To make these sectors truly commercial,competition—both foreign and domestic—should beencouraged.

The government once carried out virtually allnonagricultural economic activity, but today privateinvolvement is growing in most sectors in Bhutan.National contractors carried out about 36 percent ofthe roadworks under the Eighth Five-Year Plan, andprivate schools are beginning to emerge. Private par-ticipation is also on the increase in the forestry sector,with the Forestry Development Corporation (a fullygovernment-owned entity responsible for logging inthe country) subcontracting logging operations to pri-vate parties. But there is still room for the governmentto reduce its engagement further, particularly in log-ging and road construction.

The government has no established procedure forprivatization except final approval by the cabinet. Nordoes any government unit have sole responsibility forprivatization (the main agencies involved in divest-ments are the Ministry of Trade and Industry and theMinistry of Finance). While this has caused no particu-

lar problems, establishing a single body responsible forthis function and a framework for privatization would in-crease transparency, a highly desirable outcome.

Trade Regime

Trade policies have a direct and often dominant effecton economic incentives and resource allocationswithin the economy. Bhutan has a small domestic mar-ket; its population numbers only around 805,000 andan estimated 85 percent of the people depend onsmall-scale and often near-subsistence farming. Withsuch a small market and with hydropower providing a significant revenue base, there is little reason toimpose high taxes on trade to protect domestic pro-ducers or to generate government revenue. Gradualintegration into the global trade system is a key gov-ernment objective for promoting economic growth.

Regional Trade RelationsBhutan enjoys a trade agreement with India, dating to1949, that provides for duty-free trade between thetwo countries and for the transit of goods betweenBhutan and third countries without the application ofIndian tariffs. This agreement is the cornerstone ofBhutan’s international trade relations, and the govern-ment is committed to maintaining and renewing it.Bhutan also has a preferential trade agreement withBangladesh that provides for tariff concessions on arange of negotiated product lines. Since the agree-ment was signed in 1980, Bhutanese exports toBangladesh have risen to Nu 179 million. The govern-ment intends to expand the scope of this agreementwith Bangladesh through further negotiations. Giventhe positive record of bilateral trade agreements in im-proving market access for Bhutanese exporters, theMinistry of Trade and Industry intends to initiate bilat-eral trade talks with other countries in the region, suchas Thailand.


At the regional level Bhutan has fully participatedin and supported the South Asian Association forRegional Cooperation (SAARC), particularly the ne-gotiations for the SAARC Preferential Trading Ar-rangement. Bhutan will continue to push for greaterliberalization of tariffs in the region and work towardthe transition to a South Asian Free Trade Area by2002.

Accession to the World Trade OrganizationTo facilitate Bhutan’s integration into the global econ-omy, the government intends to accede to the WorldTrade Organization (WTO) as a full member. Bhutanwas granted observer status in the WTO on 24 April1998, and its application for accession was discussedat the WTO General Council Meeting on 6 October1999 in Geneva. The Ministry of Trade and Industryhas appointed a WTO liaison officer and establishedthe WTO Reference Center in the Trade Division. It ex-pects that Bhutan will be granted full membership in2002.

Foreign Investment

The first foreign investment in Bhutan was the StateBank of India’s 40 percent holding in the Bank ofBhutan, purchased in 1972. Since then Bhutan haspursued a conservative and restrictive foreign invest-ment policy. All foreign investments are approved caseby case, and until recently no firm in Bhutan had ma-jority foreign ownership. Foreign direct investment haslong been a sensitive issue in Bhutan, largely becauseof concerns about its potentially adverse effect on theBhutanese culture and traditions. The concerns mayalso stem in part from the private sector’s belief that itbenefits from the restrictions and from a general fear ofa large influx of foreign businesses from the region.

Until recently the only foreign investments were inBhutan National Bank (Asian Development Bank), the

Bank of Bhutan (State Bank of India), and BhutanFerro Alloys (Marubeni Japan), with the foreign own-ership share 20 percent in each case. In 2001 thegovernment allowed two international hotel chains toinvest in Bhutan with a majority shareholding, consid-ered a major shift in its approach to foreign directinvestment.

Infrastructure

In Bhutan, unlike in other countries in the region, in-frastructure generally is not considered a major con-straint. The only serious concern is transport. Therugged terrain and topography allow little alternativeto road transport, and the narrow, winding roads meanhigh transport costs. Road standards are low (thoughrapidly improving), allowing maximum loads of 8–10tons and maximum speeds of 40 kilometers an hour inthe hills. The closest port is in Calcutta, about 950 kilo-meters from Phuentsholing. The state-owned Druk Air,the only airline operating in Bhutan, flies to five desti-nations in four countries in the region but lacks the ca-pacity to handle large amounts of cargo. The countryhas no railways or river transport facilities.

Labor and Employment

Shortages of skilled and unskilled labor are a seriousconstraint on the private sector in Bhutan. Exacer-bating this problem, the growing number of Bhuta-nese joining the labor force often lack the skills orexperience required for skilled occupations yet areunwilling to perform the menial work of unskilled jobs.

Each year some 4,000 Bhutanese leave Bhutan’seducational institutions to join the labor force, a num-ber projected to increase to almost 14,000 by 2010(table 2.3). Of the 5,000 leaving the school system in2001, only around 270 were tertiary graduates. Of the


others, around 1,000 had finished high school (grade12), while the rest had completed grade 10 or evenless.

In the past most graduates found jobs in the civilservice, generally within a year. Private sector em-ployment remains a second-best option for mostBhutanese because of perceived job insecurity, lackof social standing, fewer perks, and lack of trainingopportunities. But the civil service is reaching the sat-uration point. Between 1996 and 1999 the number ofgraduate officers in the civil service increased by only129. In 1999, 30 graduates sat for the civil serviceexam, and only 21 were selected.7

Most businesses depend on nonnational (mainlyIndian) workers, whose employment is regulated bythe government. Nonnational workers, who accountfor an estimated 50 percent of formal wage employ-ment,8 tend to earn less than Bhutanese workers at allskill levels, though the disparity narrows at higher skilllevels.

More than 90,000 Bhutanese are expected tocome out of the school system in 2000–10, of which75,000 will have no tertiary education. But formal sec-tor employment in Bhutan is thought to be only around60,000, with around 35,000 of these jobs in the privatesector. Thus while the unemployment rate has beenlow (1.4 percent in 1999), the outlook is bleak.

The urgent need to create new employment op-portunities for the growing number of school-leaversrepresents the most serious labor challenge facingthe government. This challenge is heightened by thecurrent capacity of the Bhutanese private sector andthe expectations of Bhutanese workers, especiallythose who have received some education. While theprivate sector requires mainly low-skilled manualworkers and experienced, highly skilled workers,most school-leavers have few skills and are averse tomanual work. Moreover, young people’s expectationsfor income are not matched by the types of jobs avail-able. These expectations are based not on skills but

Education level attained 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total

Grade 6 440 390 321 256 171 70 0 0 0 0 0

Grade 7 436 395 324 259 222 241 262 290 315 345 368 3,426

Grade 8 363 325 284 219 196 217 235 256 282 307 337 2,983

Grade 9 284 255 224 185 167 190 211 230 249 275 299 6,204

Grade 10 1,615 2,387 2,659 2,872 3,094 3,236 3,476 3,661 3,756 3,823 3,934 30,656

Grade 11 18 17 21 27 32 39 45 52 61 68 77 5,777

Grade 12 657 953 1,032 1,687 2,097 2,539 3,061 3,511 4,132 4,780 5,397 34,861

Total 3,813 4,722 4,865 5,505 5,979 6,532 7,290 8,000 8,795 9,598 10,412 75,511

Tertiary degree 270 270 270 299 362 1,447 1,855 2,211 2,526 2,844 3,160 15,514

Total school-leavers 4,083 4,992 5,135 5,804 6,341 7,979 9,145 10,211 11,321 12,442 13,572 91,025

Note: Data after 2001 are projected. An estimated 125 degrees are obtained outside the country each year.Source: Government of Bhutan.

Table 2.3 School-Leavers Joining the Bhutanese Labor Force, 2000–10


on a sense of social standing derived from the level ofeducation and literacy achieved.

To deal with this challenge, the government willneed to continue to address the high expectations,develop a blue-collar culture, and increase the num-

ber of tertiary institutions providing the skills soughtby the private sector. Recent initiatives include theestablishment of the National Technical TrainingAuthority in 1999 and the National Employment Boardin 2000, later converted to the Department of

Since the early 1960s successive five-year plans haveprovided the basic framework for development planning inBhutan. The Bhutanese authorities recently conducted amidterm review of the Eighth Five-Year Plan (1997–2002)and established guidelines for preparing the Ninth Five-Year Plan (2002–07).

Midterm Review of the Eighth Five-Year PlanThe Eighth Five-Year Plan was aimed at achieving sus-tainable growth and better living standards while ensuringthe preservation of Bhutan’s environment and cultural her-itage. The review found that:

• Macroeconomic performance has been satisfactory,with the hydropower projects contributing significantlyto economic growth. Fiscal performance has beensolid, with better tax collection and a higher power tar-iff leading to higher domestic revenue.

• Most social development goals have been achieved.The number of educational facilities increased sub-stantially, and 90 percent of the population now hasaccess to basic health services.

• The Department of Urban Development and Housingwas created to provide urban infrastructure servicesand manage the municipal affairs of growing town-ships. By the end of 1999, 45 kilometers of new roadhad been constructed, and funding to construct an-other 122 kilometers of new roads had been secured.

• Much progress was made in expanding the telecom-munications network, which now connects all 20 dis-trict headquarters. National television and Internet ser-vices were launched in 1999.

• Since 1997 the government has substantially reducedits ownership in a number of public enterprises

through divestiture. The Agriculture Ministry estab-lished a marketing section to encourage private par-ticipation. In education one private secondary schooland seven private primary schools have been estab-lished, and applications for more private schools arebeing reviewed.

• All infrastructure development has been undertakenin line with the policy of conserving the country’s richnatural resources. More than 72 percent of land areais now under forest coverage.

• As part of the program to restructure government, twonew divisions (the National Employment Board andthe Division of Information Technology) and one newdepartment (Legal Affairs) have been created.

Guidelines for the Ninth Five-Year PlanThe Planning Commission released guidelines for prepar-ing the Ninth Five-Year Plan in January 2001, focusing onbalanced development, decentralization, and promotionof private sector development. The guidelines emphasizethese objectives:

• Mobilizing greater revenue by improving tax collectionand enhancing the tax base.

• Focusing on a rural access program to improve thequality of life and income of rural people.

• Consolidating and improving existing infrastructureand services.

• Initiating regionally based planning and increasingthe autonomy of local governments in financing theirdevelopment programs.

• Investing in areas that will generate the mostemployment.

Box 2.3 Bhutan’s Five-Year Development Plans


Employment and Labor in the Ministry of Education.The main responsibilities of the National TechnicalTraining Authority include coordinating efforts to de-velop technical and vocational skills, establishingstandards for skills certification (in close collaborationwith the private sector), and promoting traditional artsand crafts. The Department of Employment and Laboris expected to provide employment exchange ser-vices; support policies and programs to generateemployment; monitor unemployment; formulate rulesand regulations for employment, working conditions,and compensation; and take a lead role in developingnational human resource policies and plans. Duringthe Eighth Five-Year Plan period the government alsosupported the development of entrepreneurial skillsthrough the Entrepreneurship Development Program(conducted by the Ministry of Trade and Industry) andby providing scholarships and training in such fieldsas culinary science and hotel management.

Through these measures, the government hastried to address some of the supply-side problems.But the real challenge lies in creating jobs in a grow-ing and dynamic private sector. This is all the morecritical given the slow growth expected in civil serviceemployment.

Notes

1. The gross national income figure is from the WorldBank’s World Development Report 2002 (NewYork: Oxford University Press, 2002), based on anestimated population in 2000 of 805,000.

2. For a description of Bhutan’s tax regime, see ap-pendix 2.

3. The data on employment may not always be ac-curate and are not always consistent with the find-ings of the private sector survey.

4. These data are based on the Bhutan PlanningCommission’s “Report on the National Census of Manufacturing Industries, 1998” (CentralStatistics Office). These figures differ significantlyfrom those in the Planning Commission’s“Statistical Yearbook of Bhutan 1997” (CentralStatistics Office), which shows the number of li-censed manufacturing and mining firms in 1997as 405.

5. Because of the lack of data on employment pro-vided by the service and construction sectors (thetwo sectors with the strongest growth in companyregistrations), no comparison of employment gen-eration in the major sectors could be made thatwould provide meaningful insight into private sec-tor employment in Bhutan.

6. Table 2.2 shows public ownership in listed com-panies only. The government also holds shares inunlisted companies, such as the Bank of Bhutan,in which public ownership increased from only 60percent in 1972 (with 40 percent held by the StateBank of India) to 80 percent in 2001.

7. Government of Bhutan Development towardGross National Happiness (Thimphu, 2000).

8. RTM Background Document. In addition, an esti-mated 10,000–20,000 non-Bhutanese wage work-ers receive day employment in the border areas,and around 1,900 seasonal workers are employedduring the winter in southern Bhutan.

3. Cross-Cutting Issues 21

Biggest Business Problems for the Private Sector 22

Labor Issues 23

Technology Issues 29

Financial Sector Issues 32

Land Issues 38

Auditing, Accounting, and Taxation Issues 39

Infrastructure Issues 41

Regulatory Environment 43

Trade Regime 45

Institutional Issues 46

Benchmarking the Business Environment 48

Alternative Development Tracks 49

Privatization 51


Bhutan’s increased focus on private sector develop-ment and employment creation comes at a time ofgreat regional and global change. Among the mostimportant developments has been India’s gradualmove to reduce and simplify tariff and nontariff barri-ers. Bhutan’s free trade agreement with India gives itprivileged access to the Indian market, which hasbeen protected by high tariff barriers. As tariffs andother trade restrictions fall in India, Bhutanese ex-porters will need to become more efficient if they areto grow and prosper in the face of stiff competitionfrom low-cost producers around the world.

As a small, landlocked country, Bhutan has hadfour main competitive advantages: relatively unre-stricted access to the large Indian market for importsand exports, low electricity prices, access to low-costand stable labor, and a competent, committed, anduncorrupt government. In addition, Bhutan’s uniquedevelopment path—with a strong focus on the envi-ronment—and its geographic location provide a po-tential for producing niche market goods based onenvironmental advantages (organically producedgoods and sustainably managed forests) or location(such as tourism, some agricultural products,Himalayan herbs, and medicines). The challenge forthe Bhutanese government is to develop policies insupport of private sector–led growth that build onthese competitive advantages. Indeed, different ap-proaches to private sector development may beneeded in different parts of the country.

Against these considerable advantages, Bhutan’sprivate sector faces equally imposing obstacles.Chief among these has been the relatively late open-ing of the domestic economy to the outside world.Economic evidence suggests a strong link betweenexternal interactions—particularly through exports,imports, and foreign direct investment—and eco-nomic growth. But the closed Bhutanese economyprecluded most of these interactions. Moreover, thealmost exclusive reliance on agricultural production

until recently has meant a lack of well-developed en-trepreneurial skills in Bhutan outside such basic areasas agriculture and trading.

A second challenge for the private sector comesfrom geographic barriers and their impact on trans-port infrastructure. Road links are often disrupted bylandslides or by political disruptions in India (severalparts of Bhutan are accessible only through India),and air links are adversely affected by weather, equip-ment breakdowns, and landing and takeoff restric-tions at Paro International Airport.

A third challenge is a government that is “new tothe game” of supporting the private sector. Adding tothe challenge, the private sector is even newer to thegame of private sector–led growth. Because the gov-ernment is relatively well run, efficient, and effective, ithas a general perception of the private sector as lesswell organized, less effective, and likely to be morecorrupt. In short, the government has developed asomewhat patronizing attitude toward the private sec-tor that it strongly wishes to support.

This chapter examines some of these concerns ingreater detail by reviewing a set of issues that affectall sectors. It uses survey data to investigate the prob-lems and seeks to identify policy measures that willhelp Bhutanese industry become globally competitiveand enable the private sector to eventually replacethe government as the main engine of economicgrowth.

Biggest Business Problems for the for the Private Sector

The survey respondents, in ranking their biggestbusiness problems, clearly identified a lack of skilledlabor as the most significant concern (table 3.1).Ranking next were the bureaucratic burden and gov-ernance issues, lack of demand, credit and finance,and infrastructure. The rankings of problems re-


mained much the same across all sectors andregions.

While most of these issues are self-explanatory,lack of demand is more complicated. Firms oftencomplain that they cannot compete with importsdumped in the domestic market or that the local mar-ket is too small for their production base. But the un-derlying problem is that Bhutanese producers areoften unable to compete in price, quality, delivery, andmarketing. That Bhutan has significant imports showsthat there is consumer demand. Moreover, the Indianmarket, where Bhutanese producers can sell withoutrestriction, is among the largest in the world.

Labor Issues

Among the ironies of Bhutan is that the governmentshows growing concern about employment issues

when by some estimates nonnationals—mainlyIndians—make up around 50 percent of the formalsector workforce. These low-cost workers have ac-cepted jobs that many employers feel Bhutaneseworkers will not undertake, including menial andbackbreaking work in factories, on construction sites,and in road building.

That has resulted in the second irony of employ-ment in Bhutan: despite the desire to increase theemployment of Bhutanese workers, the government is concerned about increasing mechanization ratherthan promoting labor-intensive methods of produc-tion. The bountiful supply of low-cost, unskilled Indianlabor has resulted in the adoption of labor-intensivetechnologies in Bhutan. But there is a general per-ception that the quality of production has suffered asa result and that firms are relying on less expensivenonnationals in the place of local workers or more ap-propriate capital equipment. Consequently, the gov-ernment advocates mechanization as a way to im-prove production quality and break the reliance onnonnational labor.

But in attempting to spur job creation and mobilizethe private sector to absorb the growing Bhutaneseworkforce, the government must take care not to hand-icap the competitiveness of the budding but fragile in-dustrial sector. Arbitrarily cutting off the supply of inex-pensive and skilled nonnational labor or forcing firmsto adopt inappropriate technology so as to reduce theemployment of unskilled nonnationals could renderBhutanese industry uncompetitive, slow growth, andlead to a loss of jobs. The key to success lies insteadin developing the country’s human resources and itsproductivity to levels that will make Bhutanese industryglobally competitive while creating job opportunitiesfor the expanding Bhutanese workforce. Thus the focusmust be on strengthening training and education andacquiring better technology.

Bhutanese industry is labor intensive, as effi-ciency demands in an environment with low-costlabor and high-cost capital. So keeping labor costs

Firms citingas number Weighted

Problem one problem indexa

Skilled labor 20 0.51

Bureaucratic burden 16 0.38

Lack of demand 17 0.36

Credit and finance 16 0.30

Infrastructure 8 0.20

Business support services 1 0.06

Import regime 0 0.05

Foreign exchange regulations 1 0.03

Note: The table groups related problems. For example, allissues relating to government regulations—such as laborlaw, tax policy, and regulations on obtaining land—aregrouped under bureaucratic burden. Similarly, lack of de-mand includes competition from imports.a. The weighting was calculated by assigning a numberone ranking a weight of 3, a number two ranking a weightof 2, and a number three ranking a weight of 1.Source: World Bank private sector survey, Bhutan, 2001.

Table 3.1 Biggest Business Problems forBhutanese Firms


down in relation to productivity is critical to maintain-ing competitiveness. Geography tightly links Bhutan’sfuture with that of India. A long, unpoliced border anda free trade agreement strengthen these ties by per-mitting reasonably free movement of goods and laborbetween the two countries. Thus in all but exceptionalcircumstances wages and productivity cannot be toofar out of line with those in India.

As Bhutan implements requirements of the WorldTrade Organization, it will also have to match the pro-ductivity levels of other low-cost producers. If wagesin Bhutan remain higher than those in neighboringcountries, companies will be able to survive only iftheir labor productivity is correspondingly higher. Andbecause capital in Bhutan is no cheaper than thatelsewhere—and possibly more expensive than that inIndia—Bhutanese industry also needs to take carethat its efforts to raise labor productivity do not re-sult in the adoption of high-cost, inefficient, capital-intensive modes of production.

Labor Market Advantages—Stability and FlexibilityThe Bhutanese labor market has two valuable attri-butes, the principal one being the total absence oflabor unrest. Disruptive union activity does not exist,and no companies in the sample recorded workdayslost as a result of strikes (though some were lost be-cause of nonnational workers attending festival cele-brations in India). Thus Bhutan has access to cheap,nonnational labor without the unrest prevalent in othercountries of the region. The stable labor force, com-bined with low wages, gives Bhutan a considerablecompetitive advantage relative to its South Asianneighbors.

A second advantage is that the labor law allowsfor almost complete flexibility in labor markets.Although the government ostensibly regulates theemployment conditions of all Bhutanese citizens,1

labor regulations are largely undeveloped, and em-ployers can easily hire and fire workers and set wages

with no influence from organized labor. No companyin the sample experienced problems in firing poorperformers, whether national or nonnational. Em-ployers lay off workers at will, and workers, since theyhave no job security to lose, leave their jobs whenother demands (rice planting, harvesting) loom largeor they simply become discontented with their job.This flexibility has costs as well as benefits for firms,since it introduces an unwelcome element of labormobility.

Adding to the flexibility is the absence of an offi-cial wage policy. The minimum wage law applies onlyto the national workforce—those who work for thegovernment or on projects contracted by the govern-ment—not to private sector employees. While somecompanies follow the government’s lead on wages,they are not obliged to do so. Most manufacturingfirms, especially those relying on nonnational labor,do not pay the government minimum wage.

This lack of a formal wage policy gives the privatesector much flexibility. Wages tend to be sticky (thatis, they do not move often or easily), and there is littleunion agitation for salary increases. But the disadvan-tage is that wages tend to go for long periods withoutadjustment and then are suddenly increased by largeincrements. In 2001, for example, the government an-nounced a doubling of the minimum wage—from Nu50 a day to Nu 100. Because the government is awage leader in the economy, some private firms fol-lowed suit.

Wage levels vary widely by location and national-ity. The survey shows, for example, that private sectorwages tend to be higher in areas away from the bor-der. Bhutanese workers of all skill levels appear tohave high reservation wages (the minimum wage thatwill induce them to work) and generally demandhigher pay than Indians. As a result, many industrialfirms—especially those in the border areas, wherethere is free movement of labor—rely on low-cost non-national workers to produce competitive products forsale in the Indian market. In manufacturing firms sur-


veyed in the two main towns, Bhutanese workers in allcategories receive higher pay than their Indian coun-terparts (table 3.2). (The comparison focuses on man-ufacturing because its workforce is more homoge-nous than that in the service sector and thereforemore comparable.) At the lower end of the scale, sev-eral firms surveyed in the border towns were payingunskilled nonnational female workers as little as Rs 25a day and nonnational male workers Rs 30 a day—ex-tremely low rates by both regional and internationalstandards.

Because of the high labor mobility, especially inthe border areas, the only way for Bhutanese workersto sustain higher pay than nonnationals receive is tobe more productive. A cursory comparison showsthat firms with mostly Bhutanese workers have higheraverage value added per worker than those withmostly nonnational workers. The average valueadded per worker in manufacturing firms employingless than 20 percent Indian workers is almost 30 per-cent more than the average for firms employing morethan 80 percent Indian workers (table 3.3).

Yet anecdotal evidence and interviews suggestthat Bhutanese workers are less productive than theirIndian counterparts. These two findings are not con-tradictory. Since Bhutanese workers have a higherreservation wage, they tend to accept employmentonly in firms with the high value added per worker that

comes with higher pay. That suggests that most Bhuta-nese workers seek employment in capital-intensivefirms or those demanding higher skill levels.

Reliance on Nonnational LaborThe government, concerned for some time about therelatively large share of nonnationals in the formallabor force, has instructed firms to reduce the em-ployment of nonnational workers. This has been diffi-cult to enforce in border areas, where day laborerscan freely walk across the uncontrolled border, unde-tected and unrecorded. But these nonnationals arenot allowed to travel beyond the border areas withoutspecial permission. Consequently, firms in Thimphuemploy a significantly smaller share of nonnationalsthan do firms in Phuentsholing (table 3.4). In the sam-ple as a whole, Bhutanese account for 64 percent ofthe workforce but 71 percent of the presumably moreskilled nonproduction workers. Companies in Thim-phu appear to rely on Indians for skills that they can-not find in Bhutan and for jobs that locals will not un-dertake. By contrast, for firms in the border areas,where Indians account for a larger share of both pro-duction and nonproduction workers, their lower wagesappear to be the determining factor.

The exception to this rule is construction compa-nies, involved largely in building sites and road con-

Location Production Nonproduction Alland nationality workers workers workers

Thimphu

Bhutanese 4,823 13,811 6,112

Indian 3,905 8,839 5,609

Phuentsholing

Bhutanese 4,176 9,000 5,718

Indian 2,393 6,369 3,048


Table 3.2 Average Monthly Salary byLocation and Nationality, Bhutan in Ngultrum

Manufacturing Services

All firms 2,892 4,950

Firms by share of Indiansin their workforce

Less than 20% 3,411 5,841

20–80% 2,450 5,645

More than 80% 2,645 398


Table 3.3 Average Annual Value Added perWorker by Share of Indians in Workforce,Bhutan(U.S. dollars)


struction projects. These companies, whose highlylabor-intensive techniques mean strenuous jobs forlow wages that few Bhutanese are willing to accept,are provided generous allocations of nonnationalwork permits, even in central Bhutan. (This practicehas spawned “construction companies” more inter-ested in securing work permits for nonnationals thanin undertaking construction projects.)

In justifying their appetite for nonnational work-ers, many firms assert that Bhutanese workers areexpensive, are less productive than their nonnationalcounterparts (and thus doubly expensive), are unre-liable and disappear during rice planting and har-vesting seasons, lack a good work ethic and willleave a job without notice if they feel slighted or af-fronted by their employer, and are unprepared to un-dertake dirty, repetitive, or menial work. The govern-ment counters these complaints by arguing thatBhutanese workers will never develop a good workethic and higher productivity unless they are ex-posed to a workplace environment. Thus the govern-ment is increasingly insisting that private companiesreduce their nonnational workforce (one company inThimphu had been told to reduce its nonnationalworkforce by 25 percent by the end of December2001 and another 25 percent by the end of June2002).

Replacing nonnational workers means highercosts, lower productivity, and a weaker work ethic,placing Bhutanese companies at a competitive dis-advantage. Thus the natural desire to “Bhutanize” thelabor force will need to be sensitively calibratedagainst the desire to generate a larger and strongerprivate sector, since these two objectives, at least forthe short term, are likely to be in conflict.

Shortage of Skilled LaborAsked about their biggest business problem, firms inall sectors and locations overwhelmingly cited thelack of skilled labor in Bhutan. Until recently the pub-lic sector absorbed virtually all Bhutanese with a fullsecondary or tertiary education. As a growing numberof graduates are unable to find the preferred employ-ment in the civil service, however, more are seekingemployment in the private sector. But companiescomplain that the best candidates still go to the gov-ernment, while those who come to them have little ex-perience yet demand high pay. Moreover, managersreport that the skills provided by most schools andtraining institutions do not match the skills needed byindustry. So while a growing number of school-leaverscannot find jobs, industry still feels that its biggestproblem is a shortage of skilled and experiencedlabor.

Thimphu Phuentsholing Full sampleJob category Bhutanese Indian Bhutanese Indian Bhutanese Indian

Nonproduction 89 11 63 37 71 29

Production 76 24 57 43 63 37

All workers 79 21 59 41 64 36

Note: Nonproduction workers include managers, owners, technicians, and professionals.Production workers include office workers and service workers as well as general productionworkers.Source: World Bank private sector survey, Bhutan, 2001.

Table 3.4 Share of Indian and Bhutanese Workers Employed, by Locationand Job Category, Bhutan(percent)


Because most private industries are fairly young,skills tend to be weakest in management. MostBhutanese entrepreneurs have a background in civilservice or government. Almost 48 percent of the sam-ple were working for the public sector (including thecivil service, nongovernmental organizations, theroyal family, and the military) immediately before es-tablishing their business. Less than 30 percent camefrom another private business. Managers from thepublic sector often do not know their industry well.Without seasoned managers, firms fail to properlymanage their business, find the right technology, traintheir workers, or even hire workers with the skills re-quired. And managers often “don’t know what theydon’t know.” Many managers in the survey group didnot recognize management failures that were evidentto the sector specialists involved in the survey.

Developing a cadre of Bhutanese managers,school-leavers, and graduates with the necessaryskills will take time. Thus where skill shortages exist in the Bhutanese workforce, the government shouldallow liberal recruitment of skilled nonnational work-ers. Areas where skill shortages are immediately evi-dent include accounting, auditing, marketing, pack-aging, information technology, and human resourcemanagement. Taking advantage of the skills of work-ers from neighboring countries in these areas shouldaid the development of industry in Bhutan.

Information technology is a case in point: SouthIndia has developed a vibrant export sector in this ac-tivity that the government of Bhutan now wishes topursue. Providing the skills needed by the privatesector will require liberal rules on work permits forskilled nonnationals. Access to relatively low-cost andhighly skilled Indian workers gives Bhutan an impor-tant cost advantage that it should seek to leverage.

Shortage of TrainingEven though managers cited the lack of skilled work-ers as their biggest business problem, very few pri-vate firms (apart from the largest companies) provide

significant formal training for their workers. Indeed,only about 39 percent of surveyed firms reporteddoing any training (table 3.5). Less than 3 percent ofthe sample’s workforce received any training in theprevious year, and training costs average an ex-tremely small 1.4 percent of sales. Service firms weremore likely than manufacturing firms to provide train-ing and trained a slightly larger share of their work-force. This finding is expected, since service firms,especially tour operators, cannot easily hire skillednonnationals. With a growing body of evidence linkingworker training with greater growth and productivityfor firms, the lack of training in Bhutan needs to be addressed.

Almost 30 percent of the firms that conduct nosignificant formal training cited a lack of governmentincentives as a reason (table 3.6). Many firms laborunder the misconception that worker training costsare only tax deductible up to 2 percent of total profits(as entertainment and some other allowable deduc-tions are). For small firms and those just breakingeven or making a small profit, this provides no incen-tive to allocate scarce resources to training. But ac-cording to the Ministry of Finance’s Department ofRevenue and Customs, this is not the case; trainingexpenses are allowed case by case and are grantedreasonably liberally.

Another major reason cited by managers for nottraining is that Bhutanese workers can move on at

FullManufacturing Services sample

Share of firmsproviding training 28 52 39

Training expenses as a share of sales 1.1 2.0 1.4

Share of workforce trained 1.8 4.7 3.0


Table 3.5 Training by Bhutanese Firms(percent)


a moment’s notice. And there is an automatic biasagainst training Indian workers, since they are sup-posed to be phased out.

But the reason cited most often is that training isnot needed. Almost all companies use mature Indiantechnology, and it is less expensive to hire trainedworkers from the large labor pool on the border thanto train their own staff. Indeed, some managers saidthat they stay with older Indian technology rather thanupgrading because it makes it easier to find trainedworkers and maintain equipment. Forgoing trainingalso reduces the cost of worker turnover. Another rea-son that managers see no need for training was ap-parent to the sector specialists participating in thesurvey: the managers themselves often lack technicalskills and do not know or fully understand the need for upgrading skills. The reliance on old technology,combined with the low levels of training, augurs ill forraising labor productivity and improving internationalcompetitiveness.

The pressing need to encourage firms to trainworkers and the misperception of what expenses areallowable suggest that the policy on training ex-penses should be made as explicit and automatic aspossible. To this end, the Department of Revenueand Customs needs to move away from the case-by-

case approach to determining what training ex-penses are allowable and devise an explicit al-lowance freely available to all companies. Also im-portant will be the work of the National TechnicalTraining Authority, which is looking at how to structureincentives to make training workers more attractive inan environment where Bhutanese workers are highlymobile.

Priorities for Labor PolicyThe government is preparing new labor regulationsthat are expected to be implemented soon. The regu-lations will extend the minimum wage to the privatesector, set working hours, and define overtime bene-fits. While ensuring fairness and equity in the work-place is important, one of Bhutan’s competitive ad-vantages is its lack of excessive labor regulations,which plague many other countries in the region.Developing an appropriate balance between fairnessand a “light touch” in regulation will be important in re-taining Bhutan’s labor market flexibility and competi-tive edge.

Several key issues need to be considered withparticular care. Since public sector wages are alreadyhigher than market wages and significantly higherthan the wages accepted by nonnationals, extendingthe minimum wage to the nascent private sectorthreatens to impose an unmanageable burden on it.In contrast, a wage policy that provides for smaller,more frequent, and automatic salary increases in thepublic sector—and only the public sector—would goa long way toward ensuring that wages do not lag toofar behind other prices in the economy. It would alsohelp shield the economy, and possibly the privatesector, from sudden sharp shocks in wage levels.

In designing policies to spur employment, thegovernment needs to be careful not to cripple thesmall and still relatively fragile private sector. Thecompetitive advantages arising from labor stability,labor flexibility, low labor costs, and the ability to pickup missing skills from India need to be carefully cali-

Share of firmsReason citing reason

No need 64

Lack of government incentives 30

Worker turnover 26

Cannot afford training 25

Lack of training by associations, chambers of commerce, and the like 17

Note: Data refer to the 66 firms reporting that they do nottrain workers.Source: World Bank private sector survey, Bhutan, 2001.

Table 3.6 Reasons Cited by BhutaneseFirms for Not Providing Training(percentage of firms responding)

Bangladesh’s Investment Climate in International Perspective 29

brated against the desire to protect workers’ rightsand gradually increase the share of Bhutanese work-ers in the formal labor force. These advantagesshould not be sacrificed to the detriment of the youngprivate sector, given the disadvantages that it alsofaces.

Key to developing the private sector is raisingworker productivity, which will improve the competi-tiveness of Bhutanese goods even at existing wagelevels. Labor policy needs to:

• Ensure that private firms have access to the skillsthey need, including liberal access to skilled non-national labor when adequately skilled or experi-enced Bhutanese workers are unavailable.

• Ensure that firms are not arbitrarily cut off fromlow-cost unskilled labor from India.

• Make sure that, in an effort to raise worker pro-ductivity, firms do not mechanize in ways that in-crease the capital-labor ratio beyond what is opti-mal. This strategy would merely reduce profitsand make firms less competitive against countriesusing more appropriate technology.

• Promote productivity gains through the transfer of appropriate technologies—through bettermanagement techniques, greater worker train-ing, and careful introduction of appropriateequipment.

• Promote productivity gains by encouraging firmsto move up the value chain to new products—forexample, in niche markets and in such servicesas design, tourism, accounting, and informationtechnology, which typically have higher valueadded per worker but require higher skills.

• Permit continued wage flexibility as well as rea-sonable latitude in hiring and firing.

Since it is critical that Bhutan invest in improvingthe quality of its workforce, and since individual firmswill be unable to capture the full benefits of training,the government needs to be prepared to offset some

of the associated costs.2 Readily available tax incen-tives, matching grant schemes to share the costs oftraining or acquiring technology, and direct subsidiesfor training should all be considered. In addition, ed-ucational and vocational training programs need tobe aligned with the requirements of private industry,and more needs to be invested in secondary andhigher education.

Technology Issues

To enter world markets and compete successfully withimports, Bhutanese firms must dramatically improvetheir productivity. That means not only upgrading theirhuman capital but also adopting appropriate newtechnology. The preferential access to the Indian mar-ket, India’s high tariffs, and the natural protection pro-vided by Bhutan’s remote location have led to littledomestic competition and created few incentives forfirms to seek productivity improvements. Investmentis low and directed mainly at increasing production orreplacing worn machinery with existing technology,mostly from India. Few resources are devoted to im-proving production processes or introducing newproducts. All this, combined with the lack of workertraining, has led to low productivity and a lack of com-petitiveness for most Bhutanese products both glob-ally and within South Asia.

Long experience in many countries has shownthat learning mechanisms—such as exporting, for-eign investment, foreign consultants, worker training,and external support services—are key determinantsof productivity growth.3 Such mechanisms help firmsobtain information on the most productive practicesand improve their technical capabilities. But most ofthese learning mechanisms are poorly developed ornonexistent in Bhutan. Exports other than electricityare extremely low, few firms train workers, and for-eign direct investment has been almost completelyabsent (as a result of conscious government policy).

Bangladesh’s Investment Climate in International Perspective 30

Exacerbating all this, most businesspeople lackknowledge about the technical aspects of their busi-ness. As a result, they do not recognize the impor-tance of technical innovation or do not know how togo about making technical changes. Strengtheningthe private sector in Bhutan will require dramaticallyimproving the learning mechanisms that enable firmsto improve productivity.

In technology, Bhutanese companies need to lookbeyond India. Enterprises have found it easier andcheaper to look across the border for tried-and-trueproduction methods supported by a ready pool oftrained labor. But this technology may not always bethe most efficient for Bhutan. With Indian trade barri-ers falling, Bhutan will have to adopt international bestpractices to compete globally. This may mean thatBhutanese companies have to leapfrog Indian tech-nologies and take up more developed third-countrytechnologies. Although this may be more expensiveand difficult, it will help ensure competitiveness inworld markets.

Key Technology NeedsTechnology is a general term covering a wide rangeof areas. Those most relevant to Bhutan include man-agement knowledge, market knowledge, productiontechnology, design and product development, infor-mation technology, and management and qualitysystems.

Management Knowledge. Management infirms is weak, with owners commonly lacking techni-cal qualifications or relevant experience. Owners andmanagers need to be more aware of appropriate bestpractice before they can effectively transfer newtechnologies to their firms. In other developing coun-tries many managers develop skills and knowledgeof best practices by working for foreign companies orattending technical courses abroad. But these prac-tices are rare in Bhutan. Less than 13 percent of themanagers in the sample worked for a foreign com-

pany, almost all of them in India. Compare Nepal,where a similar survey found that more than 51 per-cent of managers had worked outside the country.More than 60 percent of managers in the sample hadstudied outside Bhutan, but most pursued a non-technical basic education (often in their former ca-pacity as a civil servant) with no direct relationship totheir business.

Market Knowledge. As a result of Bhutan’s pastisolation and the government’s dominance of the mar-ket, firms lack an awareness of marketing and famil-iarity with marketing tools. Identifying and penetratingniche markets is difficult because Bhutan lacks rele-vant skills and Indian expertise may be inappropriate.

Production Technology. Productivity and qualityin Bhutan fall short of international standards not onlybecause of weak management, but also because of old equipment, insufficient maintenance, and pooroperator skills. Firms need to leapfrog Indian technol-ogy and use globally competitive know-how. And theyneed to improve production management so thatmanagers can make the most effective use of existingresources and future investments.

Design and Product Development. Innovativeproducts are seen as a way to enter niche markets inthe agroprocessing, wood, and tourism sectors. Butbefore developing such products, firms first need to develop product policy—procedures to balancemarket needs with suppliers’ resources—and market-driven, product-specific briefs.

Information Technology. Firms are struggling tointroduce information technology, which is essentialfor such activities as managing their finances, search-ing for technology, and developing market links.

Management and Quality Systems. Manyfirms lack consistency in their products. These firms


would benefit from introducing ISO 9000, a set ofstandards for quality management systems, or theHazard Analysis Critical Control Point system, a pro-cess control system aimed at ensuring food qualitythat is mandatory in some countries.

Difficulties in Technology TransferFirms face difficulties in searching for, acquiring, andabsorbing technology. Some managers reported thatreaching the point where a firm is reaping the full ben-efits of a new technology can take up to two years.Because of the costs and difficulties of changingtechnology, firms in Bhutan often rely on familiar tech-nologies from India rather than upgrading. While stay-ing with old technology lowers costs, it also meansrapidly losing competitiveness.

Searching for Technology. Large firms generallyrely on their equipment suppliers and buyers to iden-tify sources of technology, but many recognize thatthey need more advanced technology that they can-not easily identify. Small companies often use guess-work to estimate their technology needs, which fre-quently leads to costly mistakes.

Acquiring Technology. Acquiring technology isless problematic, though still time consuming, if com-panies use reliable suppliers who commission theequipment and provide training for operators. Firmsacquiring used equipment, however, often find that itis incorrect or defective. Hiring consultants can alsobe problematic, since many may be inappropriate un-less recommended by a supplier or buyer.

Absorbing Technology. Absorbing—or internaliz-ing—technology poses significant challenges. Onceproduction technology is acquired, it often has to beadapted to meet orders from customers. Some firmsreported that such absorption problems can increasethe costs of technology transfer by a third. Main-tenance and spare parts add further difficulties. With

information technology, for example, three-quarters ofthe firms surveyed had difficulties in adequately train-ing staff, in obtaining backup service, or in develop-ing and customizing software.

Need for Learning MechanismsOvercoming these problems will require efforts to cre-ate an information-rich environment of training oppor-tunities (from institutional or private sources) and in-formation sources that address specific businessproblems as well as networks of specialized consul-tants. Learning mechanisms that could contribute tosuch an environment include government and devel-opment agencies, business associations, exporting,foreign consultants, and matching grant schemes.

Government and Development Agencies.Many countries have a network of institutions, oftensupported by the government or donor agencies, thatprovide training, technical information, recommenda-tions on consultants, and other means for firms to ob-tain information and assistance in finding and ab-sorbing new technologies. The institutions are fundedand managed in a variety of ways, but all seek to buildpartnerships with the private sector. Bhutan appearsto have few such institutions. Bhutanese firms couldbenefit, for example, from the voluntary services of re-tired executives from industrial countries, particularlyin obtaining management technologies and catalyz-ing other technology transfers.

Business Associations. By promoting informa-tion sharing among peers and helping form coopera-tive agreements between firms, business associa-tions can play a key role in helping small enterprisesidentify and obtain technology. Firms often need out-side help to overcome coordination problems andform cooperative agreements with competitors.Associations can also lobby the government to helpestablish institutions to promote technology transfer.In Bhutan business associations are at an early stage


of development, and information does not appear toflow between firms.

Exporting. Firms often learn about new technolo-gies in the process of exporting. To compete in exportmarkets, firms must undertake market research andwork closely with their buyers. Indeed, buyers willoften help their producers design products, improvequality, and ensure a consistent supply.

Foreign Consultants and Matching GrantSchemes. Consultants and equipment suppliers areanother important learning mechanism. But Bhutanhas few consultants with technical knowledge andvery few equipment suppliers with a permanent pres-ence. And bringing in consultants is usually prohibi-tively expensive for a small enterprise. Matching grantschemes, sponsored by donors, promote technologytransfer by sharing the cost with firms (box 3.1). All ofBhutan’s main trading partners have implementedsuch schemes or are doing so.

Financial Sector Issues

In Bhutan, as in many developing countries, the im-mature financial system adds to the cost of doingbusiness and hampers investment. While the banks’high liquidity positions show that they are efficient inmobilizing savings, the survey results suggest thatthey are less successful in transforming these fundsinto productive loans. Firms cited finance as theirfourth biggest business problem. Most complaintscentered on the high cost of borrowing and the pooraccess to credit, which restrict investment and forcecompanies to rely on internal funds to finance mostnew investments.

Thus while Bhutan has made important strides in developing its financial system, the system still falls far short of what the private sector needs to be-come internationally competitive. The financial sys-tem’s weaknesses will become an even more impor-tant constraint as the private sector grows andespecially as foreign investors enter Bhutan and local

Funded by such organizations as the European Union andthe World Bank, matching grant schemes are a commonway of helping firms obtain international technology at asubsidized cost. (The subsidies exclude the cost of hard-ware.) The schemes center on a technology fund, usuallymanaged by an international contractor that is typicallyselected through an international tender. The contractorreports to a steering committee that generally representsboth government and the private sector. The schemesmay last three to five years.

Firms (or groups of firms) that want to obtain technol-ogy submit a project proposal detailing the technology, itsprovider, and the cost of acquiring the technology. Firmsusually also have to show how the project fits into theirbusiness plan. In assessing a project, contractors should

ensure that the firm would not have undertaken it withoutthe fund and that the project will lead to spillovers in thewider economy, such as other firms copying the firm re-ceiving assistance. Once a project is completed, the firmrecoups part of the cost (typically 50 percent) from thefund.

The contractor running a matching grant scheme maybe required to hire staff familiar with the sector (or sectors)being assisted, to advise firms on business planning,technology sources, and project implementation. Activi-ties eligible for support could include training, marketing,product design, production assistance, management de-velopment, development of business associations, andsearches for joint venture partners.

Box 3.1 Matching Grant Schemes to Aid Technology Transfer


firms attempt to break into world markets. Encour-aging competition and innovation would help improvethe cost and efficiency of banking services. The re-sults of the financial sector study funded by the AsianDevelopment Bank—and the role of the RoyalMonetary Authority—will both be important in helpingto create more effective financial markets in Bhutan.

High Borrowing CostsHigh nominal and real interest rates were a major con-cern cited by firms. Most lending rates fall in the rangeof 13–16 percent. With consumer prices increasing3–6 percent annually in the past two to three years,that implies real interest rates of 7–10 percent.Moreover, lending rates have changed little duringmost of the past decade.

The banks justify the high interest rates by point-ing to their high liquidity position, which has left alarge share of bank funds underutilized, increasing in-terest rate spreads and the upper limits on lendingrates. High interest rates are also blamed on the rela-tively large share of nonperforming assets in the bank-ing system (interviews suggest that it is around 15percent), which has further increased banking costs.The Royal Monetary Authority now allows banks to re-deposit large excess fund balances with banks inIndia, and banks hold 30–40 percent of their assets inthese nearly risk-free foreign deposits, earning rea-sonable rates of return and reducing the non-income-earning assets on their balance sheets. Developingprofitable alternative outlets for commercial bankingfunds will help narrow spreads and reduce the highfees on banking transactions. But providing risk-freeforms of investment in India also reduces banks’ in-centives to find ways to increase private sector lend-ing in Bhutan.

Many bank customers believe that the Royal Mone-tary Authority determines interest rates for the commer-cial banks; in fact, it deregulated interest rates sometime ago. Publicizing the fact that banks are free to de-

termine their own lending rates and that customers arefree to negotiate rates might help inject some much-needed competition into the banking system.

Anecdotal evidence suggests that Bhutanesebanks set interest rates based on the borrower’s sec-tor rather than its risk profile—a common practice inunderdeveloped banking systems—though hard evi-dence of this was difficult to obtain. Training bankcredit officers to properly assess risk is an importantstep in moving banks away from using simplistic andless relevant criteria in determining interest rates—and in moving toward market-determined rates.

Besides being high, interest rates are also ex-tremely inflexible, varying little with changes in eco-nomic circumstances. This lack of market orientation isdriven by the banking system’s lack of competition aswell as its lack of innovation and creativity. Increasingcompetition for depositor funds and lending opportu-nities is likely to be the best way to promote innovation,creativity, and market orientation. In small, underdevel-oped banking systems the most effective competitionoften comes from nonbank sources—such as leas-ing companies, insurance companies, venture capital,and private debt instruments.

High Collateral RequirementsCollateral requirements, which remain high despitebanks’ claims to the contrary, add to the cost of funds(table 3.7). In interviews, banks stated that as a gen-eral rule they demand that project finance be securedby property worth only 33 percent of the value of theloan—and that they accept machinery and otherequipment purchased by the loan as security. But in-terviews with firms revealed that they face consider-ably higher collateral requirements and that banksoften do not accept machinery as collateral. Morethan half the outstanding commercial bank loans ofthe sampled firms required more than 100 percentcollateral; for loans from the development lenders, theaverage collateral required was 116 percent.


Poor Access to CreditDespite the banking system’s high liquidity, the surveyresults show that access to credit is a major problem.Almost 43 percent of firms reported being credit con-strained—that is, wanting to borrow more at currentinterest rates (table 3.8). Close to 30 percent of firmshad neither short-term nor long-term bank credit, and8 percent had been rejected for a bank loan. Morethan a quarter of the firms had never bothered toapply for a loan, most because they did not needcredit or did not believe that they would receive aloan.4 Firms reported dealing with a median of onlytwo banks, and 40 percent of the sample used onlyone bank or none at all—further evidence of a shallowfinancial system.

Companies in the service sector were more likelythan manufacturing companies to be credit con-strained, and fewer had bank credit. This differencemay arise because service companies generally havefewer physical assets to pledge for collateral—or be-cause lenders are less comfortable in assessing therisks of such service providers as tour operators,transport firms, and computer training schools.

BhutanFull

Access to credit Manufacturing Services sample Nepal

Credit constrained 40 46.5 42.5 32

No bank credit 25 33.3 28.5 26

Never applied for a loan 25 29 26.5 20

Rejected for a loan 9 5.5 7.5 5

More than two banks 11 7.5 9.5 —

— Not available.Source: World Bank private sector survey, Bhutan, 2001; the World BankRegional Program on Enterprise Development survey of manufacturing firms,Nepal, 1999.

Table 3.8 Firms’ Access to Credit, Bhutan and Nepal(percentage of firms surveyed)

Collateral asCountry and a share ofsource of credit Interest rate loan value

Bhutan

Banks

Mean 13.4 86

Median 13.0 100

Development institutionsa

Mean 13.7 116

Median 13.5 150

Overdrafts

Mean 14.4 n.a.

Median 15.0 n.a.

Nepal

All souurces (mean) 14.3 190

n.a. Not applicable.a. Bhutan Development Finance Corporation and RoyalInsurance Corporation of Bhutan.Source: World Bank private sector survey, Bhutan, 2001;World Bank Regional Program on Enterprise Developmentsurvey of manufacturing firms, Nepal, 1999.

Table 3.7 Interest Rates and CollateralRatios, Bhutan and Nepal(percent)


Weak Information and EnforcementBanks attribute their reluctance to lend to two factors.The first is lack of information and of mechanisms tocollect information, which makes it difficult to identifyprofitable projects in a risky environment. Most firmsdo not keep accurate, transparent financial accounts(see the section in this chapter on auditing and ac-counting issues), and Bhutan has no credit ratingagencies or other institutions providing information onborrowers. Bhutan’s small, thin market, where fewfirms are diversified, is particularly vulnerable toshocks, and predicting earnings is difficult. Moreover,because banks lack both information and well-trainedloan officers, they are unable to adequately monitorthe use of borrowed funds.

The second factor is inability to enforce contracts.The legal code is improving rapidly and many newlaws have been passed, but financial institutions stillfind it difficult to enforce agreements or seize collat-eral. While the laws may be adequate, they are notenforced. Banks reported, for example, that passingchecks with insufficient funds is a violation of the crim-inal code, but no one has ever tried to enforce the law.As a result, even government agencies are reluctantto take checks.

Courts are extremely slow and inefficient, andseizing the assets of borrowers who default is almostimpossible unless the property is directly attached tothe loan. Thus all banks demand high collateral,specifically tied to a loan, so that it can be seized tooffset the cost of long court proceedings. That thecourts are considered a very inefficient way to resolvedisputes is evidenced by the fact that only around 5percent of firms in the survey reported hiring a lawyeror threatening to take a client to court for nonpayment(table 3.9).

Improving and streamlining the legal systemwould help improve access to capital and probablyalso lower its cost. It would also facilitate trade by en-couraging firms to extend more trade credit.

Low Efficiency and High FeesThe payments system and other banking services arerelatively costly and inefficient, leading firms to con-duct a large share of business on a cash basis. Thatraises the cost of doing business for all sectors butparticularly for tourism and for firms attempting to ex-port to markets beyond India.

The payments system and check clearance are ex-traordinarily slow, discouraging firms from acceptingchecks or other noncash forms of payment. One studysuggests that clearance can take as long as 19 daysbetween Paro and Thimphu.5 Moreover, banks chargemyriad fees that add to the cost of using banks and theformal financial system. One bank levies a fee of 0.25percent to move money from Thimphu to its branch inPhuentsholing, and the transaction can take severaldays. In most countries such a service is free.

As the private sector grows—and especially asforeign investors come to Bhutan and exports in-crease—the inefficiency of the payments system andbanking services will become a severe obstacle todoing business.

Lack of Innovative Financial InstrumentsAs noted, the banking system provides few innovativelending instruments. The survey team came acrossonly one example of factoring services, in which theRoyal Insurance Corporation of Bhutan providedloans to a private entity based on work orders. But this

Indicator Value

Share of firms reporting nonpayment in the previous year (percent) 31

Average cases of nonpayment per firm 10.4

Share of firms hiring lawyers (percent) 6.0

Share of firms going to court (percent) 5.3


Table 3.9 Bhutanese Firms’ Experience withNonpayment and Enforcement


practice did not appear to be common. Other ser-vices that are missing include leasing finance, privatedebt markets, electronic banking, automated tellermachines, venture capital (or risk capital) for startupenterprises, and even credit or debit card facilities.

Leasing. A potentially powerful yet relatively sim-ple financial service that is increasingly offered in thedeveloping world, leasing has several important ad-vantages for small and medium-size enterprises.Most important, the leased equipment (such as avehicle or machinery) belongs to the finance com-pany throughout the lease period, so repossession inthe case of nonpayment is simple and requires nolong legal process. Indeed, the leased equipmentusually forms the collateral for the transaction, doingaway with the need for the “borrower” to providelarge amounts of security. These two advantages are particularly powerful in environments such asBhutan’s.

Bhutan’s private sector could benefit in otherways from private leasing companies. In many coun-tries leasing companies have provided not only im-portant new financial instruments but also effectivecompetition for commercial banks. Thus it would beuseful for the Royal Monetary Authority to examine thepossibility of establishing private leasing companiesin Bhutan.

Private Debt Markets and IntercompanyBorrowings. Another potentially effective way toincrease competition for banks is to develop privatedebt markets, allowing companies with sound finan-cials to issue their own debt in the domestic market.Like a government debt market, a private debt marketprovides funding directly to an enterprise withoutchanneling funds through the banking system.Commercial banks receive fewer deposits as a result(reducing excess liquidity). And because the interme-diation mechanism squeezes interest margins moreeffectively than intermediation through a commercial

bank, savers benefit through higher rates while bor-rowers benefit through lower ones.

The main concern in developing new private debtmarkets is that issuers must be of sufficiently goodstanding and in sufficiently good financial conditionthat the risk is acceptable. This is particularly impor-tant where investors will be unfamiliar, at least initially,with properly assessing the risks and rewards of in-vesting in these new instruments. In Bhutan, with itsfew large, good-name firms, the market for such is-sues is bound to be small (though the demand couldwell be high). Nonetheless, the potential benefits forboth investors and borrowers suggest that the RoyalMonetary Authority should seriously examine the pos-sibility of developing such markets in Bhutan.

Other ConcernsFour other issues relating to the financial sectoremerged from the survey as concerns for the privatesector.

Inversion of Interest Rates on TermLending. Virtually all enterprises surveyed re-ported that interest rates on short-term lending ex-ceeded those on long-term lending. This contrastswith the situation in most countries, where rates aregenerally higher on long-term lending because it isconsidered to have higher risk. It would be useful forthe Royal Monetary Authority and the Asian Devel-opment Bank to examine why rates are inverted inBhutan.

High Charges on Credit Card Transactions.Where credit card payments are possible in Bhutan,the charges on the transactions tend to be extremelyhigh (7–8 percent for some hotels). These high chargeshave the greatest effect on the tourism industry, sincevisitors from Europe, Japan, and North America usemainly credit cards rather than cash or traveler’schecks. Making credit card facilities more accessiblethroughout Bhutan, and finding ways to reduce their


costs, could improve the efficiency of payment mecha-nisms in the country, with particular benefits for tourismand related industries such as handicrafts.

Inefficient Debt-Equity Mix. Many Bhutanesecompanies lack the skills to determine the most ap-propriate mix of debt and equity in their business op-erations. While some undertook no borrowing, appar-ently because of an aversion to debt rather than aninability to borrow, others significantly overleveragedthemselves to banks and were experiencing financialproblems as a result. Better training in securing thebest mix of finance would benefit many entrepreneurs.

Royal Monetary Authority as Scapegoat.On several issues the Royal Monetary Authority ap-pears to have become the scapegoat for the actionsof other parties. As noted, there is a general misper-ception in the private sector that it is the RoyalMonetary Authority that sets interest rates, not thebanks. Another misperception is that it is the RoyalMonetary Authority, not the Ministry of Finance, that isstopping the use of hard currency to purchase raw

materials for goods to be exported to “non–hard cur-rency” India. Thus it might be useful for the centralbank to explain, in these cases and any others, whatits role is relative to the commercial banks and theMinistry of Finance.

Effect of Borrowing Constraints onInvestmentInvestment is low in the Bhutanese private sector.More than a quarter of the firms surveyed made no in-vestments in 1999–2001, though service firms weremore likely to invest than manufacturing firms were(table 3.10). The median ratio of equipment invest-ment to capital was 0.05, higher than the ratio inNepal and some other developing countries but lowby international standards. And at 5 percent, the in-vestment rate still falls well short of the 10 percent av-erage depreciation rate found in many developingcountries. This suggests that most companies arerunning down their capital stock faster than they arereplacing it. The average age of machinery was 6–10years in the manufacturing sector, though it was only1–5 years in the service sector. But these averages

Bhutan, 1999–2001Full Nepal,

Manufacturing Services sample 1999a

Share of firms investing(percent) 71 78 74 NA

Average capacity utilization (percent) 60 50 58.3 58

Average age of machinery (years) 6–10 1–5 6–10 NA

Median ratio of investment to capitalb 0.05 0.21 0.09 0.014

— Not available.a. Data refer to manufacturing firms.b. For Bhutan this is the ratio of investment in 2000 to the value of capital stock.Source: World Bank private sector survey, Bhutan, 2001

Table 3.10 Firms Investing in Recent Periods, Bhutan and Nepal


mask wide variation. In almost 44 percent of manu-facturing firms equipment was more than 11 years oldon average. Clearly, Bhutanese industry needs to in-crease investment if is to improve its productivity andcompetitiveness.

The low level of investment has many causes.Firms pointed mainly to the perceived lack of de-mand. With firms utilizing only 58 percent of capacityon average, they see little reason to expand. But firmsstill need to invest to improve their productivity andcompetitiveness, and the high cost and poor avail-ability of finance make this difficult.

Firms finance most new investment from internalfunds, such as retained earnings, loans from friendsand relatives, and personal savings (table 3.11). Thisputs companies in a doubly difficult position: Theymust delay investments until they have accumulatedsufficient internal capital to cover the costs. But astheir equipment ages, maintaining competitivenessbecomes more difficult, which in turn makes raisingsales and building up capital more difficult.

On average, banks financed less than 27 percentof the sample firms’ most recent equipment invest-ment.6 But this share still exceeds that in Nepal,where a similar World Bank survey found that

banks funded less than 20 percent of equipmentinvestment.

Land Issues

Though land is not always easy to obtain in Bhutan,access to land did not emerge as a major issue in thesurvey. The government has established industrialestates in Phuentsholing, Thimphu, Galephu, andSamdrup Jongkha. The best developed is the one at Phuentsholing, with 58 acres of fully serviced sites created in 1979. With 25 establishments, thePhuentsholing site is fully occupied. The governmentwould like to construct additional sites in thePhuentsholing area close to the Indian border. TheThimphu industrial site is under construction 26 kilo-meters outside the city center. Known as the Jeminaindustrial estate, the site now hosts two firms (onemanufacturing hollow blocks, the other handmadepaper). Thimphu has additional serviced land for in-dustrial development in the Changzamtog ServiceCenter, established for service industries. The gov-ernment is trying to relocate some of these industriesfarther outside Thimphu.

FullSource of financing Manufacturing Services sample

Retained earnings 49 37 44

Personal savings 16 23 19

Loans from relatives 4 4 4

Bank loans 24 24 24

Bank overdrafts 1 6 3

Equity 0 0 0

Other 6 6 6


Table 3.11 Average Share of Financing fromDifferent Sources for Most Recent Investment by Bhutanese Firms(percent)


To facilitate industrial development and overcomeconstraints of space and infrastructure during theNinth Five-Year Plan, the government has identifiedand approved five industrial sites:

• Singhi Gaon for the southwestern region, a newsite 16 kilometers west of Phuentsholing on 267surveyed acres.

• Chuwabari for the south-central region, a 300-acresite 15 kilometers from Geylegphug

• Samdrup Jongkhar for the southeastern region, a31-acre site near Samdrup Jongkhar

• Bodima for the northeastern region, a site 22 kilo-meters from Mongar.

• Tingtibi for the central region, 21 kilometers fromZhemgang on the central highway.

Traditionally the rates charged at industrial estateshave been very low, providing an effective subsidy forindustrial investors but often with an eye to directingindustry away from preferred sites close to borderareas in the south. This policy was motivated by thedifficulty of controlling the use of nonnational workersin the border areas and a desire to diversify employ-ment opportunities. Recently, however, policy appearsto be changing, with the government now discussingthe possibility of developing industrial estates nearIndian border areas, particularly around Phuentshol-ing and Galephu.

Auditing, Accounting, and Taxation Issues

The tax laws of Bhutan require every private enter-prise to prepare annual accounts and every regis-tered company to produce externally audited financialstatements, mainly to ensure that proper tax assess-ments can be made. Despite this legal requirement,Bhutan has an extremely weak accounting and audit-

ing tradition. Many companies keep no accounts.Others keep two sets—one for the tax authorities andthe other for management.

Weaknesses in Auditing and AccountingThe lack of transparent accounts and the poor ac-counting standards impede private sector growth intwo important ways. The lack of good informationmakes evaluating a company’s financial strength diffi-cult and therefore discourages lending and investing.Even more important, firms are not using accountingas a management tool to improve their competitive-ness—it is difficult to lower costs or to be cost effec-tive if you don’t know what your costs are.

Many of the companies surveyed do not maintainbooks of accounts as required by the tax laws.Indeed, companies tend to see accounting as a nec-essary evil to be undertaken for the tax authoritiesrather than as a management tool. As a result, thevery purpose of accounting and internal control—pro-viding managers with information so that they canmake decisions—goes largely unrecognized.

Firms appear to do very little day-to-day collectionof accounting information, instead keeping mostvouchers and receipts until the end of the year whenthe accounts are compiled for the tax authorities.Many firms do not maintain stock registers and fixedasset registers, and as a result cannot monitor the ma-terials they use. Firms do not always keep books ofprimary records and general and party ledgers in ac-cordance with accounting standards, making it diffi-cult to obtain information on the acquisition and loca-tion of fixed assets. And most do not prepare periodictrial balances, profit and loss accounts, or balancesheet information.

Much better accounting systems need to be de-veloped over time in the private sector, supported bywell-qualified accountants and auditors (box 3.2).Greater emphasis on internal auditing functions willhelp firms develop better financial control. And estab-


lishing better financial records, information, and con-trol will help firms control their costs and obtain fi-nancing as well as aid the tax authorities. Theseadvances will require gradually expanding the “audit-ing net” to encompass more—and, by necessity,smaller—firms.

To support these goals, the government needs todevote more resources to developing auditing andaccounting skills; the National Technical TrainingAuthority has made a good start by establishing train-ing courses in accounting. Standardizing accountinginformation will also need to be emphasized.

Concerns in TaxationTo fill the gaps in company accounts, RevenueDepartment staff conduct audits in most enterprisesevery two or three years (though the frequency ofaudits appears to vary widely). Many of these audits lead to a demand for additional tax paymentsbecause firms are often confused about what con-stitutes an allowable expense. Areas of confusioninclude:

• The limits on write-offs of staff expenses (tax de-ductions for salary payments had been limited toNu 20,000 a month but were recently increased to Nu 60,000).

• The ad hoc arrangements for write-offs of trainingexpenses.

• The limit on write-offs of sales promotion and ad-vertising expenses to 2 percent of profits.

• The limits on write-offs of substantial repairs thatdo not create new assets.

The limits on tax allowances and inflexible or adhoc application of rules by the tax authorities canhave a perverse effect on the development of the pri-vate sector by discouraging such desirable actionsas hiring skilled workers or training staff. The rules ontax deductible expenses need to be reviewed to en-sure that they are reasonably liberal (within prudentfiscal constraints). They also need to be made trans-parent and easily applicable.

Other measures would also help improve the effi-ciency of taxation:

The following actions could help improve accounting andauditing in Bhutan and encourage the use of formalaccounting systems as a management tool in privatecompanies.

• Improve accounting skills and standards. To help im-prove standards, licensed accountants could be re-quired to attach a responsibility statement to financialstatements verifying that they have been prepared inaccordance with the firm’s books and vouchers andwith accepted accounting principles. Also importantis providing proper training to Bhutanese students inaccountancy and computers.

• Develop auditing skills. Bhutan lacks well-trainedauditing professionals and instead must rely onIndian chartered accountants. To fill this skills gap,

young Bhutanese accountants with good skillsshould be sent to India or elsewhere to obtain audit-ing qualifications.

• Improve quantitative information. Private firms’ ac-counts should incorporate quantitative information onsales, purchases, production, and stocks so that thefinancial statements can be verified and relied on.This requires maintaining stock books.

• Install modern systems. Modern systems of internalauditing and cost accounting, missing in much of theprivate sector, should be installed to improve the ac-curacy and efficiency of these functions.

• Establish fixed asset registers. Businesses shouldmaintain registers of fixed assets, lacking in most pri-vate companies, to help in determining the location,user, and age of their fixed assets.

Box 3.2 Recommended Actions for Improving Auditing and Accounting


• Limit cash transactions. The large cash transac-tions that take place result in unrecorded dealingsand underreporting of income. Suitable legislationshould be put in place to disallow cash transac-tions over a certain threshold.

• Assess taxes annually. Performing tax assess-ments annually, rather than every three or fouryears as is now done, would increase the objec-tivity of assessments and help private firms betterplan their yearly tax liabilities.

• Introduce appropriate tax treatment of assetrevaluations. Gains from asset revaluation aretaxed at normal rates even though this exerciseleads to no cash accruals. This discourages firmsfrom revaluing assets. However in potential jointventures with foreigners more accurate valuationof fixed assets will be important in determining theequity contribution of Bhutanese partners. Moreappropriate tax treatment of revalued assets isalso important for insurance purposes.

• Allow expenses for substantial repairs and reno-vations. Substantial repairs and renovations areconsidered capital expenditures and not treatedas allowable expenses for tax purposes. This taxtreatment discourages proper asset mainte-nance. Tax authorities should allow such ex-penses in the year in which they are incurred oras a deferred revenue expenditure to be amor-tized over time.

• Reimburse tax deductions at source quickly. Tohelp improve the cash flow positions of loss-making firms, tax authorities should give priority tosuch companies in reimbursing tax deductions atsource.

• Revise limits on tax deductible expenses. To elim-inate the adverse effects of current limits on de-ductible expenses for sales promotion, advertis-ing, training, entertainment, and salaries, taxprovisions on these expenses should be revisedand made more transparent and automatic.

• Enter into double taxation agreements. Bhutanshould consider establishing double taxationagreements with neighboring countries to encour-age cross border investment

Infrastructure Issues

In Bhutan, in stark contrast to most developing coun-tries, infrastructure is generally not perceived to be an important constraint. The survey results show thatpower supply is regular in most urban centers and in-dustrial sites, with relatively few outages or brownoutscompared with neighboring countries.7 (In more re-mote and rural areas, particularly in the east, however,electricity supply is understood to be a significantissue.) Water supply is also reasonably reliable in theareas surveyed. And telecommunications, waste dis-posal, and postal services are perceived to be oper-ating well. Transport is the only exception to the gen-erally positive perception of infrastructure.

These results attest to the government’s consider-able efforts to support the development of infrastruc-ture. Still, continuous improvements will need to bemade to support the growing and increasingly de-manding private sector.

Costly and Unreliable TransportBoth air and road transport received considerablecomplaints from the firms surveyed. More than 33 per-cent of the firms cited transport services as theirbiggest infrastructure problem (power was next, withless than 21 percent). Air and road transport facilitiesare expensive and unreliable, significantly reducingBhutan’s cost competitiveness. The costs are so highthat in some industries they completely offset the ad-vantage of abundant natural resources.

Road Transport. Firms complained less aboutroad transport than about air transport. This differ-


ence can be attributed in large part to the fact thatwhile the roads are in relatively poor condition, theyare much better today than in the recent past. Indeed,the government undertook major investments in roadsduring recent plan periods and has given roads evengreater priority in the Ninth Five-Year Plan.

Nonetheless, depending on where firms are lo-cated, the road network can make a great differencein their ability to compete. Firms that are competitivein the border areas (because, for example, they ex-port to India) might not be competitive in the center ofthe country. Most enterprises import raw materialsfrom India, send finished products to that country, orboth. As a result, the road network creates a big costdisadvantage for producing goods anywhere exceptalong the border. During the monsoon season land-slides disrupt business and make it difficult to main-tain external markets. In August 2000, for example,landslides cut Thimphu off from Phuentsholing forthree weeks.

The country’s physical characteristics pose sucha constraint on road transport that Bhutan faces achoice between investing heavily in roads and focus-ing the development of transport-dependent indus-tries solely in the border areas. Choosing the secondoption would mean that only niche industries relyinglittle on transport could be profitably developed in thecenter of the country.

Air Transport. Druk Air and the efficiency of ParoInternational Airport were big targets of criticism.Companies expressed concern about the unreliabilityof the airline, the high cost of air transport services,the effects of weather on the ability to fly in and out of the airport, the constraints imposed by the airfieldon the type of aircraft that Druk Air can use, and thelack of reliable air cargo facilities, particularly fromBangkok. These limitations affect many aspects of pri-vate sector activity—from the ability of foreign touriststo enter Bhutan to the ability of companies to ship rawmaterials and finished products in and out of the

country in a timely way. The high-cost, unreliable airtransport is among the main obstacles to penetratingmarkets beyond India and developing service indus-tries (such as information technology) and niche ex-port markets (such as fresh mushrooms).

The authorities are well aware of the Paro airport’slimitations, the restrictions on the types of aircraft thatcan be used in Bhutan, and the uncertainties theseproblems create for transporting goods and people.They are considering several alternative airport sites.One option for developing an international airport haslong been Galephu, though the unrest in the Indianborder state of Assam has recently led to considera-tion of other, less desirable alternatives. Until the air-port facilities can be improved, efforts to upgrade ser-vice at the existing airport will be critical.

Upgrading existing facilities or introducing alter-natives are long-term solutions, however. The growingnumber of unemployed school-leavers means that thedevelopment of the private sector cannot wait for anew airport to be built or even for the road network tobe upgraded. In the short to medium term, while in-dustries relying heavily on transport are likely to beprofitably developed only along the border with India,the development plan for the center of Bhutan willprobably need to focus on niche-type industries withless need for cheap, reliable transport.

But this does not mean that other options shouldbe neglected. Indeed, Bhutan’s difficult physical ter-rain calls for “thinking outside the box.” The Ministry ofTransport could review all possible alternatives—suchas using private charter airlines from India and Nepalto bring tourists into Bhutan and developing helicop-ter services to ferry goods and passengers into andaround Bhutan.

Favorable Electricity PricesCheap, reliable electricity is among Bhutan’s biggestcompetitive advantages over other countries in SouthAsia. Indeed, several firms, including Bhutan Carbideand Chemicals and Bhutan Ferro Alloys, were estab-


lished in Bhutan because of this advantage. Elec-tricity prices in Bhutan are less than half those of itsclosest competitor in South Asia and only a fifth of theprices in other important locations in the region (table3.12).

Electricity prices in Bhutan are subsidized: thepurchase price from the Chhukha Hydro PowerCorporation is Nu 0.3 per kilowatt-hour (productioncosts are around Nu 0.25), the transmission and dis-tribution costs are around Nu 1.0 per kilowatt-hour,but the urban sales price is only Nu 0.8 (the rural priceis Nu 0.5) In 2002, however, the government intendsto establish the Bhutan Power Corporation, a com-mercial entity responsible for transmission and distri-bution. The entity’s commercial orientation means thatthe price subsidy for electricity will disappear overtime. Although Bhutan’s electricity prices will still re-main well below regional levels, the loss of the sub-

sidy will reduce the profitability of power-intensive in-dustries in Bhutan.

Regulatory Environment

One of Bhutan’s most important competitive advan-tages is its good governance and the friendly busi-ness environment that this creates. The government isgenuinely concerned with proper administration, andofficials are seen as being honest and helpful. Thisbusiness environment stands in stark contrast to thatin some of Bhutan’s neighbors, where business ishandicapped by corruption, labor unrest, bureau-cratic burdens, and political instability. Bhutan’s goodbusiness environment and political stability should beattractive to investors, particularly foreign investors,seeking to serve South Asian markets.

But Bhutan has reached a critical point where itcould easily lose this advantage. Many important gov-ernment decisions have been made case by case—such decisions as issuing a business license, deter-mining allowable tax deductions, issuing permits forforeign workers, and approving applications for for-eign direct investment. And laws and regulations havenot been clearly publicized or consistently imple-mented. While this system has served Bhutan reason-ably well, it will become a growing obstacle as theeconomy expands. The discretion that the system al-lows could open the door to corruption and certainlyto the appearance of favoritism.

To guard against the corruption and bureaucraticburden that impose such high costs on business in itsclosest neighbors, Bhutan must take steps to improvetransparency and implement laws openly and consis-tently. The survey reveals that most managers nowsee the government as a benign helping hand, in con-trast to the perspective in other South Asian countries.That could well change unless the system becomessubstantially more transparent. Several issues will be key.

Price perkilowatt-hour

Country (U.S. cents)

Bhutan 1.7

Bangladesh 6.1

India

Assam 7.6

Bihar 5.6

Delhi 7.7

Gujarat 9.1

Maharashtra 4.2

Uttar Pradesh 8.8

West Bengal 7.2

Nepal 8.2

Pakistan 6.2

Sri Lanka 6.1

Source: For India, Annual Report on the State ElectricityBoards; for other countries, World Bank.

Table 3.12 Electricity Prices for IndustrialCustomers in Selected South AsianCountries


Fairness and TransparencyMany businesspeople talked about “relationship deal-ing”—being able to get the right approval, the properagreements, and a quick government signoff be-cause of knowing “the right person.” For the most partthis approach to getting things done reflects the smallsize of the Bhutanese economy and indeed Bhu-tanese society, not corruption. But there is a thin linebetween relationship dealing and what could becomecorrupt practices. Developing a fair and transparentpolicy environment is therefore critical in avoiding badpractices in the future.

Policy ConsistencyA related issue is consistency in government policy—both consistency across different players in a sectorand consistency over time. The survey providesample evidence that different players are treated dif-ferently. Some companies had little difficulty obtainingwork permits or access to land, while others in thesame line of business did have difficulties. There wasalso evidence of inconsistency over time. Some firmscomplained that abrupt changes in government pol-icy on labor, taxation, licensing, and the export ofwood products disrupted their plans and hinderedtheir growth.

Some of these complaints are simply sour grapes.Still, it is important that the government strive to en-sure as much policy consistency as is possible.Investors and entrepreneurs must deal with greatuncertainty from world markets, the weather, andother factors beyond their control. By adding to theirrisk, government policy inconsistency will reduceinvestment.

The survey results suggest a need for greater ef-forts by the government to be open and consistent.Asked to rate the predictability of government on ascale of 1 (completely predictable) to 5 (completelyunpredictable), more than 26 percent of managersgave the government a 4 or 5 rating. And more than55 percent said that they expected the government to

change regulations that are important to their busi-ness without taking into account their company’sviews (table 3.13).

Access to Clear and Concise PolicyInformationTo reinforce the fact that the regulatory environmentwithin which firms operate is consistent, informationneeds to be written down and made easily available.One way to disseminate such information is to creategovernment Web sites. That could produce dual ben-efits—providing information to private sector playerswhile increasing the public and private sector’s use ofinformation technology as a tool for doing business.

Publishing precise policy guidelines on employ-ing nonnationals, writing off training expenses, andthe like would do much to close some of the apparentinformation gaps. One area of particular confusionappears to be the government’s policy on licensingnew businesses in the south, particularly in Phuent-sholing. Most companies spoke of being unable to li-cense new businesses, while others spoke of long de-lays. But some understood that the government wasreversing its policy, with a view to encouraging newbusiness activities in the south. Clearly, the policy onthis issue needs clarification.

Share ofsample

(percent)

Firms rating the government as unpredictable (4 or 5 rating) 26.3

Firms expecting regulatory changes that will not not take into account their views 55.8

Firms viewing the government as anopponent 17.0


Table 3.13 Bhutanese Firms’ Ratings of the Government


Trade Regime

Two main concerns relating to the trade regimeemerged from the survey. The first is the movement ofmost countries to lower tariffs within the framework ofthe World Trade Organization, with trade liberalizationin India a particular worry. The second concern is thelack of export incentives given to Bhutanese firms.

Trade Liberalization in IndiaThere is growing concern among some exportingbusinesses about the gradual move toward lower tar-iffs in India and the effect it will have on the ability tobenefit from Bhutan’s preferential access to theIndian market. Removing tariff and nontariff barriersin India is likely to take time. But some companies are already complaining about Chinese produc-ers “dumping” cheap goods in India as tariffs fall.India’s dominant role in Bhutan’s trade means thatBhutanese companies will be forced to become morecost efficient and competitive. In 1999 Bhutan re-ceived around three-quarters of its imports from Indiaand directed around 95 percent of its exports to thatcountry (table 3.14).

India’s trade liberalization is something over whichBhutan has little control. But rather than see thischange as a threat, the private sector should see it asa challenge—an opportunity to become internation-

ally competitive and gain access to markets beyondIndia. To meet that challenge, the private sector willhave to focus increasingly on areas of comparativeadvantage, while the government should seek to en-sure that business costs are not increased by unnec-essary interventions.

Lack of Export IncentivesIn contrast to most governments in South Asia and in-deed around the world, the Bhutanese governmentoffers no incentives to exporting firms, possibly be-cause of the historically low export trade. (Electricityexports have recently taken off, but all this trade isconducted through government-to-government dealswith India, so no incentives are needed.) Exportingfirms complained that the lack of incentives puts themat a disadvantage relative to competitors in countriesthat do offer incentives.

The most important disadvantage is the lack ofduty exemption or duty drawback on imported rawmaterials for use in export production. Most importedraw materials originate from India and are subject toIndian excise duties. Under the trade agreement be-tween the two countries, these duties are refunded tothe government of Bhutan. But they are not refundedin turn to the Bhutanese firms producing for export.

Financial incentives for exporting companies, inconjunction with other policy changes (relating to for-

Imports from India Exports from IndiaTotal Trade

Total Share Total Share trade balanceYear imports Value (percent) exports Value (percent) balance with India

1996 4,525.19 2,896.16 64.0 3,553.77 3,226.98 90.8 –971.42 330.82

1997 4,977.94 3,453.59 69.4 4,274.18 4,041.94 94.6 –703.76 588.35

1998 5,516.37 3,620.94 65.6 4,455.62 4,175.64 93.7 –1,060.75 554.70

1999 7,834.88 5,845.28 74.6 4,987.96 4,711.23 94.5 –2,846.92 –1,134.05

Source: Bhutan Ministry of Trade and Industry.

Table 3.14 Bhutan’s Trade with India and the Rest of the World, 1996–99


eign direct investment, for example), could provideimportant support to the growth of export industries inBhutan. The Committee for Private Sector Develop-ment is considering a package of incentives that in-cludes tax exemptions and tax holidays. The costs of such incentives, however, should be carefullyweighed against their likely benefits. And serious con-sideration should be given to including duty ex-emption on imported raw materials for use in the pro-duction of exports. The government should alsoencourage banks to provide both pre- and postship-ment finance in support of export activities.

Establishing dry port facilities in Phuentsholingcould also assist exporting industries. The governmentis examining this option, which would allow goodsdestined for Bhutan to be consigned directly thererather than through the port of Calcutta. Though thisoption needs to be further investigated, it could ad-dress the concerns of some firms that customs clear-ance charges are inflated by the mandatory use ofBhutanese customs clearing agents in Calcutta.

Another measure that could encourage thegrowth of exports to India is easing the restriction onthe use of hard currency to import raw materials forproducing goods destined for India (exporters gainautomatic access to a hard currency only if they haveearned it through exporting, which a company ori-ented toward the Indian market is unlikely to do). Thisrestriction needs to be reviewed for three reasons:The demand for such funding is likely to be relativelysmall. Bhutan has large foreign exchange reserves.And barriers to entry in the Indian market, which iswell known and the easiest to penetrate, could under-mine the ability of new entrepreneurs to grow intomore difficult and less familiar export markets.

Institutional Issues

Several important institutional issues also emergedfrom the survey.

Government Dominance of the EconomyThe government has historically been the dominanteconomic force in Bhutan and is likely to continue tobe for the foreseeable future. As a result, the privatesector depends heavily on government tenders andgovernment activity for its markets.8 This is particu-larly true for construction, one of the fastest-growingprivate sector activities. But relying on the govern-ment is not a sustainable strategy. Government de-mand can support only a limited private sector, andgovernment contracts can divert firms from seekingways to become internationally competitive. The gov-ernment’s importance in the economy is likely to de-cline only slowly. But it is important that the privatesector be permitted to play a growing role, with pri-vate-to-private relationships replacing private-to-public relationships as the dominant model.

The government deserves great credit for estab-lishing the visionary development path that Bhutan isnow pursuing. But its relationship with the private sec-tor appears to have an element of paternalism, re-flected in a “we know better than them” attitude or asense that the government is less corrupt than the pri-vate sector. While these sentiments may be true, theyare likely to impede rather than support private sectoractivity. Indeed, the government has been trying tostep back from involvement in the private sector andto provide space for private firms to operate—its pri-vatization and corporatization plans are but one im-portant example. But to ensure that the private sectorhas enough space to grow and flourish, the govern-ment may need to accept a slightly lower level of ser-vice (at least initially) and accelerate the withdrawal ofownership and control.

One possible way to support a better understand-ing in the public sector of the constraints faced by theprivate sector is to set up internship-type programsfor employees of key ministries and public corpora-tions (industry, finance, banking), with participantsworking for two to three years in private companiesinside or outside Bhutan. This experience not only


should help improve the understanding of privatesector constraints but also might encourage youngerpublic servants to leave the public sector for produc-tive careers in the private sector. An alternative wouldbe to create “reverse internships,” with successful pri-vate businessmen—most of whom came out of thepublic sector—returning to the public sector forshorter periods, to provide a greater voice for privatesector concerns in public policymaking.

Need for a Stronger Private Sector VoiceGroups lobbying in support of the private sector’s in-terests can play a vital part in its development—byensuring that the private sector has a voice in identi-fying critical needs and designing policy. The lack ofexport incentives, inattention to training, and pro-posed labor law are all issues that could be ad-dressed by a strong private sector representative.Most important, a strong private sector voice isneeded to help ensure continued good governance,promote consistency and transparency in policy im-plementation, and ensure that, as Bhutan grows, bu-reaucracy does not become the crippling burden thatit has in other developing countries.

The Bhutan Chamber of Commerce and Industryand associated sector associations (such as theWood Association thus have a key role to play. Butseveral survey participants alleged that the chamberis not proactive enough in pursuing the private sec-tor’s goals or in lobbying for its interests. Some alsobelieve that the chamber supports commercial andtrading interests more than industrial interests—andpursues the concerns of the business community inThimphu more than those of the business communityelsewhere. Indeed, the chamber held only two meet-ings in Phuentsholing in the two years before the sur-vey, even though Phuentsholing is Bhutan’s secondbiggest city and its largest industrial base.

The government was instrumental in establishingthe Bhutan Chamber of Commerce and Industry andhas done much to support its development; a mem-

ber of the chamber sits in the National Assembly.Thus the onus of strengthening representation liessquarely with the chamber and its private sectormembers. Possible ways to strengthen the chamberinclude increasing its interaction with other chambersof commerce in the region and recruiting an externalprivate sector representative to work with the cham-ber for several years. Such alternatives need to be ac-tively pursued if the Bhutan Chamber of Commerceand Industry is to fulfill its potential as a successfullobbyist for private sector interests.

Need for Central Coordination of PrivateSector IssuesA common problem for governments in dealing withprivate sector issues is that they lack a designatedministry or unit for this task, largely because privatesector activity is so multifaceted. While the BhutanMinistry of Trade and Industry comes closest to beingthe designated government body for dealing with theprivate sector, its mandate does not cover all the is-sues affecting the sector. Indeed, a range of public in-stitutions deal with private sector issues—includingthe Ministries of Finance, Education, Agriculture, HomeAffairs, Trade and Industry, and Transport andCommunications as well as state corporations such asElectricity, Druk Air, Posts, and Telecommunications.(Many firms expressed much gratitude for the whole-hearted support of the Ministry of Trade and Industry,but had concerns about dealing with other parts of thegovernment.)

This complexity calls for a central coordinatingbody that addresses all the needs of the private sec-tor. The Higher-Level Committee on PrivateSector Development has been an important steptoward such an entity. But this committee, composedof busy, high-ranking government officials, cannot beexpected to devote the time and resources needed toaddress many of the detailed concerns of the privatesector. Establishing an interministerial working groupto support this committee in coordinating the work of


government entities on private sector issues is thushighly desirable.

Benchmarking the Business Environment

The private sector survey shows that many basicproblems in the business environment are perceivedto be less severe in Bhutan than they are in otherSouth Asian countries. Part of the reason might be areluctance of Bhutanese managers to criticize thegovernment. Nonetheless, private firms in Bhutanclearly perceive government as more supportive thando firms in most other countries. Comparative findingsfrom the World Business Environment Survey, con-ducted by the World Bank in 1999–2000, provide abenchmark for the survey results in Bhutan. While thequestions asked in the two surveys were not exactlythe same, some categories are comparable.

Bhutanese firms participating in the World Bus-iness Environment Survey saw their country’s busi-ness environment as more transparent and more sup-portive of industry than did firms in other countries inSouth Asia (table 3.15). Only 17 percent of firms in theBhutanese sample rated laws and regulations asmoderately or highly unpredictable, compared with56 percent of firms in all of South Asia. Indeed,Bhutan fares better on this measure than any region inthe survey. Performing next best are the newly indus-trialized countries of East Asia, and even here almost30 percent of the sample rated laws as unpredictable.Similarly, while less than 20 percent of the Bhutanesesample perceived the government as unhelpful, 39percent of firms in all of South Asia did.

These are only perceptions, of course, and mak-ing cross-country comparisons is difficult becausedifferent countries have different frames of reference.What might be perceived as a negligible problem in

Share rating Share ratinglaws and national

regulations governmentRegion unpredictablea unhelpfulb

Africa 74 33

Middle East and North Africa 52 13

East Asia

Newly industrialized countries and China 29 11

Developing countries 59 14

South Asia 56 39

Bhutan 17 17

a. Firms responding with a 5 or 6 (with 1 indicating fully agree and 6 fully disagree) tothis question: To what degree do you agree with the statement, Interpretations of reg-ulations affecting my firm are consistent and predictable?b. Firms rating the government a 4 or 5 on a scale of 1 (very helpful) to 5 (neverhelpful).Source: World Bank, World Business Environment Survey, 1999–2000.

Table 3.15 Firms Perceiving Laws as Unpredictable and Government as Unhelpful, Selected Regions(percent)


one country might be considered a serious burden ina country with a better business environment.Nonetheless, such comparisons give some indica-tions of regional and country differences. The com-parison here plainly shows that Bhutan’s businessenvironment is seen as relatively supportive andtransparent. Even so, managers expressed concernabout the need for the government to become moresystematic in its approach to the private sector toavoid corruption in the future (see the section in thischapter on the regulatory environment)—and the poorratings in the rest of South Asia suggest the dangersthat Bhutan could face.

The positive perception of government amongmost firms in Bhutan is reflected in the ratings given toregulation. For all categories of regulation, a smallershare of firms reported significant problems in Bhutanthan in all of South Asia—where firms have the worstperception of regulation—or any other region (table3.16). The lack of regulatory interference in Bhutan,

which enhances its competitiveness and helps inspireconfidence among investors, is something that thegovernment should strive to maintain.

Bhutan also performs well on the provision of pub-lic services. For all categories, a smaller share of firmsrated government services as a moderate or majorconstraint in Bhutan than in South Asia as a whole(table 3.17). Bhutan’s ratings are more in line withthose in East Asian developing countries. As ex-pected, roads were the most likely service to be citedas a constraint by firms in Bhutan, followed by waterand power.

Alternative Development Tracks

The clear difference between the opportunities andbusiness environment in the border areas and thosein the center of Bhutan call for different approaches todevelopment. In the southern border region—with a

Customs Foreign TaxAnd exchange administration

Business trade or and HighRegion registration regulation Labor currency Environment regulation taxes

Africa 26 49 38 36 22 59 76

Middle East andNorth Africa 26 44 33 26 24 51 54

East Asia

Newly industrializedcountries and China 22 20 27 18 17 21 39

Developing countries 28 36 35 35 29 55 74

South Asia 39 57 61 39 44 52 72

Bhutan 17 17 21 15 10 10 9

Note: Data show the percentage of firms giving each area of regulation a 3 or 4 rating on a scale of 1 (very good)to 6 (very poor).Source: World Bank, World Business Environment Survey, 1999–2000.

Table 3.16 Firms Perceiving Regulation as a Moderate or Major Constraint, Selected Regions(percentage of firms)


large pool of inexpensive labor and better access toraw materials and markets for final products—it ismore feasible to develop industries that make inten-sive use of labor and raw materials. Firms could takefull advantage of Bhutan’s inexpensive power to de-velop heavier industries.

In central Bhutan, where labor costs are appre-ciably higher and expensive transport (both inward,for raw materials, and outward, for finished products)significantly raises the cost of producing for any butthe local market, a more feasible development strat-egy would focus on services to support labor-inten-sive industry in the south and on niche industries.Industrial development on the border will create de-mand for support services—for management, ac-counting, maintenance, information technology ser-vices, and the like. Service jobs typically demandhigher skill levels than most manufacturing jobs butalso provide higher value added per worker and thushigher wages. However, developing a service sectorthat provides a large source of well-paid employmentwill require significant investment in human resources.

The central region also has the potential to de-velop niche industries that do not require large inputsof raw materials (particularly from outside Bhutan)and do not produce heavy finished products thatincur high transport costs in export. Niche industriesshould build as much as possible on the country’sagroprocessing base—such as wasabi, medicinalherbs, and shiitake mushrooms. For niche industriesto succeed, quality production will be critical. Thus ifBhutan is to break into such niche markets, it is im-perative that it establish quality standards and con-sistent production. Bhutan could build on advantagesthat provide a marketing niche, particularly by obtain-ing certification for its organic status and for its sus-tainably managed forests. Efforts to obtain such certi-fications should be undertaken quickly.

Nontraditional niche industries could gradually in-clude those based on handicrafts and informationtechnology as well as other industries not heavily de-pendent on transport or low-cost labor. One excellentexample of a nontraditional niche activity is an exportbusiness producing fishing flies (box 3.3). This busi-

Public works PostalRegion Customs and roads service Telephone Power Water Police

Africa 38 53 32 35 39 43 57

Middle East and North Africa 14 20 7 5 9 14 14

East Asia

Newly industrialized countries

and China 8 14 7 7 8 9 12

Developing countries 32 41 9 15 19 25 37

South Asia 40 59 22 25 45 39 49

Bhutan 15 40 9 8 23 30 18

Note: Data show the percentage of firms giving each service a 4, 5, or 6 rating on a scale of 1 (very good) to 6(very poor).Source: World Bank, World Business Environment Survey, 1999–2000.

Table 3.17 Firms Perceiving the Quality of Public Services as a Moderate or MajorConstraint, Selected Regions(percentage of firms)


ness is based on an association with a foreign busi-nessman, employs a large number of women who ap-pear to have a natural aptitude for producing high-quality flies, and produces a lightweight product thatcan be easily exported at low cost. But as anotherpossible niche business illustrates, developing non-traditional export markets involves big challenges(box 3.4).

In both central and southern Bhutan the develop-ment of industries based on locally available, high-quality raw materials should also be encouraged.Examples include tourism, wood-based industries,and mining opportunities throughout the country.Wood-based industries as well as agroprocessing,however, will continue to be affected by the high costsof transport to bring both raw materials and finishedproducts to market.

Privatization

As the Bhutanese government gradually extracts it-self from the productive sectors of the economy andincreasingly focuses on the social sectors and otherswhere the market fails to provide the servicesneeded, the private sector will be able to play alarger and more dominant role. The government hasmade good progress in privatization over the pastdecade, selling shares in several important corpora-tions to the private sector and corporatizing somestate-owned enterprises. It will be important to con-tinue—and possibly accelerate—this process duringthe Ninth Five-Year Plan, preferably within a more pre-cise and transparent structure. This could includeselling the government’s remaining minority stake-holdings in some companies and beginning the pri-

The Bhutanese owner of Yangphel Handicrafts initially de-veloped the idea of producing fishing flies—a nontradi-tional product for Bhutan—through an association with anAmerican partner from Montana who had been trying todevelop fly-fishing tourism in Bhutan. The American part-ner expressed interest in developing an export businessbased on producing flies—considered an ideal businessbecause the product was lightweight, could be handmadein Bhutan, and could be easily exported by air to foreignmarkets. To get the business launched, two American ex-perts came to Bhutan in 1989 to work with and train 12Bhutanese workers. The workers—most of them women—appear to be particularly adept at producing high-qualityflies.

The business faces competition from China andSoutheast Asia as well as Africa and Latin America. Withworkers in Bhutan paid relatively high wages, it cannotcompete on price but it does appear to have a quality ad-vantage. A worker in the Bhutanese factory can produce120–200 simple flies or 12–20 complicated ones a day.

Retail prices in the United States and the United Kingdom,the two main export markets, range between $1.50 and$3.50 for each fly. The company employs mainly women(of its 50 employees, only 10 are men) and pays workerson a piece-rate basis, which seems to suit women withchildren particularly well.

The company’s main obstacle has been the lack ofduty concessions on raw material imports: the duties andBhutan’s business sales tax together amount to 30 per-cent. These duties have reduced the company’s pricecompetitiveness. Problems with Druk Air also threaten itscompetitiveness, since production turnaround needs tobe quick (while it takes three days to get raw material fromthe United States or the United Kingdom to Bangkok, ittakes one month on average to get this material fromBangkok to Paro). The government’s decision to grant thecompany exemptions on import duties and the businesssales tax since July 2001 has made a big difference.

Source: Firm interview.

Box 3.3 Yangphel Handicrafts—a Nontraditional Niche Business


vatization of additional companies and corporations.Also important is to seek strategic partners to takeover purely productive activities and to investigategreater private sector involvement in areas tradition-ally operated by the public sector, such as health andeducation.

Notes

1. Government of Bhutan, Rules and Regulations onEmployment of Bhutanese Nationals in the PrivateSector (Thimphu, December 1997).

2. As a result of large spillover effects from firm-leveltraining, the net social benefits exceed the privatebenefits captured by firms. That leads to subopti-mal investment and thus a need for the govern-ment to provide some support. The spillovers in-clude trained workers taking their skills to otherfirms, training by one firm providing a demonstra-tion effect to others, firms providing training tosuppliers and customers, and benefits to cus-tomers that result when firm training raises thequality of products.

3. Tyler Biggs, Manju Shah, and Pradeep Srivastiva,Technological Capabilities and Learning in

A Bhutanese company hand-producing traditional in-cense using a closely guarded Tibetan formula illustratesthe problems facing potential exporters of niche products.This enterprise is an established one with a product wellknown in the local market. And there should be strong de-mand for handmade incense in the high-end export mar-ket in the West given the growing Buddhist population andthe popularity of all things Eastern. But without a greatdeal of assistance, this small enterprise is unlikely to beable to access that market.

The owner has no contacts abroad and no idea ofhow to find buyers. Indeed, finding buyers from Bhutan isnearly impossible, even in the days of the Internet andgood telephones. Unlike India and other developing coun-tries, Bhutan has no large expatriate community that couldprovide potential contacts overseas. And almost no buy-ers travel to Bhutan because of the cost and the lack ofpossible producers. Moreover, the owner knows nothing ofthe foreign market and would not know how to package ordesign his product. For that information he would have torely on buyers. But attracting buyers for a poorly designedor packaged product is difficult.

If the owner were to receive an order, the local pack-aging technology would be inadequate, and importing

packaging on such a small scale would be expensive.Because of the unreliable transport system, the companywould be unable to guarantee delivery dates, and thetransport of raw materials within Bhutan could be delayed.

The biggest problem after finding a buyer would be toobtain financing to support manufacturing and shipment.Even if the company had an order in hand, the poor infor-mation systems and enforcement mechanisms in Bhutanmake it unlikely that any lending institution would be will-ing to incur the administrative costs or take the risk of pro-viding a small working capital loan, even with substantialsecurity. And foreign buyers would be unlikely to take therisk of making prepayments to finance production be-cause of the communication difficulties and the inefficientlegal system.

Thus while there is almost certainly a market for nicheproducts such as incense, the small Bhutanese manufac-turers are not positioned to enter them. Better travel facili-ties, matching grant schemes that subsidize technologytransfer, less restriction of foreign direct investment (in-cluding foreign partners), and new financial instrumentsand greater competition in the financial sector would allhelp small producers take advantage of Bhutan’s uniquecultural and natural resources.

Box 3.4 The Challenges of Developing Niche Markets


African Enterprises, World Bank Technical Paper288 (Washington, D.C., 1995).

4. When firms say that they do not need credit, it isdifficult to disentangle their lack of desire for creditfrom the effect of the high cost. Although firmswere asked whether it was a matter of not wantingcredit or of credit being too expensive, many man-agers said that they did not want credit when theymeant that they did not want credit at the currentcost and collateral requirements. Many entrepre-neurs said that they could afford to borrow but didnot believe in taking on debt. But this responsecan be seen as a reflection of the immaturity ofboth the financial system and the private sector.Entrepreneurs fear taking on debt or lack knowl-edge about how to manage it.

5. World Bank, “Financial Sector Vision ConceptNote” (Washington, D.C., 2000).

6. The study focuses on investment in equipmentbecause it accounts for the vast majority of recentinvestment expenditures. Investment in buildingswas insignificant.

7. Survey responses show a difference in the relia-bility of power supply between Phuentsholing (onthe border) and Thimphu (in the center). Firms inPhuentsholing reported losing power five times amonth on average, while those in Thimphu re-ported losing it less than once a month. Almost athird of firms in Phuentsholing had backup gener-ators, compared with only 17 percent in Thimphu.

8. Some firms that rely on government tenders com-plained that the government places too much em-phasis on price over quality—and that this em-phasis tends to adversely affect Bhutaneseproducers while benefiting Indian producers. Thegovernment, however, refutes this claim.

4. Agroprocessing 54




Potential 66



Present Situation

Agriculture is an important sector in the Bhutaneseeconomy, with 79 percent of the population depend-ing on some form of agricultural production for theirlivelihood. Although its contribution to GDP has fallenin recent years, agriculture still remains the largestsector. In 1999 it was estimated at 35 percent ofGDP—17 percent from agriculture, 10 percent fromforestry, and 8 percent from livestock. In 2000 agro-based industries employed 2,536 people and had aturnover of less than $4 million, with output accountingfor 2.8 percent of the total in manufacturing.

Agricultural land, about 7.7 percent of the totalland area, consists of small landholdings that are frag-mented and scattered over difficult terrain. Manyfarming communities exist in isolation, often severaldays’ walk from the nearest road head. Land in themain river valleys commands a high price.

The agricultural system in Bhutan has traditionallybeen subsistence based, and in many parts of thecountry that is still the case. Many farmers are unableto participate in the market economy because theyhave no surplus or are cut off from markets by poortransport. Lack of access to markets is the main rea-son that farmers are reluctant to produce a crop sur-plus beyond that required for barter trade. In some re-gions, however, farmers have adopted cash crops.

Developing Bhutan’s agricultural production basemust be a priority for developing the agroprocessingsector. The government’s self-sufficiency program,under the Ninth Five-Year Plan, calls for giving equalpriority to all important cereal crops. But land could beused for cash crops, with the earnings from exportsused to buy rice from cheaper producers.

Bhutan produces about 60 percent of its annualfood requirements. Because most food is consumedfresh, processing opportunities are limited, and farmsare isolated, only about 3 percent of output isprocessed for commercial purposes (mainly fruit and

vegetables). The opportunities for on-farm processingwill increase as rural infrastructure, packaging, trans-port, and processing capacities improve (many ofthese issues are addressed in the Ninth Five-YearPlan). And while commercial food processing is virtu-ally absent today, given the right environment, agro-processing industries could have good potential forgrowth, mainly through exports of high-value, low-volume products.

Industry StructureBhutan produces a narrow range of fresh produceand an even narrower range of processed foods (seeappendix 3 and table 4.1). In 2000 fruit processingcontributed more than 90 percent of turnover and em-ployment in the sector (excluding alcoholic bever-ages). But the category that has grown fastest in thepast five years is bakery, expanding by 16 percent ayear.

The relatively unorganized agroprocessing sectoris dominated by small firms, none of which are foreignowned: 104 cottage and small-scale enterprises andonly 3 large-scale enterprises. Agroprocessing enter-prises in developing countries are typically micro orsmall scale.

Bakery. Bhutan’s fledgling bakery sector consistsof four to five firms whose scale is akin to the small,retail-level bakeries found in more developed parts ofAsia. Despite their relatively small size, these compa-nies are successful. They produce cakes and pastriesfor affluent consumers, and biscuits for mass con-sumption. Domestic producers have a market share of 70 percent, while the balance is imported, mainlyfrom India as well as some from Thailand andBangladesh. The bakery industry is characterized byhealthy margins and roots in urban markets and by a reputation for quality and reliability that drivesgrowth. The bakery sector in India is a $3 billion a yearindustry.


Vegetable Oil. Production capacity in the localvegetable oil sector (mainly mustard seed oil) hasshrunk in recent years. Firms have closed mainlybecause of an inability to compete with cheaperimported products from India (about 5 percentcheaper) and shifting crop production patterns.Technology is at a low level. Raw materials comemainly from India, supplemented by a small share (20percent) of mustard seed from local sources. Butprocuring raw materials locally depends on subsis-tence farmers generating surpluses, and there hasbeen little effort to initiate contract farming or to pro-mote oilseeds as a cash crop. Brand loyalty is weak,and products are sold as a commodity. Annual do-mestic consumption of fats and oils amounts to about5,000 metric tons (including 1,800 metric tons ofmustard seed oil, of which 330 metric tons is pro-duced locally).

Consumer Foods. Surprisingly, the production ofconsumer foods, even traditional items, is small. Mostleast developed and developing countries have many

small establishments producing traditional consumerproducts—in East Asia, usually noodles or confec-tionery, and in South Asia, packaged atta (wheat flour,a $4 billion industry in India) or confectionery (a $2 bil-lion industry in India).

Fruit and Vegetable Processing. Bhutaneseproduction of all forms of agricultural produce (grains,fruits, vegetables) amounts to 177,000 metric tons ayear, with fruit accounting for 39,000 metric tons andvegetables for 32,000. (Grains account for about106,000 metric tons.) Bhutan’s neighbor India is theworld’s third largest producer of fruits, after Brazil andthe United States, and the largest producer of vegeta-bles. The main fruit crops grown in Bhutan (mango,citrus, and apple) are similar to those produced inIndia. Bhutan has a small fruit and vegetable pro-cessing industry (three firms), which, like its Indiancounterpart, produces fruit pulps, pickles, chutneys,canned fruits and vegetables, concentrated pulps,juices, and dehydrated vegetables. The Bhutanesecompanies have a turnover of about $3 million, while

Category Products Production in Bhutan

Bakery Bread, biscuits, cake Four to five small, retail-level bakery outlets in Thimphu

Consumer food Confectionery, soft drinks, Little production; a few cottage and small processing units makingready-to-eat products, noodles noodles.

Grain and oilseed Rice and wheat milling, edible Limited number of small, village-level rice and wheat mills. In oil extraction Phuentsholing, a small wheat mill with a capacity of 65 metric

tons a month; total wheat mill capacity in Bhutan is about 620 metric tons a month. Also in Phuentsholing, one small mustard oil extraction plant with a capacity of 330 metric tons a year.

Dairy products Milk, cheese, butter and ghee, Staple products produced in villages. One modern dairy processor yogurt, milk powder in Phuentsholing, with a capacity of 250 metric tons a year.

Meat and poultry Meat cuts, processed products Mostly informal sector activity. One small poultry processor in products Thimphu.

Others Tea, coffee, spices, alcoholic Informal drying of spices but no processing plant. One distillery beverages in southern Bhutan.

Table 4.1 Early Entrants in Agroprocessing Categories Typical in Developing Countries


their Indian counterparts have a turnover of $900 mil-lion (excluding canned products).

Dairy Products. Dairy products form the base ofthe Bhutanese diet. Locally, about 27,000 metric tonsof milk is produced annually, of which 15 percent is di-rectly consumed. The rest is converted into cheese(1,442 metric tons) and butter (1,316 metric tons). Inaddition, Thimphu imports milk powder (877 metrictons a year), butter (199 metric tons), cheese (72 met-ric tons), and yogurt (20 metric tons) from India. InPhuentsholing a small dairy processor (with a capac-ity of 700 liters a day) produces pasteurized milk anddairy products, mainly for Thimphu, obtaining freshmilk from India. The dairy industry in India is valued at$11.5 billion a year.

Meat and Poultry Products. Most of the popu-lation consumes meat or poultry products, and meatconsumption is growing by an estimated 10 percent ayear. But in Buddhist culture there is a strong religiousand cultural revulsion toward the slaughter of animalsthat in many communities also extends to the rearingof livestock for slaughter. Bhutan has only a smallmeat and poultry industry. It produces 1,700 metrictons of meat annually, supplemented by 234 metrictons from India and a small amount of processed meatproducts that is also imported. Most locally producedmeat is of poor quality. Only about 1 percent of themeat is converted into value added products, andmost meat is purchased by consumers in rural areas.Bhutan has only one poultry processor. By compari-son, meat and poultry in India is a $10 billion industry.

Other Products. Bhutan has a small traditionalmedicine sector and produces essential oils at thecommunity level, mainly lemongrass oil. In addition,one of the main agroprocessing companies is a dis-tillery that reconstitutes whiskey concentrate and pro-duces a range of liquors, including brandy, its mainexport product.

MarketsAs noted, the food products consumed in Bhutan aremainly from local sources, supplemented by importsfrom India and some from Bangladesh and Thailand.Imports are increasing as urban populations grow andfood preferences change to higher-value processedproducts. One exception is bakery, which takes ad-vantage of the perishability of the products and chang-ing consumer tastes.

Bhutan’s three main food processors sell morethan 65 percent of their production to India, a smallamount to Bangladesh, and the balance locally. Bycontrast, smaller units restrict their sales to the localmarket. Of the firms surveyed, only two reported ex-porting to countries outside the free trade zone withIndia.

Bhutan also exports a range of fruit and vegetableproducts, in a fresh or chilled state, mainly to Indiaand Bangladesh. Trade in fresh produce is modest(Nu 225 million in fruit and Nu 230 million in vegeta-bles and spices), as is that in processed products (Nu103 million in juice, Nu 99 million in processed fruitand vegetables, Nu 80.3 million in rum, and Nu 37 mil-lion in jams).

To put the industry in perspective, world agricul-tural and food trade amounted to $464 billion in 1996.Processed foods constituted the fastest-growing partof this trade. Expanding at twice the rate of primaryproducts, processed foods grew from 50 percent ofglobal agricultural trade in 1985 to some 75 percent in2000.

Government PolicySeveral aspects of government policy create a favor-able environment for the agroprocessing sector, justas for other manufacturing sectors. These include theimport-export regime and the stable exchange ratewith India. Moreover, the steps taken to introduceproduct quality standards—drafting food safety regu-lations and establishing the quality control and regu-latory service units in the Ministry of Agriculture—are


important in moving the industry toward internationalnorms in this area.

Labor and EmploymentThe agroprocessing firms surveyed were generallymodest in size, with more than half employing only5–15 people (table 4.2). The largest employed 364.

In the Phuentsholing-Samtse area, except for theArmy Welfare Project, firms rely on Indian day workersfor 90 percent of their workforce. Firms hire Indiansbecause of their skills and experience, their better at-tendance, and their lower wage rates. In Thimphu

Indian workers make up only 1–2 percent of the work-force and are employed as regular staff.

Most firms identified labor costs as an impedi-ment to their survival. Companies employing Indianworkers generally view Bhutanese workers as unreli-able, too expensive, and lacking the necessary tech-nical skills and experience. Thus the risks associatedwith training are thought to be too high to warrantmuch investment. But many of the problems identi-fied by firms may be of their own making; the com-panies relying on Indian workers tend to be charac-terized by poor working conditions and little sense ofownership. In contrast, the few companies employingBhutanese workers and providing a reasonable work-ing environment appear to be rewarded by employeeloyalty.

Reliance on Indian workers was most apparent forfirms operating at or near a loss. Given the apparentinefficiencies in their operation, these firms are un-likely to survive if they pay the higher rates demandedby Bhutanese workers. Yet firms also face little incen-tive to automate.

None of the firms interviewed volunteered viewsabout the productivity of labor, and none recognized aneed for training. No firm articulated the links betweenthe cost of labor, labor productivity, and internationalcompetitiveness. Firms that ranked cost of labor as a significant obstacle to competitiveness may reallyhave been pointing to low labor productivity, which re-sults at least in part from poor management skills, lowlevels of training, and inappropriate technology.

Costs and Competitiveness

Three main factors determine the competitiveness ofthe processed food sector:

• At the front of the value chain, the cost, availabil-ity, and reliability of raw materials delivered to theprocessors.

Share of firmsCharacteristic (percent)

Employees

Less than 6 8

6–99 70

100–200 15

More than 200 8

Annual turnover (millions of ngultrum)

Less than 5 40

5–10 25

10–100 15

100–200 15

More than 200 8

Share of raw materialsimported (percent)

Less than 50 8

50–95 15

95–100 78

Capacity utilization (percent)

Less than 50 30

50–75 45

More than 75 25


Table 4.2 Agroprocessing Firms in theSurvey, by Characteristics


• Along the value chain, the relative efficiency withwhich value is added—in financing, manufac-turing, packaging, branding, marketing, anddistribution.

• The business environment.

Lack of Price Competitiveness for RawMaterial InputsThe agroprocessing industry in Bhutan has severalcompetitive advantages relating to local raw materials:

• The ability to produce a wide range of producebecause of the huge variety of microclimates, in-cluding high-altitude zones (alpine), central val-leys (temperate), and low-lying foothills of theHimalayas (subtropical).

• Organic farming, which is practiced by default be-cause the country has not developed the pest in-festations endemic in the rest of the region andhas never used agricultural chemicals in largeamounts.

• An extension service that is experienced in intro-ducing new high-value crops.

But while the country could produce many high-value primary products, it lacks mechanisms for real-izing this potential. Processors need to work with farm-ers to progressively identify and exploit opportunities.

Unfortunately, Bhutan’s agroprocessing industryrelies on low-value markets, where the raw materials

produced in Bhutan confer no appreciable cost ad-vantage.1 And the sector lacks appropriate manage-ment or marketing strategies that might compensatefor the lack of cost advantage. While benchmarkingthe price of raw materials used in the sector was be-yond the scope of the survey, respondents provideduseful information, as do some existing studies (table4.3).

All the agroprocessing companies surveyed citedthe high cost of raw materials as a significant impedi-ment to profitable operation. Local products have highfarm-gate prices and incur high transport costs fromfarm to factory, made worse by the high incidence ofdamage and loss. Farm-gate prices average 35–300percent more than those in India, transport can addanother Nu 0.7–1.0 per kilogram (over distances of upto 200 kilometers), and losses can be as high as 40percent. For companies located away from the borderareas, products from India also incur high transportcosts and are subject to taxes (see chapter 3).

The relatively high farm-gate prices for Bhutaneseraw materials reflect low yields, low farmer productiv-ity, and poor land use (farmland is only 45–50 percentutilized). Evidence shows that given the right stimulus,productivity gains could be considerable and shouldtranslate into lower raw material prices and higher on-farm income.

Comparative data on worker productivity in agri-culture suggest much room for improvement. Valueadded per agricultural worker in Bhutan is $148 a

Raw material Competitiveness

Dairy Bhutanese costs are high because of high transport costs when raw milk is purchased from India. Local milkcosts are high because cow yields are low and herds fragmented.

Chicken meat Bhutanese costs are high because feed must be purchased from India and transported to Thimphu.

Horticulture Bhutan is considered a high-cost producer.

Grain Bhutan is considered a high-cost producer.

Source: World Bank private sector survey, Bhutan, 2001; various studies.

Table 4.3 Price Competitiveness of Agricultural Raw Materials, Bhutan


year, compared with $407 in Cambodia, $526 in theLao People’s Democratic Republic, an average of$567 in low-income countries, and an average of$18,918 in high-income countries.2

The most widely used indicator of crop productiv-ity, production per unit of land (or crop yield), is alsolow in Bhutan. Yields of basic food commodities (ce-reals, oil crops, and roots and tubers) are 30–50 per-cent lower in Bhutan than in other least developedcountries, where yields average less than half theaverage for all developing countries.3 Here againthere appears to be potential for substantial gains inproductivity.

The conclusion: If local raw materials are notcheaper than imports, the development of a local agro-processing industry able to export to price-sensitivemarkets such as India will be unlikely.

Lack of Competitiveness in Adding ValueValue adding activities in Bhutan—including manufac-turing, packaging, branding, marketing, and distribu-tion—may not be competitive for a number of reasons(see table 4.4 for a summary).

Marketing. A key issue in marketing is whetherBhutan should seek to compete on price or value.Bhutan will have difficulty competing in processedfoods in Asia and India as these markets rapidly ma-ture, because of the difficult challenges for Bhutaneseprocessors in developing scale, modern processingand management systems, and brand awareness—allcritical factors. Realistically, Bhutan can only be aniche player in Asia. Niche markets are often lucrative,but Bhutan lacks the world-class management, pro-cessing structures, research and development (R&D),and product or process innovation needed to com-pete in niche markets. None of the firms interviewedinvest in R&D, for example. In contrast, more than 80percent of Australian agroprocessing firms do—yetAustralia still struggles to compete in niche markets

because of its lack of innovation. ExacerbatingBhutan’s problems, all the firms source their technol-ogy conservatively, preferring to buy from India.Indian technology is often outdated and cannot becalibrated or optimized, making it difficult for proces-sors to produce a quality product.

Another key issue is the need for innovative mar-keting. Bhutan’s main export market is under increas-ing pressure as Indian producers learn how to in-crease quality and lower costs in response to foreigncompanies and imports. Despite awareness of the ad-vantages of Bhutanese agricultural products, neithercompanies nor government officials articulated a strat-egy for developing innovative export marketing. Firmsexporting to India or other countries do so in a con-ventional and conservative manner, often relying onestablished or chance contacts. Because Bhutaneseproducts are not clearly differentiated, they struggle formargins in the markets where they are sold. Expandingexports will require devoting resources to communi-cating the nutritional and other advantages of Bhu-tanese food products to potential customers.

Human Resources. Firms reported weak capa-bilities in exporting and, in several cases, even in sus-taining market positions. The wide range of firms in-terviewed generally had outdated or at best mediocreprocessing technology, lacked vision, and showed noability to battle the poor prospects for survival char-acterizing much of the agroprocessing sector. Manyof these weaknesses relate to the firms’ human re-sources, motivation, training, and outlook.

Bhutan lacks a cadre of talented managers withworld-class business experience and perspectivesand with entrepreneurial skills and abilities in innova-tion. Skills are poor at all levels, and firms are unableor unwilling to invest in training to rectify this situation.The sector will not improve unless it addresses short-comings in general management and technical andmarketing skills.


Capacity Utilization and Scale of Operations.Three-quarters of the firms surveyed reported utiliza-tion rates of less than 75 percent; the rest were work-ing near full capacity.4 The reasons cited for the lowcapacity utilization include seasonality and logisticalissues with the supply of raw materials and a lack ofmarket resulting from poor price competitiveness.Difficulties in obtaining raw materials and the cost oftransport can seriously undermine firms’ ability to op-erate efficiently (box 4.1).

Without exception, processing plants were toosmall to compete with Indian units. Being small can bean advantage, sometimes allowing a firm to succeed

in niche markets too small to attract the attention oflarger companies. But this is not yet the case inBhutan.

Packaging. Most of the firms interviewed wereconcerned about the cost and other problems asso-ciated with packaging and the effects of these is-sues on their competitiveness. An ideal packag-ing for many of Bhutan’s food products would beTetra Pak. But Tetra Pak systems, in their smallestconfiguration, deliver several thousand units aminute—a much greater capacity than that neededtoday.

Link in the value chain Critical factors Competitiveness

Raw material Price, quallity, length of Produce delivered to factories has no price advantage and the quality(delivered to factory) supply season, reliability is often low because of the lack of a grading system. The harvest sea-

of supply son could be extended by vertical cropping, but this has not hap-pened. Supply to factories is unreliable.

Manufacturing Technology, labor, None of the firms has a competitive advantage. Technology is old and utilization rates, inefficient, labor productivity is low, capacity utilization is poor, and innovation processes lack innovation.

Packaging Costs, quality, design Uncompetitive processors rely on imported raw materials from India. Recycled bottles are used, which are not appropriate for many mar-kets. The production scale is too low to use alternative packaging suchas Tetra Pak.

Branding Recognition, support Bhutanese food products have a good reputation for quality in India, but this has not been built into a brand. Establishing and building in-ternational (or regional) brands is beyond the resources of most Bhutanese companies.

Freight Price, time for delivery, Firms in the interior are at a disadvantage. Firms on the border havedamage less problem unless they require a refrigerated container. The time to

market generally reduces shelf life. There is a high incidence of prod-uct spoilage and damage.

Marketing Innovation, investment No competitive advantage. Firms need to learn the requirements of their target markets and how to take advantage of this knowledge.

Financing Cost of debt, availability No competitive advantage.

Research and For small-scale firms There is no culture of research and development in agroprocessing.development hands-on development

most appropriate.

Table 4.4 Can Bhutan Compete in Agroprocessing?


The Bhutanese food processing industry is toosmall to support a thriving local packaging industry.Yet without one the industry will face extra costs andother constraints to its growth. Efforts are also neededto ensure that packaging is acceptable to the buyer.The bottle top used in Bhutan is not acceptable inThailand, for example, because it is difficult to confirman accurate seal.

Output per Worker. Output per worker, an im-portant measure of supply-side efficiency, is very lowin Bhutan. In Thimphu it is $9,147 a year, and inPhuentsholing $5,864. By contrast, in the Lao People’sDemocratic Republic it is $74,000.

A simple comparison suggests that Bhutanesefood processors are no more efficient than small-scaleIndian processors—and are disadvantaged by highraw material costs and logistical constraints. The laborproductivity of Bhutanese companies is therefore as-sumed to be similar to that of unregistered Indian foodprocessors, estimated at 9 percent of the level in the

United States (figure 4.1). The labor productivity ofregistered processors in India, with greater econ-omies of scale, is estimated at 16 percent of the U.S.level.

The supply and price of raw materials and the cost oftransport pose major challenges to the development of anagroprocessing sector in Bhutan. The effect of these chal-lenges can differ dramatically among firms, depending ontheir location. Consider these two fruit and vegetable firmsproducing nearly identical product ranges.

Company A, located in the interior of Bhutan, buysabout 43 percent of its raw materials from India and ex-ports most of its products. Since both inputs and outputsare transported to and from the Indian border, its transportcosts are comparatively high (about 6 percent of the ex-factory price). The firm also depends on raw materialsfrom local producers. The quality of the raw materials isusually poor, adding to the production costs. Moreover,local supply is inconsistent, and as a result the firm usu-ally runs at less than 75 percent capacity, based on a sin-gle shift. With such low capacity utilization, the company

is unable to take full advantage of mechanization, and itsproduction is relatively capital intensive. The firm has ex-perimented with schemes to promote contract farmingand believes some are slowly beginning to have an effect.

In contrast, company B, located on the Indian border,imports 98 percent of its raw materials from India andelsewhere and reports no problems with supply. Its trans-port costs are lower (3 percent of the ex-factory price)than company A’s. With a regular supply of raw material,the firm operates at near full capacity for two shifts a day.In the past the firm depended on cheap Indian labor, re-flected in the low mechanization and high labor intensity ofits operation (with output per worker 36 percent lower thanthat in company A), but it is now increasing its mecha-nization. The firm makes a profit every year.

Source: Firm interviews.

Box 4.1 The Importance of Location

0

20

40

60

80

100

120

Bhutan India Brazil Japan Australia UnitedStates

Figure 4.1 Labor Productivity inAgroprocessing, Selected Countries(index: United States = 100)


Cost Structure of the Industry. The cost struc-ture of the food processing industry varies widelywithin Bhutan. Processors in Thimphu face higher rawmaterial costs, for example, because of the largershare of local raw materials used or the cost of trans-porting imports from India (see box 4.1).

Labor costs vary by district, by the background ofthe worker, and by industry. Monthly pay averages$120 in Thimphu and $45.50 in the Phuentsholing-Samtse area, with much of the difference explained bythe predominance of Indian workers in Phuentsholing.But pay varies among firms. For example, the ArmyWelfare Project in Phuentsholing, which employs 90percent Bhutanese staff, pays its employees $153 amonth on average, more than the average in Thimphu.While labor costs account for 9 percent of the ex-factory price of products in Phuentsholing, they ac-count for 14.5 percent in Thimphu (these relativeshares are also influenced by the cheaper raw mate-rials in the border area of Phuentsholing).

Factors Critical for SuccessMany factors need to be present for agroprocessingfirms to be successful. Several factors important forfirms in all sectors are in place—the favorable import-export regime, the exchange rate, reliable and afford-able infrastructure services, and trade agreementswith other countries (these are covered elsewhere inthe report). For firms in agroprocessing, however, fiveadditional factors are critical for success:

• Availability of consistently high-quality raw materi-als. Firms need access to good-quality, graded rawmaterials that suit the needs of the market and theirprocessing lines and are available at market com-petitive prices. In Bhutan today, however, factoriesreceive surplus material that is generally of lowquality, has not been graded, and is high priced.And both supply and quality are inconsistent.

• Friendly policy toward manufacturers. Govern-ment policy needs to be sympathetic to the needs

of manufacturers and provide an environment inwhich the processors can develop and grow. Butnew agroprocessing enterprises in Bhutan facechanging policies, unfavorable tax treatment, andhigh cost structures.

• Product innovation. Firms need to transcend pricecompetition by developing differentiated productsthat do not need to compete on price. That re-quires investing in innovation, which must occurall along the value chain. Innovation can takemany forms—managing the supply chain, posi-tioning products in clever ways, and improvingprocesses, products, and packaging. Govern-ment support is critical in providing an enablingenvironment for such innovation.

• Access to appropriate technology and labor. Thetechnology in agroprocessing needs upgrading.Firms are prepared to invest if they have assur-ances that their land leases will not end before in-vestments in technology have paid off. They alsoneed guidance in sourcing competitive technol-ogy that will propel them ahead of the competition.In addition, the policy environment needs to beappropriate and consistent. And companies needskilled labor at predictable wage rates.

• Market-led production. Industry should be led bythe needs of the market. Efforts to introduce newproducts should start by identifying the targetmarket and precisely defining its needs andsustainability.

Impediments to Growth

Firms reported being disadvantaged relative to Indianfirms in labor, raw materials, domestic freight costs,and financing for new equipment. (Labor is discussedabove in this chapter and in chapter 3; raw materialsare discussed above.) Disadvantages also stem frommanagement weaknesses and poor information onmarkets. If Bhutan tackles these key impediments to


performance and makes substantial productivitygains, it will be able to compete in global niche mar-kets—the high-value, high-quality markets that nowelude the country’s agroprocessors.

Costly and Unreliable Domestic FreightMost firms cited the cost of domestic freight andtransport as a major issue. Most businesses musttransport raw materials, packaging, or finished prod-ucts—or all of these—within Bhutan or to or from Indiaor even farther afield. The sector faces serious trans-port constraints, many related to the country’s land-locked and isolated location, that affect both the sup-ply of raw materials and processing inputs and theshipment of final products. Some of the constraintsare related, and few will be easily solved. The most im-portant constraints cited by companies are these:

• The distance from the nearest seaport (Thimphu is950 kilometers from Calcutta).

• The poor standards of roads, including nationalhighways.

• The tendency of roads to close during the mon-soon season.

• Lack of competition in air services to and fromParo.

• High road and air transport charges.• Difficulties in shipping fruit exports through India

to Bangladesh.

Transport time is vital when transporting fresh pro-duce from farms. But farms may lie several days froma road head and more days from the processing site,limiting the area within which raw materials can besourced. Transport time can be just as critical in ex-porting finished goods. Typical transit times by truckfrom Thimphu to Calcutta are reported to be up to sixdays.

The costs associated with transporting raw mate-rials and finished products reduce the competitive-

ness of Bhutanese agroprocessors. These costs climbdramatically if containers are required. Charges forcontainers from Phuentsholing to Calcutta are quotedat Rs 10,000 for a 20-foot container—and at Rs40,000–50,000 for a refrigerated container, which nor-mally has to be shipped empty from Calcutta.

Another problem is that several fruit and veg-etable products with good export potential are avail-able for export only during the summer months, whenmonsoon weather tends to disrupt both land and airtransport.

Firms exporting products to Bangladesh faceparticular difficulties. The products exit India atChangrabandh and then enter Bangladesh atBurimari. Fruit is generally carried in boxes byBhutanese trucks to Burimari, where it must be trans-shipped to Bangladeshi trucks for onward carriage tosuch markets as Dhaka, Rangpur, and Chittagong.The products can hit several snags along the way:

• The poor conditions at Changrabandh—wherequeues to clear Indian customs are often long—can seriously delay even vehicles carrying perish-able transit products (which should be givenpriority).

• The flow of products such as apples may be fur-ther disrupted by the muddy conditions at the bor-der during the monsoon months, when many vehi-cles become bogged down.

• Once goods have been left for transshipment atBurimari, the Bangladeshi importers may claimshort delivery or loss of product quality and refuseto pay the full amounts specified in the letters ofcredit.

Goods may also be damaged in transit. They maybe loaded and offloaded several times, and breakageis common (the breakage rate for glass bottles is 7–9percent). And haulers may fail to use proper care andhandling procedures.


Limited Financing for New EquipmentMost firms acknowledged problems with undercapi-talization. Small firms generally must rely on retainedearnings or borrowing to finance expansion or invest-ment in innovation. Because profitability tends to below in the food sector, using retained earnings usuallyslows investment. Lenders treat the sector conserva-tively, expecting to lend funds against fixed assets, sosmall firms find it difficult to expand.

Management ProblemsBeyond the issues cited by survey respondents, man-agement problems also hamper the agroprocessingindustry. Bhutan faces deeper management problemsthan many countries because of its lack of qualifiedand experienced entrepreneurs and a resource poolfrom which innovations can grow. In the agroprocess-ing sector the absence of these resources stems fromthe lack of agro-industrial development and opportu-nities to develop necessary skills and knowledge.When poor management means that firms fail to ad-dress the needs of buyers, the consequence can bethe loss of business (box 4.2).

The low productivity of Bhutanese agroprocessingfirms stems in part from their low capital intensity,small scale, and problems with raw material supply.But these problems are much less important than thelow management aspirations and limited innovation inbusinesses. The firms surveyed are characterized by:

• Slowness in adopting innovative new processesdeveloped overseas. All firms lack adaptive skillsand interest in systems, technology, and concep-tual product development. In these areas Bhutanlags far behind its neighbors—and these coun-tries are far from leading edge. Firms that haveupgraded their technology have done so onlyminimally and have adopted technology fromIndia, which is generally far behind internationalstandards.

• Poor product and marketing innovation. Firms lackinnovation in products and marketing. Manage-ment is unable to rethink product categories andinnovate to meet new customer demand. This willbecome a serious issue as Bhutanese companiestry to identify and enter niche markets.

When firms use poor management in dealing with exportmarkets, they can establish a poor reputation for Bhutanand lose business to competitors in other countries.Consider this example.

A European company specializing in importing anddistributing aromatherapy products worked closely withthe government of Bhutan for up to 10 years to develop amarket in Europe for lemongrass oil. For a number of yearsthe company purchased some 2 metric tons of lemon-grass oil annually from Bhutan.

The company reported that it paid around $16 a kilo-gram (including carriage and freight) for the lemongrassoil, compared with a normal price of some $11 a kilogram.

Despite the price premium, the company found theBhutanese suppliers difficult to deal with. Orders arrivedlate, were often short-weighted, failed to meet technicalspecifications, and lacked consistent quality. When thecompany tried to communicate the problems, the suppli-ers claimed not to have received the messages; some-times they simply ignored them (other buyers suppliedfrom Bhutan have reported similar problems).

The company finally changed suppliers, finding bet-ter-quality lemongrass oil from other outlets. It now pur-chases the product from Nepal.

Box 4.2 Effects of Poor Management on Bhutan’s Market Potential


• Passive supplier relationships. Food processorshave tended not to build proactive relationshipswith primary producers—with the notable excep-tion of Bhutan Agro Industries—though somecompanies plan to forge closer links in the near fu-ture. Collaborative relationships are needed thatprovide opportunities to improve products andprocesses. The recently introduced CooperativeAct offers, for the first time, a framework for col-laboration at the community level. This initiativeshould help in introducing systems such as qual-ity farming and in ensuring quality through thesupply chain.

• Modest management aspirations. Companies aremore likely to adopt innovations when managerswith high aspirations push for change or whencompetitive pressures force firms to improve theirperformance to survive. Companies lacking theseaspirations and pressures may neglect promisingopportunities. None of the Bhutanese agroproces-sors showed the level of commitment needed tocompete and thrive.

Lack of Market InformationCompanies lack knowledge and experience in foreignmarkets as well as the resources for developing ex-port markets. They have neither the financial re-sources nor the management time to collect and ana-lyze market information themselves, and none knewthat governments provide such services. This un-awareness is evidenced by the lack of response to re-quests by the Bhutan Export Promotion Center whenorganizing trade missions and firms’ lack of under-standing of how the center could help them in devel-oping their business.

Potential

The value chains of mainstream food commoditiesare dominated by large, vertically integrated firms

and supermarket chains. To appropriate at leastsome of the sizable value added generated in mar-keting and distribution, Bhutanese firms will have toidentify specialty and niche products for which mar-kets are smaller and scale economies less importantin determining competitiveness. Naturally, the moreprocessing that takes place in Bhutan, the higher the returns will be, even with simple processing suchas drying or packing. Organic markets offer new op-portunities. And links with foreign companies canhelp Bhutanese producers gain access to exportmarkets.

High-Value, Low-Volume ProductsWith its biodiversity and range of microclimates,Bhutan is well placed to grow many high-value prod-ucts such as those used in essential oils and tradi-tional medicines. Its ability to produce the full range ofproducts—both high- and low-altitude species—givesit an important advantage over all its competitors.

But the demands of consumers require a highlevel of professionalism. To compete in the interna-tional market, Bhutan will have to offer not just a prod-uct but a range of services, including approved qual-ity systems, assured supply, and the capacity to bringnew products and product presentations to marketrapidly. And it will have to ensure quality not only in thefinal product but also in production, processing, pack-aging, and transport. Working closely with buyers canhelp producers meet the demands of niche markets(box 4.3).

For major niche food and beverage products, theprice premiums are increasingly controlled by only ahandful of companies. At the retail level price premi-ums are mostly appropriated by a few marketing com-panies, which dictate far less attractive purchaseprices to producers. Moreover, retail price premiumsvary widely among products. Those for spices, for ex-ample, are generally no more than 5 percent, whilethose for high-quality tea can be as high as 1,000percent.


Traditional medicinal herbs could offer good op-portunities if Bhutan developed links with establishedexporters to take advantage of established markets.In essential oils the best prospects may lie with spe-cialized products, usually those used in aromatherapyand not commonly grown elsewhere. Some productshave almost lost their niche advantage. Lemongrass,for example, is becoming a price-sensitive product,with minimum consignments of 1 metric ton generallyrequired.

Organic ProduceMuch of the farming system in Bhutan is organic, butthis advantage has not been exploited for several rea-sons: lack of awareness of organic farming systems,lack of infrastructure and marketing facilities, limitedaccess to capital, and inability to capture economiesof scale. Moreover, major hurdles need to be over-come, including the high costs of certification, thelack of market information and marketing strategies,insufficient export facilitation, complex procedures inimporting countries, and tariff and nontariff protectionin import markets.

Certification and accreditation issues are particu-larly important. Most exporters turn to internationalcertification bodies to allow them to market their prod-ucts as organic in foreign markets. While the costs ofcertification vary, they can be significant, and Bhutanmay find it difficult to establish a national certificationinfrastructure.

While organic markets are growing rapidly, thisgrowth raises the question of whether the opportuni-ties are real or perceived. The rapid growth in demandfor organic food in industrial countries is likely to cre-ate temporary gaps between supply and demand thatat times can be bridged by supply from developingcountries. But Bhutan can seize these short-term op-portunities only if exporters meet the certification re-quirements in foreign markets and gain access to themarkets. Maintaining a presence in these marketsthereafter will depend on Bhutan’s ability to retain sig-nificant production cost advantages, maintain sup-plies, and ensure consistent quality. In the mediumterm the organic production capacity in industrialcountries is likely to expand rapidly, spurred by at-tractive prices and government subsidies.

Working closely with buyers can lead to steady exportmarkets for Bhutanese products. Take the example ofcompany C, which exports Bhutanese red rice to Europeand the United States.

The company turned a chance inquiry from a rice im-porter in 1992 into a long-term relationship. Despite hav-ing no experience in producing for export, the companytook a chance, assuring the importer that it could supplyrice according to the importer’s requirements. It thenworked closely with the importer to ensure that it did meetthose requirements, delivering a first trial order of 1 metricton in 1994. That was followed by 4 metric tons, and thenby a container load.

A big part of the firm’s success was due to its work-ing closely with the importer to design packaging that ap-

pealed to niche markets and to overcome logistical prob-lems in supply. The design, based on traditional hand-made paper bags with Bhutanese motifs, differentiatedthe product and appealed to gourmet stores and high-end health food chains. Supply systems were worked out that ensured that farmers would supply the paddy,workers were trained in cleaning and grading rice, andproblems in customs clearance and transshipment weretackled.

Thanks to the close work with the importer to meet thedemands of the niche market for a differentiated product,good quality, and assured supply, the company has seengrowth of about 45 percent a year.


Box 4.3 Penetrating Niche Markets through Innovation and Proactive Relationships

Links with Foreign CompaniesThe prohibitively high costs and barriers to entry infood processing suggest that developing countrieslike Bhutan that want to expand into this field can bestdo so on the back of an established company. Theeconomies of scale can be considerable. Where de-veloping countries have made significant inroads intofood processing—orange juice production in Brazil,canned pineapples in Thailand, and soluble coffeeproduction in Brazil and Colombia—they have se-cured the upstream access to large supplies of rawmaterials and the downstream access to markets crit-ical for efficient production.

To attract foreign companies, a potential host coun-try needs to offer a supportive business environment.Bhutan’s business environment combined with itsstrategic location next to India should probably sufficeto attract foreign companies to Bhutan to produce forthe Indian market using raw materials mainly fromIndia. Bhutan’s business environment offers severalcompetitive advantages over India’s:

• Nonrestrictive labor laws. In India restrictive laborlaws make it difficult for companies to restructure,hampering efforts to improve efficiency and ex-pand output.

• Literate labor force. In India low literacy levels inthe labor force deter foreign companies seekinghigh labor productivity.

• Minimal red tape and lack of corruption. In Indiamultiple and often conflicting regulations in-crease red tape, delay production, and hamperexports. And surveys have shown that executivesof large companies perceive India as havingsubstantially greater corruption than other devel-oping countries.

• Reliable infrastructure. In India poor infrastructureis among the most frequently cited barriers to in-vestment, with electricity shortages common inmany regions, for example.

For Bhutan, working with foreign companies couldbe a viable strategy for upgrading capacity in agro-processing and penetrating new markets. Such rela-tionships could address many of the strategic gaps inthe sector:

• Bhutanese managers would receive valuabletraining and exposure to international manage-ment practices, technology, and marketing meth-ods—forming a pool of high-quality agribusinessmanagers with the skills and vision for world-classmanufacturing and marketing.

• The modern facilities and international workingenvironment could entice more skilled Bhutaneseto work in agroprocessing.

• Foreign companies could be encouraged to pur-chase more Bhutanese ingredients, such as spicesand herbs, leading to multiple benefits. Increaseddemand would stimulate production systems anddiffuse skills and technology back through the sup-ply chain as companies seek high-quality prod-ucts. And as the skills spread in rural communities,Bhutan would become better equipped to exportits own products to high-value markets.

• Bhutanese-made products would gain greatermarket penetration and recognition.

• And as the industry grows, it would stimulate thedevelopment of support services.

Recommendations for the Sector

Recommendations for developing Bhutan’s agropro-cessing industry center on creating an enabling envi-ronment, strengthening competitiveness, and devel-oping production and marketing bases.

Creating an Enabling EnvironmentMany of the constraints on the development of agro-processing in Bhutan are due to the industry’s being



new. Firms will be unable to overcome these con-straints without a supportive enabling environment.Creating such an environment calls for:

• Developing food laws to cover issues relating tosafety standards, nutrition, and merit goods.

• Creating a food processors association or relevantchapter within the Bhutan Chamber of Commerceand Industry.

• Initiating a concerted promotion campaign tocreate new markets, with a first step being tostrengthen the export promotion center.

• Expanding the supply of high-quality raw materi-als—by practicing vertical cropping, increasingproduction, and improving productivity.

• Developing databases and market intelligencesystems or strengthening existing ones to supportplanned investment matching the availability ofraw materials and the marketability of processedproducts.

• Strengthening the technical skills of extension ser-vices and cooperatives in postharvest manage-ment of produce, to encourage the developmentof preprocessing facilities (washing, fumigation,packaging) near the farms.

• Encouraging the establishment of agroprocessingfacilities as close to the production area as possi-ble to avoid waste and reduce transport costs.This might include primary processing units. Es-tablishing product belts, as called for in the NinthFive-Year Plan, will be an important step.

• Promoting investment, both foreign and domestic.• Building strong infrastructure for value added

products, with a special emphasis on food safetyand quality to match international standards.

• Providing a program for developing skills at alllevels, especially in management and marketingsystems.

• Supporting innovation at the company level byproviding national R&D facilities and resources.

The mushroom research center is an excellentexample.

• Encouraging the development of an industrialcluster of foreign food processors.

Strengthening CompetitivenessSuccessful agroprocessing firms need to be compet-itive all along the value chain, from farm productionthrough marketing. Possible ways to increase com-petitiveness include:

• Devoting more company resources to developinga well-trained workforce.

• Improving performance in innovation. For exam-ple, firms need to find ways to capture the “valueof values” in their products, such as by promotingthem as “eco-efficient.”

• Conducting a detailed study to precisely assessthe range and level of skills needed in agropro-cessing.

• Encouraging firms to invest in technology andadopt best-practice management systems.

• Initiating a food safety program.

Pursuing a Multiphase StrategyPromoting agroprocessing also requires developingthe production base and marketing base in parallel.

Production Base. Efforts to develop the produc-tion base need to focus on:

• Improving the availability of raw materials. Thiscalls for extending the area from which raw ma-terials are procured, improving yields, reducinglosses, and lowering transport costs. Farmers willaddress yield issues as they come to understandmarket opportunities. Efforts to develop this un-derstanding should work through a cooperative orassociation, since dealing with individual farmersis inefficient. Cooperatives could also be used to


introduce primary processing, to extend the life of produce and lower transport costs. To controlthe quality of primary processing, training will becritical, reinforced by a management system thatlinks all actors in the chain.

• Developing a central collection site, to help en-sure the quality of material processed in the co-operatives. The center would need to work closelywith the cooperatives to ensure that quality issuesare continually addressed.

• Exploring product diversification through market-directed opportunities.

Marketing Base. Efforts to strengthen the market-ing base need to center on:

• Promoting import substitution. Some products nowimported from India could be replaced by localproducts. Possibilities include most perishableitems—including bakery, dairy products, and icecream—as well as vegetable oils, potato products,maize products, and animal feed.

• Developing niche exports. This category includesa wide range of high-value products, such as can-dies, herbal drinks, herbal medicines, mushroomextracts, fruit products such as health bars, and

organic products such as tea and nuts. Key re-quirements in this market are quality, consistency,assured supply, responsiveness to consumer de-mand, and vigorous marketing to support theproducts.

• Developing a cluster of foreign companies nearthe Indian border. In time these companies wouldpurchase domestically produced ingredients suchas herbs and spices that have a competitive ad-vantage over those obtainable in India.

Notes

1. One processor claimed that it purposely pro-duced low-quality products, since they were bet-ter suited for the segment of the Indian market thatit was targeting.

2. World Bank, World Development Indicators[year?] (Washington, D.C., [year?]).

3. Based on data for 1995–99 from the Food andAgriculture Organization’s FAOSTAT database.

4. If calculated on the basis of the international stan-dard of 24-hour operation, capacity utilization wouldbe much lower.

5. Wood and Wood-based Industries 71




Potential 85



Present Situation

Forestry contributes some 11 percent of Bhutan’sGDP and generates about 3 percent of governmentrevenue through sales of forest-related products androyalties. Forest-related products account for 20 per-cent of exports, and forestry generates more than25,000 jobs in the informal and formal sectors.

Bhutan has 2.8 million hectares of forest area—in-cluding fir, mixed coniferous, chir pine, and broad-leaved forests—representing more than 70 percent ofits total land area. The broad-leaved species, or hard-woods, grow in the lowlands, and the coniferousspecies in the highlands. A relatively large share ofthe forests are in protected areas, and much of theforestland that could legally be harvested remainsundisturbed. Of the estimated annual allowable cut of35 million cubic feet, only about 10 million is extractedeach year. Some 20 percent of this originates in natu-ral but managed forests, harvested by the govern-ment’s forestry management units.1 These units sup-ply the wood for commercial use. Extraction hasremained relatively stable in recent years.

According to the Ministry of Agriculture, good for-est management calls for extracting the full annual al-lowable cut, but it lacks the capacity for this. The 14or so forestry management units cover only about 8 percent of the forest area. About 53 percent of theharvested timber is coniferous; the balance is broad-leaved.

Commercial users buy timber through auctionsfrom the Forestry Development Corporation. Thewood-based industry comprises around 56 sawmills,60 furniture workshops, 1 large particle board firm,some producers of wood handicrafts, and some pro-ducers of broom handles, fruit boxes, veneer, ply-wood, and blockboard. Most of these establishmentsare in the western and southern parts of Bhutan. Sincetransporting timber from one district to another iscostly, hardwoods are processed mainly in the low-lands and conifers in the highlands. Sawmills are

widely dispersed, specialist furniture firms are mainlyin Thimphu, and panel and board producers, whichconsume some 60 percent of hardwoods, are in thePhuentsholing area. In mid-2001 a Wood-Based In-dustries Association was formed to represent thesector.

The market is fragmented, as is common in devel-oping countries, and the fragmentation is exacer-bated by Bhutan’s small population and its geogra-phy. Achieving economies of scale is difficult. Thegovernment is a major customer for timber products:of the timber available for commercial use, perhaps70–80 percent is consumed by the construction in-dustry, and of this, more than 70 percent is said to befunded by the government or donors.

Government PolicySeveral aspects of government policy create a fav-orable environment for the wood sector as well as for other manufacturing sectors. These include theimport-export regime, the stable exchange rate withIndia, and, to a greater or lesser extent, the tradeagreement among members of the South AsianAssociation for Regional Cooperation (SAARC). Theeffects of other aspects of government policy havebeen mixed.

Bhutan’s Eighth Five-Year Plan emphasized sus-tainable forest management for the dual purpose ofconserving environmental resources and supplyingwood resources to the domestic market. In January1999 the government introduced a new pricing andmarketing policy enabling the urban, commercial, andindustrial sectors to purchase timber through openauctions; allowing the market to determine prices; andbanning the export of logs and sawn timber exceptwhen there is a glut in the market. As a result of the ex-port ban, timber exports in 2000 fell to only 10 percentof the amount in 1998 (table 5.1). At the auctions thetimber lots invariably consist of mixed species, ofvarying grades, sizes, and qualities. If a lot remainsunsold after two auctions, the Forestry Development


Corporation may sell it through an international auc-tion in which foreign buyers can participate.

While the industry generally welcomed the newpolicy, two new regulations introduced in 2000 havehad adverse effects. First, in April 2000 the export ofsemifinished products was banned to counter suchpractices as exporting barely processed timber dis-guised as finished products. Second, in September2000 the system for measuring timber was changedfrom the quarter girth to the true volume system, re-sulting in buyers getting 21.5 percent less timber forthe same nominal price.

Earlier in 2000, out of a belief that sawmills werecolluding to keep prices high, the Forestry Develop-ment Corporation started two sawmills to force privatemillers to lower their prices. While the Forestry De-velopment Corporation and private firms both buyconifers for about Nu 130 per cubic foot, the corpora-tion sells the sawn wood for Nu 140 per cubic foot,and the private sector for about Nu 220.2

In addition, two policy changes have adversely af-fected the sector’s labor situation: the announcementthat government workers should be paid a minimumof Nu 100 a day (a policy that many private firms have

found it necessary to follow) and the pressure on firmsto reduce the number of nonnational workers theyemploy.

Other factors in the government domain have alsohad significant effects on the industry: the many (un-coordinated) ministries and agencies with influenceover firms, the terms and conditions of tendering forgovernment contracts, the perception that the gov-ernment discourages joint ventures with foreign firms,and the difficulties that foreign businesspeople face intraveling to Bhutan (mainly in obtaining flights andvisas).

Labor and EmploymentFirms in the wood sector are generally modest in size,with an average of 31 employees. The two large firmsproducing particle board and plywood and block-board, however, employ 292 people on average. Totalemployment in Bhutan’s wood sector is estimated atno more than 2,000.

Skilled labor is in short supply, as evidenced bythe low productivity and poor quality in the sector.Firms reported that there is a scarcity of labor intowns, while in rural areas workers are seasonal andlack an “industrial culture.” Because of high laborturnover, firms do not provide workers with any formaltraining. The Woodcraft Center, established in 1991 by the government and the Danish InternationalDevelopment Agency (Danida), is the only organiza-tion in Bhutan that provides systematic training forwoodworkers. The center, which combines trainingwith production, has produced some 36 trainees by2001, some of whom work in local firms (box 5.1).

Firms deal with labor shortages by hiring Indianworkers, often preferred because of their skills, betterattendance, and lower pay. In the Phuentsholing areaIndian day workers make up 69 percent of the work-force in the sector. In Thimphu, where Indian workersform 49 percent of the workforce, they are formallyemployed as regular staff—that is, the workers haveidentity cards and their employment has been ap-

1998 1999 2000

Rural 214,826 242,235 162,254

Urban 730,809 44,771 690

Defense 19,208 1,348 0

Industry 158,408 1,000 0

Auction, export 720,484 201,004 74,897

Auction, internal n.a. 1,406,686 1,425,940

Total 1,843,735 1,897,044 1,663,781

Total for commercialuse (direct or throughauctions) 878,892 1,608,690 1,500,837

n.a. Not applicable.Source: Bhutan Forestry Development Corporation.

Table 5.1 Disposal of Timber by the BhutanForestry Development Corporation,1998–2000


proved by government agencies. The number ofIndian workers that a firm is allowed to hire is gener-ally determined by the size of the firm’s capital invest-ment. In practice, however, firms can supplementthese regular workers when they undertake govern-ment contracts by claiming that they need additionalIndian workers to complete the contract on time.Some firms also have construction companies thathire Indian workers, who may then work in the firms’woodworking factory.

The owners of most firms lack technical skills and,for production, must rely on the skills of a productionmanager or supervisor. But these managers, eventhose from India, generally lack qualifications and ap-propriate skills. All firms also need technicians formaintenance, tooling, drafting, and the like, butBhutanese workers lack these skills (which must beacquired over long experience on the job). The tech-nicians who do have these skills often have little edu-cation, and firms reported that the agencies responsi-ble for issuing work permits for nonnational workers

do not appreciate how indispensable the skills ofthese poorly educated technicians are.

TechnologySawmills use low-level technology, typically decades-old technology from India. There is no evidence thatfirms seek to upgrade their technology, whether by in-vesting in new equipment, performing maintenanceon saws, or improving work practices. The low tech-nology results in poor timber yield and quality. As a re-sult of the ban on log exports, a few firms have moveddownstream to use waste wood or to add value.

Many of the firms have kiln-drying facilities. Butthe technology is weak. Moreover, its performance isundermined by the practice of drying timber of mixedspecies and dimensions, which prevents use of theoptimum drying schedule.

In response to the ban on exporting logs andsemifinished products, firms in the Phuentsholing areahave invested in plywood and blockboard production.To identify the technology they needed, the firms gen-

A country where skilled labor is at a premium, as it is inBhutan, needs to make the best use of its skilled workers.The Woodcraft Center trains workers for the wood productsector, but there is often a big mismatch between supplyand demand. Firm 16 reported that “one day in Februaryeight or nine workers arrived at the door with a letter fromthe National Employment Board asking if I could absorbthe workers. I discovered that they were trained byWoodcraft, and I thought that I would take three of them.The firm had been stagnating for two years, and I thoughtthey would help the firm grow. But I could not decide be-tween them, so I took eight of them. But there is no changein sales and now I have more stock.”

In the same month firm 11 applied for a permit to hirean Indian worker. The request was forwarded to the Na-tional Employment Board in March, but six months later

the firm still had received no reply. In May the firm had ap-plied to the Woodcraft Center for a manager and fourworkers. The center replied that it had no graduates andadvised the firm to wait, saying that it was accepting newtrainees in September.

The needs of these two firms match the number ofskilled graduates available from the Woodcraft Center—but while one firm has too many workers from the center,the other has none. Firm 11 would like the WoodcraftCenter to write a letter acknowledging that it cannot pro-vide the skilled workers the firm needs—rather than say-ing it will have them in the future—since the firm believesthat would provide justification for a permit to hire Indianworkers instead.


Box 5.1 Supply and Demand for Government-Trained Woodworkers


erally hired Indian consultants and visited similar pro-duction units in India. The time and cost involved insearching for and acquiring technology exceededexpectations.

The most professional furniture producers are inThimphu. Compared with firms in Phuentsholing,these producers have orderly and comparativelyclean premises, and they generally have relativelynew equipment. Two newer firms in Thimphu re-ceived assistance from the Woodcraft Center in de-signing their layout and specifying equipment.Furniture made by firms in Phuentsholing tends to beof inferior quality.

Design skills are lacking in Bhutan. Firms inThimphu often use Danida-inspired designs, whichare dated and lack Bhutanese character. In someplaces designs from UNICEF have influenced theproducts made for schools. Overall, designs are verypoor.

Asked about technology needs, firms identifiedthese priorities:

• Production assistance (in order of priority, rehabil-itation and maintenance of machinery, advice onnew machines, visits to modern factories, visits tomachinery fairs, kiln-drying, and machining).

• Marketing (information on foreign markets, mar-keting techniques, study visits to foreign markets,and development of promotional materials).

• New product design.• Management development (financial manage-

ment, quality systems, business planning, com-puter training, and human resource developmenttraining).

While all these are important, more emphasisshould be given to sawmilling and kiln-drying and tobusiness development planning. And above all else,company managers need to be made aware of theglobal environment in which they operate and to be-come familiar with best practices.


For furniture firms competitiveness depends mainly onthe cost of timber (typically 40–50 percent of the ex-factory price internationally), the cost of labor (15–20percent internationally), productivity, and yield.

Competitive Raw Material CostsA precise comparison of timber costs across coun-tries is difficult (internationally there can be a fourfolddifference between the prices of different qualitiesand grades of the same timber species), but prices inBhutan generally fall within the range of internationalcompetitiveness. The price of Bhutanese hardwoodsranges from $65 to $102 per cubic meter, comparedwith international prices of $126–238 (table 5.2). Forteak the price in Bhutan is $127 per cubic meter, com-pared with international prices of $522–1,695. Forconifers Bhutan’s prices are 12–15 percent more thanthose in Indonesia.

Timber costs vary across Bhutan, however. In2001 the price of mixed hardwoods ranged from Nu50 per cubic foot in one region to Nu 76 in another.The price of mixed conifers was more consistent,ranging from Nu 85 per cubic foot to Nu 100.

On top of the cost of the timber, trucking can beexpensive—and the cost may even exceed the valueof the timber. The price for trucking timber from Mon-gar to Phuentsholing is Nu 65 per cubic foot.

Competitive Labor CostsLabor costs in Bhutan’s wood-based industries arecompetitive with those in a range of countries (table5.3). A machine operator in a furniture company inBhutan costs about $89 a month, compared with $136in Bangladesh and $156 in the Philippines. But laborcosts as a share of the ex-factory price of products ishigh in Bhutan—at 29 percent, it is nearly twice whatis desirable to be internationally competitive.

Labor costs vary by district and by the worker’sbackground. In Thimphu production workers are paid


Table 5.2 Timber Prices, Selected MarketsPrice

(U.S. dollarsper cubic

Market Timber meter) Details

Bhutan Hardwoods, mixed species 65 FDC auction price (average for Jan.–Sept. 2001)

Bhutan Hardwoods, grade A 102 FDC auction price (average for Jan.–Sept. 2001)

Malaysia Hardwoods, average of 6 species 126 Sawmill quality; ex-log yard

West Africa Hardwoods, average of 12 species 163 FOB; sawmill quality

Indonesia Hardwoods, average of various species and sizes 238 Air-dried timber for construction industry

Bhutan Hardwood, teak 127 Firms’ reported purchase price (2001)

Bangladesh Hardwood, teak (Chittagong) 522–696 Prices paid by furniture firms (Feb. 2001)

Myanmar Hardwood, teak 1,695 FOB; average price for grades 1–4

Indonesia Conifer, pine 80 Mill yard price

Bhutan Conifer, mixed species 90 FDC auction price (average for Jan.–Sept. 2001)

Bhutan Conifer, blue pine grade A 92 FDC auction price (average for Jan.–Sept. 2001)

Note: FDC is the Forestry Development Corporation.Source: International Tropical Timber Organization, Tropical Timber Market Report, 16–30 September 2001; Bhutan ForestryDevelopment Corporation; Tyler Associates.

Annual Labor costs as Monthly costoutput a share of of machine

per worker ex-factory price operatorCountry Product line (U.S. dollars) (percent) (U.S. dollars)

Bhutan Sawmills 3,654 22 59

Bhutan Plywood, particle board, blockboard 8,692 13 58

Bhutan Furniture 3,576 29 89

Bangladesh Furniture 3,668 — 136

Jamaica Furniture 10,500 25 350

Romania Furniture 28,000 20 100

Philippines Furniture 30,000 40a 156

Ireland Furniture 115,000 14 1,400

— Not available.a. It is not uncommon for labor costs to be high in Philippine firms, because they specialize in labor-intensive decorative tech-niques to add value and to differentiate their products from those of lower-cost countries.Source: Firm interviews; Tyler Associates.

Table 5.3 Labor Output and Costs in Typical Firms in Wood-Based Industries, Selected Countries


$95 a month on average, and labor accounts for 32percent of the ex-factory price. In Phuentsholing theyare paid $55 a month, and labor accounts for 20 per-cent of the ex-factory price. Much of the difference inmonthly wages stems from the predominance ofIndian workers in Phuentsholing. The lower laborcosts as a share of the ex-factory price in Phuent-sholing is due to the large number of Indian workersas well as to the number of comparatively capital-intensive board factories there.

In Thimphu firms hiring workers trained by theWoodcraft Center pay wages of $100 a month, whileother firms pay an average of $83. Firms observedthat these government-trained workers seek publicsector pay and working conditions. For example, theyinsist on government-mandated holidays, while otherBhutanese workers demand half the holidays, andIndian workers a third. Output per worker in the“Woodcraft-trained” firms is $3,753—little better thanthe national average—while in the other firms it is$5,841.3 When all issues are considered, government-trained workers may not be more productive thanother workers, because of a poorer work ethic, thoughtheir work may be of better quality.

Low ProductivityProductivity measured by output per worker is low inBhutan. In firms making furniture annual output is$3,576 per worker—one of the lowest levels amongsimilar countries. In Bangladesh, for example, wherethere is generally less mechanization, output is$3,668. Some experts believe that annual output of$12,000 per worker is needed to export regionally and$20,000 to export internationally.

Low YieldMeasuring yield—the amount of usable timber result-ing from each stage of processing—is difficult to dothrough short visits to firms, and the yield can varysignificantly (table 5.4). Where “best practice” is used,34 percent of the tree trunk can be converted into fin-

ished products such as furniture and panel doors. Butin Ghana, for example, only 7–10 percent of the treetrunk may be recovered. In the few firms in Bhutanwhere the information provided seems to be plausible,yield may be 11–20 percent. The practice in Bhutan isto convert the waste into subsidiary products.

The low yield in Bhutan can be attributed to sev-eral factors—poor equipment, poor work practices,the traditionally low price of wood, and the lack of in-ternational competition to force yield efficiencies onfirms.

Low Output PricesEfficiency, if not competitiveness, can be measuredby the price firms can achieve per unit of timber, ameasure that reflects design and marketing as well asprocessing skills. As firms move downstream, the unitvalue of the timber rises significantly (table 5.5). A firmcan obtain almost 100 times as much for its timber if itmakes key rings ($27,000 per cubic meter) than if itmakes rotary veneer ($275 per cubic meter). ManyBhutanese firms have not yet moved downstream andare still obtaining as little as $348 per cubic meter forfurniture.4

Factors Critical for SuccessFirms need a wide range of factors to be successful.Some of them, common across all sectors, are inplace—such as the import-export regime, the ex-

Bestpractice Ghana Bhutan

Share of tree trunk going to sawmill 80 45–66 60

Share of tree trunk converted to finishedproducts 34 7–10 11–20

Source: World Bank, “Ghana Country Economic Memoran-dum” (Washington, D.C., 2000); firm interviews, Bhutan,2001.

Table 5.4 Comparative Timber Yields (percent)


change rate, reliable and affordable utilities, andtrade agreements with other countries. In addition,four critical factors are specific to firms in Bhutan’swood sector:

• Availability of preferred raw materials. Firms needaccess to good-quality raw materials in speciesand sizes that suit market demand and their tech-nology and are available at predictable prices.

• Supportive policy toward manufacturers. Firms re-quire government policy that is sympathetic totheir needs. A leading industrialist described thegovernment’s attitude as follows: “the intention ofgovernment is favorable; the policy is not sohealthy; and the application of policy is bad. Andwe want to avoid frequent policy changes.”

• Access to appropriate technology and labor.Technology in the sector needs to be upgraded,starting in sawmilling and working downstream.Firms are prepared to invest in technology if thepolicy environment is appropriate and consistent.At the same time firms need skilled managers andlabor at predictable wages.

• Market-led production. Industry should be led bythe needs of private markets, particularly exportmarkets. Today much of the market is determinedby the government, as a buyer of wood products

and as a major arbiter of what firms make, throughits control of the timber being sold into the marketand its restriction on the export of certain products.


Firms in wood-based industries face several impedi-ments to growth, including lack of access to preferredraw materials, inappropriate policies, difficulties in ob-taining technology and skilled labor, and poor marketawareness and marketing skills.

Difficulty in Obtaining Preferred RawMaterialsThe government’s policy restricting the export of logsand sawn timber is appropriate, but other actions bythe government have made it difficult for the industryand the economy to reap the benefits. The export re-strictions signaled the industry to move downstreamand add more value in Bhutan. But firms cannot movedownstream if they cannot obtain single species oftimber (preferably in the right grade, size, and quan-tity) and cannot make products that are consideredsemifinished. Moving downstream is difficult: in Ghana,for example, which has a log ban and wood sector ex-ports of $180 million, only one firm consistently exportsfurniture.

Firms commonly buy lots in which a third of thetimber is good for their core business, a third can beused in some capacity, and a third is unwanted. Asone contractor explained, the Forestry DevelopmentCorporation sells timber in lots of mixed species forthe following reason:

In whatever area we are given, we have to har-vest the marked trees. We are just the contrac-tors. The amount harvested is target driven, andconsists of various qualities. We do not segmentthe species at the depot because of the cost,and what difference would it make? The users

Value(U.S. dollars per

Product cubic meter, FOB)

Rotary veneer 275

Moldings 600

Joinery 1,000

Garden furniture parts 1,200

Subassemblies 1,800

Finished garden furniture 3,000

Handicrafts (carved key rings) 27,000

Table 5.5 Value of Wood Exports by Type ofProduct, Ghana, 1999–2000


are not experienced and do not prefer certainspecies—they can switch their taste within onemonth—in the wink of an eye.5 Even after thehard work in segregating, there is no guaranteewe will get the best price for the timber. What doyou do about the rejects? It’s hard to get ap-proval from the Ministry of Agriculture to get ridof timber which industry has rejected.

To see how this practice affects firms, consider atypical lot bought by a typical sawmill (table 5.6). Thefirm wanted the lot, considering it more valuable thanothers in the auction. Of the 532 cubic feet in the lot,the firm wanted timber amounting to 302 cubic feet. Itbought the lot for Nu 67 per cubic foot. It would havepaid Nu 80–130 per cubic foot for the timber itwanted, but valued the timber it did not want at onlyNu 30 per cubic foot.

It could be argued that the firm lost little in buyingthe lot if the lower and higher values for the firm areoffset against each other: the firm paid Nu 35,644 and

estimated the actual value at Nu 34,670. In addition,however, the firm had to pay up to Nu 65 per cubicfoot to transport the wood to its factory, where it mightget only Nu 110–170 per cubic foot for convertingwhat wood it can recover from the unwanted logs intoorange and apple boxes. The firm has another prob-lem—its clients do not normally want the costly Champwood, and selling it could take up to a year.

Perhaps most important, having to buy a variety ofspecies, grades, and sizes hampers specialization,which would help the firm achieve scale economiesand facilitate technology transfer and skills upgrad-ing. Indeed, firms would commonly pay 20–30 per-cent more if they could obtain timber more suited totheir core product lines.

Auction lots that include the wrong species, qual-ities, and sizes can put firms off altogether. One of thethree biggest purchasers of auction timber stated thatit might not buy an auction lot if 10 percent of it mightbe unusable. Another of the three noted that timberbegins deteriorating the moment it is felled, so it is

Shorter lengths (3’0”–4’11”) Longer lengths (5’0” +)

Value to Actual Value to Actualfirm value firm value

Cubic (per cubic Price to Cubic (per cubic Price toSpecies Grade feet foot) paid firm feet foot) paid firm

Kaula C 32 30 2,144 960 83 93 5,561 7,719

Dabdapey C 113 30 7,571 3,390 137 93 9,179 12,741

Champ A 15 130 1,005 1,950 0

Paihely E 17 30 1,139 510 22 30 1,474 660

Bongser D 17 30 1,139 510 0

B. Kaula C 41 80 2,747 3,280 0

Katush C 0 29 30 1,943 870

Kapasy A 0 26 80 1,742 2,080

Total 235 15,745 10,600 297 19,899 24,070

a. At Nu 67 per cubic foot.Source: Firm interview.

Table 5.6 Price Paid for a Typical Timber Lot in Bhutan and Its Actual Value to the Sawmill(ngultrum, except where otherwise specified)


crucial to process it as soon as possible. The firm ob-served that the Forestry Development Corporationtried to sell the old timber first at auctions rather thanthe new timber, which then too deteriorates before it issold. The firm reported that it had bought no “new”timber in the previous two years.

Under the policy introduced in 1999, timber canbe sold in an open international auction if there are no local buyers after two auctions. But the ForestryDevelopment Corporation must first obtain permissionfrom the Ministry of Agriculture, which does not alwaysgrant it. Delays in getting the ministry’s approval maysometimes result in timber being offered at local auc-tions four or five times. And gluts in the market canmean that open international auctions need to be heldat short notice to prevent further deterioration. In May2001, for example, 70,000 cubic feet of timber was of-fered for sale, but only 15,000 cubic feet sold.

Local firms sometimes buy the deteriorated mixedlots only to regret it later. One of the biggest buyersbought 35,000 cubic feet of timber at Nu 27 per cubicfoot in December 2000, then paid Nu 30 per cubicfoot for transport. But when the timber arrived at thefactory, it was found to be unsuitable.

Because the present policy requires firms to payfor everything in an auction lot—whether they want itall or not—they face extra costs that they would notincur if the auction system worked better. The auctionsystem burdens the private sector in several ways:

• Firms cannot concentrate on core product lines,which would enable them to focus their invest-ment. Instead, they must invest time and money inprocessing or selling unwanted timber. The diver-sification being forced on firms undermines theirability to achieve scale economies and developexports—critical given the fragmented domesticmarket.

• Forced to be a jack-of-all-trades, manufacturerscannot concentrate on upgrading worker skillsthat are specific to the firm. Specialization would

make it easier to upgrade worker skills and wouldreduce labor turnover—since few firms wouldhave a similar specialization, there would be lessopportunity to poach workers trained elsewhere.

• The ability to make good-quality products is beingundermined. For example, each species of hard-wood should have a different kiln-drying scheduleso that it does not warp and crack. But as one ofthe biggest firms noted, buying sufficient timber ofa single species to fill the kiln would take a yearunder the present government policy. That is onereason that hardwood products are of such poorquality and that firms are moving to conifers andboosting the price, while the price of hardwoods isdeclining. In Bhutan hardwoods are cheaper thanconifers, though internationally hardwood may bethree to four times as expensive (see table 5.2).

• The market is increasingly rejecting productsmade from mixed species. Indian buyers, for ex-ample, are insisting that the core of blockboardmust be a single species (historically the marketdid not discriminate against blockboard consist-ing of mixed species). India no longer wants mul-ticolored parquet flooring. And all markets exceptBangladesh are turning against fruit boxes madeof wood, the most common product for which un-wanted wood has been used. If firms cannot selltheir unwanted timber, the added cost will renderthem uncompetitive.

The Forestry Development Corporation is report-edly moving toward segregating timber at two depots,a welcome step. But it will need adequate resourcesto achieve this aim.

Burden of PolicyGovernment policy—on labor, joint ventures, andbusiness licenses—and the changes in governmentpolicy do not encourage firms to acquire technologyneeded to move downstream to higher-value prod-ucts. Yet exporting semifinished products, a natural


outcome of this policy situation, is banned. If govern-ment policy encouraged technology acquisition andthe marketing of semifinished products, firms wouldbe more likely to move downstream successfully. Theban on semifinished products may have preventedsome smuggling of goods out of the country, but itsunintended effects have harmed the development ofthe sector.

Effects of the Export Ban on SemifinishedProducts. The ban on the export of logs and sawntimber announced in January 1999 encouraged firmsto move downstream to higher-value products, but theban on “semifinished” products that followed some 16months later has hurt firms that moved in that direc-tion. The new ban has affected firms in three mainways.

First, for firms that invested in downstream activi-ties after January 1999, the ban on semifinished prod-ucts has adversely affected the business in whichthey had recently invested. Consider the experienceof one of Bhutan’s largest plywood and blockboardproducers. After the government imposed the ban onlog exports, the firm diversified into manufacturingflush and panel doors, investing a considerableamount. But since the ban on semifinished productswas introduced, the firm can no longer export theframes of doors or windows, which are consideredsemifinished products, though it can export doors andwindow casements. The policy has thus severely af-fected the market potential of a firm whose pioneeringactivities would have opened opportunities for otherBhutanese firms.

Second, the ban makes it difficult for firms to gainexperience in making semifinished or secondaryproducts—experience that is often needed beforethey move on to tertiary products such as furniture.Manufacturing secondary products—such as floor-boards, picture frame moldings, and tongue-and-groove paneling—can benefit firms in several ways. Itmay require machinery that is a step up the technol-

ogy ladder, enabling firms to learn new-technologyskills. It means making relatively large quantities ofsimilar products, acquainting manufacturers withscale economies. Because the work is repetitive,training machine operators is comparatively easy. Andonce these steps are mastered, it is easier for firms tomove on to products with more value added, such asgarden decking and furniture parts.

Third, by restricting firms’ ability to manufacturesecondary products, the ban has eliminated an im-portant way to use unwanted wood. Selling secondaryor semifinished products made out of unwanted woodcan boost competitiveness—for example, the pro-cessing and sale of offcuts is one reason that Brazil isinternationally competitive in the export of pine beds.6

In Bhutan, however, some firms have had to closebusinesses because the subsidiary products theymade were considered semifinished.

A veneer exporter in eastern Bhutan found that thelarger pieces of veneer it produced were eligible forexport, but the smaller pieces made from offcuts weredeemed semifinished products and were banned forexport. It had to raise the price of the larger pieces asa result, but the market could not absorb the higherprice and the firm closed. A firm in Phuentsholing hadto close four manufacturing units, including a veneerslicing plant with a value of $300,000. Firms reportedthat valuable species suitable for veneer, such asmaple, lie in the forest for up to nine months becauseof the effect of the ban on the prices they would get atauction.

In Ghana sliced veneer exports have an averagevalue of $891 per cubic meter, though some firms getup to $18,000 per cubic meter with careful selectionand processing of logs. Even if Bhutanese firms couldobtain prices at only the lower end of the range for ve-neer, the value per cubic meter would still be morethan some firms are getting for furniture. One firm re-ported that it could no longer export even sawdust be-cause it is considered a semifinished product. Thefirm noted the damage that sawdust causes to fish if it


is dumped in the river, the fire hazard it creates if keptin the factory, and the irritation it causes to eyes whenblowing around the factory.

Effects of Policy Change on Investment.Several firms expressed a desire to invest in theirbusinesses as long as they could plan ahead with cer-tainty. But as a result of the unexpected changessince 1999, requiring firms to reorient themselves atleast twice, they lack confidence in the stability andconsistency of policy. Moreover, firms believe that fi-nancial institutions lack confidence in the sector be-cause the changes make it unclear what the govern-ment’s attitude toward the sector is.

Difficulties in Obtaining AppropriateTechnology and StaffProblems in obtaining appropriate technology andstaff are widespread in the wood sector, posing a se-rious impediment to growth.

Technology. Firms benefit from their proximity to theIndian market, where they can undertake market re-search, hire consultants, and source machinery. Butthere have been problems in acquiring technology, a process involving several steps. First, firms mustidentify the products they want to make and search forthe appropriate technology provider. Second, theymust acquire the technology—for example, buyingnew machinery from a supplier, which commissionsthe machinery and then trains workers in its use.Third, they must absorb, or internalize, the technology,using the equipment in everyday conditions once thesupplier has left. Complications often occur through-out this process, and Bhutan is no exception—acquir-ing and absorbing new technology often takes up to20 months for Bhutanese firms (table 5.7).

Larger firms, such as firm 4 in the table, are ableto hire Indian marketing and production consultants toundertake market research and plan a new facility.These firms can identify and visit foreign factories to

Step in technology transfer process 1–3 4–6 7–9 10–12 13–15 16–18 19–21

Firm 4

Technology search x x x x x x

Technology acquisition (planned) x x x x x x

Technology absorption (unplanned)

Firm 11

Technology search x x x x x x x x

Technology acquisition (planned) x x x x x x x x

Technology absorption (unplanned) x x x

Firm 13

Technology search x x x x x x x x

Technology acquisition (planned) x x x x x

Technology absorption (unplanned) x x x x x x


Table 5.7 Time Required to Transfer Technology to Bhutanese Firms in the Wood Sector(months)


study different production techniques, obtain sugges-tions from machinery suppliers about potential buy-ers, and, if they are near the Indian border, draw on alarge pool of labor. Even so, firm 4 started its facility asa pilot plant to test the market, using old technologyand available labor. To be internationally competitive,the firm wants to make a leap to technology and laborskills that are beyond the capacity of India to provide(as India liberalizes, firms need globally competitivetechnology to compete with third-country manufactur-ers on the Indian market). But given the recent policychanges, the firm is hesitant to make this leap intechnology.

Smaller firms, such as firms 11 and 13, have diffi-culties in identifying appropriate markets, determiningwhat technology they need, preparing businessplans, and obtaining financing (box 5.2). For thesefirms things are more likely to go wrong. Indeed, bothfirm 11 and firm 13 obtained second-hand equipmentthat turned out to be defective, had to acquire addi-tional machinery, and may need to make unexpectedalterations to their premises. And both firms unex-pectedly had to hire foreign engineers to solve theirproblems. For firm 13 the acquisition of technologytook more than twice as much time and money asplanned. Moreover, the price of timber went from Nu70 per cubic foot at the planning stage to Nu 130

within three months of starting production, jeopardiz-ing the firm’s market development activities.

For the greatest benefits, the wood sector shouldupgrade its technology in primary processing (saw-milling) and gradually upgrade downstream pro-cesses. Sawmilling is the weakest part of the sector,with all mills working at low capacity. Since all theequipment is depreciated and premises are freehold,too many firms remain in business, and none of themills visited can get sufficient throughput to justify newinvestment. Moreover, the sawmilling activities of theForestry Development Corporation add uncertainty.As a result of all this, inefficiency is high, and down-stream firms suffer. Because of these inefficiencies,some smaller downstream firms are investing insawmilling equipment, further reducing throughput inthe sawmills and diverting the attention of downstreamfirms from their core business.

Labor and Management. Complaints about theshortage of skilled labor are common in all sectors.But particular aspects of this problem are specific tothe wood sector. First, since the government buysmuch of the sector’s output under contracts awardedto the lowest bidder, firms tend to hire the cheapestlabor. Second, it is unrealistic for firms to train workersif they cannot rely on a consistent supply of single

Firm 11, established in 1999 by a former government em-ployee with no knowledge of the wood sector, obtained in-formation on machinery from the Woodcraft Center whenit started up. The firm recently decided to manufacturemoldings for the construction industry. Learning that itneeded to purchase a Weinig four-head molder, it ob-tained a price of $120,000 from the European manufac-turer. But the firm could not get that much financing andwas unsure that the market was large enough to justify theexpenditure even if it could.

When the World Bank wood sector expert discoveredthis, he contacted a second-hand machinery supplier andwithin 24 hours had offers of suitable Weinig machinesranging in price from $9,775 to $28,750. He also identifiedan independent technician who would visit the machinesfor $500 to ensure that they were in good order and wouldsuit the firm’s needs. The firm is now considering the pur-chase of two additional different machines.


Box 5.2 A Small Firm’s Difficulties in Sourcing New Machinery


species and cannot export semifinished products.Third, skilled woodworkers from the Woodcraft Centerare too costly for many firms to hire, and there is a mis-match between the center’s output and firms’ needs(see box 5.1).

Productivity is low even in firms with reasonablemachinery because of poor management as well aspoor labor skills. For example, in one of the betterfirms a cupboard takes one man 42 work-hours tomake, while a European firm, given the same specifi-cation, estimated 5.2 work-hours. Furniture firms andsawmills rarely have batch production that makeswork repetitive and thus more efficient, so they areunable to organize labor in the most effective way. Asa result of poor management and a lack of productionruns, there is little division of labor in firms (and onefirm believed that division of labor makes it impossibleto know who is at fault if something goes wrong).Consequently, many workers are equally unskilled. Iffirms gained scale economies, they could introduce adivision of labor and target training to potentially com-petent employees while the others become low-paidhelpers.

Uncertainty over Foreign Investment Policy.Bhutanese firms recognize that they need to upgradetheir technology, management, and labor skills if theyare to compete internationally—and that even stan-dard Indian technology and skills may be inadequate.This upgrading can be done over many years usinginternal resources, or the process can be kick-startedthrough foreign investment. Several firms reported in-terest in joint ventures—and some have made initialovertures to possible partners—but they believed thatthe government would not allow them to pursue theserelationships. Preventing foreign firms from enteringinto partnerships with Bhutanese firms encouragesmany twilight practices, which result in many disad-vantages and few benefits for the economy.

If the right conditions were in place for foreign in-vestment (policy consistency, flexible labor policy,

and easier entry into Bhutan), foreign firms would beinterested in the potentially favorable investment con-ditions in Bhutan. Two or three appropriate joint ven-tures could lead to a renaissance in the wood sectorand have spillover effects for the economy.

Lack of Market-Led FirmsFirms typically serve a small hinterland of walk-inclients or bid reactively for contracts from the govern-ment, the biggest buyer of wood products. Relying onthe government as a market is no help to firms in rais-ing their standards to those demanded for export.Firms cannot supply goods of one quality for the localmarket one day and supply export-quality goods thenext day. Since government contracts go to the lowestbidder, sawmilling, kiln-drying, and joinery skills arenot put at a premium. Nor do clients seem to ade-quately check the quality of goods to ensure that theymeet specifications. Several firms reported a desire to improve the standards of their products but saidthat their dependence on government contracts pre-vented this. They observed that it was better for busi-ness to supply products that lasted a few years ratherthan make better-quality ones for a slightly higherprice that would last a lifetime.

Firms’ dependence on a local market in whichbusiness goes to the lowest bidder and marketingskills do not attract a premium has meant that fewconduct marketing. Firms lack the ability to researchmarkets and discover niches they could serve, suchas by developing Bhutanese-inspired designs thatcould give them a competitive advantage. (One firm,however, was making Bhutanese-inspired furniturethat was selling for $5,000 per cubic meter of timber,more than 10 times what a producer of generic furni-ture was getting.) Identifying niches is important evenfor firms exporting boards. One end of the Indian mar-ket is being served by Indian cottage industries, whilethe other is being served by Southeast Asian andEuropean imports. Bhutan needs to position itself in aniche of the market where competition is minimal.


Both the furniture and board markets probably includeniches—such as the knock-down, Bhutanese-stylelow occasional tables selling on the U.S. market andthe boards with exotic face veneers selling to contractbuyers in India.

Potential

The potential of the wood sector is determined by theavailability and cost of its inputs, its productivity, themarket demand for its products, its ability to identifyand serve market demand, and the policy and busi-ness environment. Bhutan has excellent prospects fordeveloping the sector if adequate timber is harvestedand made available in single species, the export ofsemifinished products is allowed, conditions are fa-vorable for upgrading technology and achieving scaleeconomies, firms can gain access to design talent,and marketing skills improve. Nearly all firms havelooked to the Indian market, but the Bangladesh mar-ket may offer greater potential in the short to mediumterm. Handicrafts have good potential in foreign mar-kets beyond India. In the long term bulky products(such as panel products) are likely to be sold in neigh-boring countries, while smaller, more downstreamproducts should find markets in such countries asJapan and the United States as well as some coun-tries in the region.

Availability and Cost of InputsTimber could potentially be made available at theright price and, to a greater extent than today, in thespecies, quantities, and sizes that firms require.Bhutan has lower prices for hardwoods than interna-tional competitors, but quality has to be assured.Bhutan has slightly higher softwood (pine) prices thanIndonesia, though on the Indian market firms reportedthat Bhutanese timber (at Rs 160–190 per cubic foot)is less expensive than mixed conifers from NewZealand and Scandinavia (Rs 200). And labor costs in

Bhutan, particularly for machine operators, are lowerthan those in many other countries.

In the longer term international certification of sus-tainable forest management will become increasinglyimportant in realizing the value of Bhutan’s timberresource. Bhutan will need to get at least some of its forests and its management practices certified byan organization such as the Forestry StewardshipCouncil; otherwise, products will remain locked out ofpotential export markets.

ProductivityBhutan’s wood sector has among the lowest levels ofproductivity in the region. Productivity is a function ofmanagement, production technology, labor skills, andscale economies. Management could be improved iffirms could hire foreign managers and consultants atsubsidized costs. Technology transfer mechanismsfor doing so are available, but they are not used inBhutan at present (see chapter 3). Production tech-nology could also be improved. Given consistent pol-icy, firms are prepared to invest in equipment—andthey can obtain the knowledge about what equipmentto buy and where to buy it by hiring foreign managersand consultants. With these improvements, labor skillscould be upgraded. And scale economies could bedeveloped if semifinished products could be exportedand firms become aware of market opportunities forgoods produced in volume.

Market DemandMarket demand for wood products exists in neighbor-ing countries, but Bhutanese firms lack adequatemarket awareness and marketing skills. Firms special-izing in the construction industry noted that India’s de-pends on imported timber for 60–70 percent of itsneeds and that this share is growing as a result of theopening of the Indian market. In Bangladesh, wherethe market is sizable compared with Bhutan and inter-national trade is based on the U.S. dollar, timber isscarce, machine operators are more expensive than


in Bhutan, and firms are no more efficient than Bhutan-ese firms. The potential for different product cate-gories is mixed at the current performance levels inthe sector:

• Particle board. Particle board from Europe is in-creasing the competition for Bhutanese exports inIndia, but prospects in Bangladesh (especially inthe donor community) are good as long as satis-factory trade agreements go into place.

• Plywood. In the Indian market Southeast Asianand European plywood suppliers are creatinggreater competition, as are local cottage indus-tries. Typical Bhutanese exporters have seen theirsales decline significantly in the past three years,reportedly because of unfavorable governmentpolicies. One firm reported that its plywood istwice as expensive as Indonesian and Malaysianplywood in the Indian market.

• Face veneers. Bhutan now imports face veneers,but Indian firms would like to establish export firmsin Bhutan if government regulations permit this,signifying good potential for veneer manufacturing.

• Blockboard. Bhutanese blockboard falls within therange of competitiveness. The Bhutanese pricefor 19-millimeter blockboard is Rs 385 per squaremeter, compared with a range of Rs 150–450 inIndia. One firm that set up a plant after the exportban on semifinished products reported that itsblockboard sells for slightly more than that ofIndian competitors, but is of better quality—thekey to market penetration. As noted, the marketpotential of Bhutanese blockboard is constrainedby the growing demand for single-species cores.

• Panel doors. Bhutanese panel doors and windowsare competitive in India, though firms’ inability toexport frames (which fall under the export ban onsemifinished products) limits their potential.

• Moldings. Demand for moldings is high, espe-cially in Bangladesh, where firms specializing in

moldings have difficulty getting timber and oneleading firm has closed. But exports of moldingsfrom Bhutan are presently banned.

• Furniture. Many firms see the best potential inexports of knock-down furniture. While there arelong-term prospects, today all firms lack the nec-essary design and marketing skills and, almostwithout exception, production skills.

• Handicrafts. Wood handicrafts have good marketpotential. For traditional products possible distri-bution channels include museum shops and ven-dors of Buddhist supplies. Wooden containers,which could be produced from timber offcuts,have potential as packaging for food products.Developing this market will require improving de-sign and merchandising, which could be donethrough technology transfer mechanisms.

Policy and Business EnvironmentThe policy environment imposes the biggest con-straint on the potential of the wood sector. There canbe no meaningful development without better andmore consistent policy. Once policy is put right, thebusiness environment is generally favorable. Thetrade regime is generally conducive to exports. Forexample, firms that truck goods to Mumbai reportedno transport problems. But some details in theSAARC trade agreement may not be favorable to the wood sector (for example, particle board ex-ported to Bangladesh is subject to the 765 tariff). Andtransshipping goods at borders is an unnecessaryproblem.


The recommendations that follow relate to areas ofconcern for private manufacturing industry. They donot consider forestry policy and policy implementa-tion, which are beyond the scope of this report.


Improving the Availability of Preferred RawMaterials

Reconcile the Roles of the Forestry Devel-opment Corporation. The Forestry DevelopmentCorporation fulfills contradictory roles as an agent forthe Ministry of Agriculture’s forestry policy and anagent in the development of the manufacturing indus-try. These roles should be examined and reconciled.

Better Match the Industry’s Timber Needs.The Ministry of Agriculture and Forestry DevelopmentCorporation should make available, through auction,the industry’s preferred species, grades, and sizes oftimber in single-species lots. This would require regu-larly auditing the industry to identify the species,grades, and sizes of timber it needs; minimizing thetime from felling to auction; and informing the industryin advance of the species, grades, and sizes likely tobe made available for auction so that firms can per-form medium-term planning. The Forestry Develop-ment Corporation believes that it could make medium-term information available based on the plans offorestry management units.

Give the Forestry Development Corporationthe Tools It Needs. The Forestry DevelopmentCorporation, to carry out its work effectively, needselectronic systems to help audit the industry’s require-ments and disseminate information on auctions tolocal and international buyers, equipment and humanresources to carry out its auctions more efficiently, andthe ability to speedily dispose of timber (through inter-national open auctions or by other means) that doesnot meet the needs of local industry.

Since it makes little sense for the ForestryDevelopment Corporation to introduce recommendedpractices if it lacks the resources to implement them,or to implement some and not others, it may be bestto introduce new practices in pilot areas or depots tominimize cost. Pilot schemes should be monitored,

assessed as to their costs and benefits, modified asneeded, and then rolled out when proven. Externalfunding to implement the recommendations should besought where needed.

Ensuring a Supportive Policy towardManufacturers

Ensure That Policy Is Planned, Phased, andConsistent. Because firms need to plan their activ-ities up to 10 years ahead, and financial institutionsneed assurance that changes in government policywill not unreasonably affect their risks, policy changesneed to be introduced in a planned, phased mannerafter consultation with those affected. In addition, theactivities of all government agencies dealing with thewood sector—whether as suppliers or as end users oftimber—need to be coordinated (there should be co-ordination between the Ministry of Agriculture and theMinistry of Trade and Industry, for example). And theimpact of construction projects and government pro-curement on the manufacturing industry—the respon-sibility of several ministries—should be forecast andthe results communicated to those affected.

Remove the Ban on Exporting SemifinishedProducts. Semifinished products have an importantrole as a source of income for manufacturers, as a ve-hicle for introducing new technology and upgradingworker skills, and as a means for developing market-ing skills and penetrating foreign markets. To enablefirms to reap the potential benefits of semifinishedproducts, the ban on their export should be replacedwith other measures to control the export of un-processed and primary processed products, such asimproved monitoring of timber movements.

Renegotiate Trade Agreements. Provisions inbilateral and regional trade agreements that hamperthe export of value added products should be rene-gotiated. And the haulage of goods across borders

should be simplified to reduce delays, damage togoods, and unnecessary costs.

Privatize the Forestry Development Corpo-ration’s Sawmills. Since the public sector shouldseek to withdraw from activities that can be better un-dertaken by the private sector, consideration shouldbe given to privatizing the Forestry DevelopmentCorporation’s sawmills. Indeed, these sawmills maybe impeding the flow of private investment intosawmilling.

Design Government Purchasing to AwardQuality. Measures should be introduced to givequality a premium in awarding contracts to industryand to encourage the processing of building productsat factories rather than construction sites For exam-ple, independent monitors could annually rank ap-proved contractors and award them points for qualityand for such things as after-sales service. Thesepoints could be translated into a price premium whencontractors bid for government contracts.

Strengthen the Dialogue between Industryand Government. The dialogue between the gov-ernment and the private sector should receive greateremphasis. The establishment of a wood sector asso-ciation has been an important step forward. To ensureits effectiveness, the association should concentrateon a few key issues for a specific period when lobby-ing government while ensuring that these issues aresupported by all interests. When different tiers in in-dustry have different priorities, less is achieved.

Pursue Forestry Certification. To help attractforeign direct investment and, in the longer term, as-sist manufacturers in penetrating foreign markets, theforestry department should identify, and plan to intro-duce over time, the measures needed to obtain certi-fication of sustainable forest management from suchorganizations as the Forestry Stewardship Council.

Improving Access to AppropriateTechnology and Labor

Introduce Mechanisms and Incentives forTechnology Transfer. The government could en-courage the private sector to acquire technology, hirecompetent management, and train workers by provid-ing or supporting incentives and mechanisms fortechnology transfer. These could include matchinggrant schemes, schemes relying on retired execu-tives, the hiring of skilled foreign staff, and foreign di-rect investment. Eligible activities could include de-sign, training, production, marketing, management,the development of joint ventures, and the develop-ment of business associations. Such efforts shouldemphasize primary processing (sawmilling and kiln-drying). And they should foster process-specific train-ing, especially short courses on a single topic for afirm or group of similar firms. These mechanismscould be supported by the World Bank (which hassupported matching grant schemes in many othercountries), tax breaks, a levy on auction sales, or acombination of these.

Ease Immigration Restrictions. Immigration reg-ulations should be eased to facilitate the entry intoBhutan of foreign buyers and technology providers.

Notes

1. Petri Lehtonen, “Bhutan Forest Policy Review” (In-ternational Development Association, Washing-ton, D.C., and Swiss Development Corporation2000).

2. There is no concrete evidence that sawn timberprices are high. A consultant to the Bhutan For-estry Institutional Development Initiative recentlyconcluded that sawmills’ pricing was reasonable.In addition, a Bhutan mission to Switzerland foundthat a sawmill was selling timber for more than



three times its purchase price, while in Indonesiasawn rubberwood is sold for more than four timesthe price of logs.

3. These figures are based on a small sample. More-over, the product lines vary, with “Woodcraft-trained” firms producing Woodcraft-inspired de-signs and the other firms making other types offurniture.

4. But some Bhutanese producers are adding valuethrough timber selection, processing, design, andmarketing. In the Thimphu weekend market plain,

new, turned wooden bowls sell for prices rangingfrom $3,492 to $508,000 per cubic meter.

5. Firms reported, however, wanting a continuedsupply of the same species so that they couldspecialize.

6. Tyler Biggs, Margaret Miller, Caroline Otto, andGerald Tyler, Africa Can Compete! Export Op-portunities and Challenges for Garments andHome Products in the European Market, WorldBank Discussion Paper 300 (Washington, D.C.,1996).





6. Tourism 90

6. Tourism 91

Bhutan represents a unique tourism product—a pris-tine environment, high mountains, excellent trekkingroutes, nature parks with rare and endangeredspecies, a culture considered both rich and unique,and the natural warmth and friendliness of theBhutanese people. With these resources, tourism of-fers important earnings potential for the country. Butthe sector has always been, and will continue to be,developed with an eye toward the high-end tourismmarket. The focus on small numbers of high-payingtourists is dictated by several factors. Most importantis Bhutan’s desire to ensure that its cultural heritage isnot overpowered by large numbers of visitors enteringthe country—overwhelming and even “polluting” thisnation that has only recently begun to cautiously openup. The Nepalese model of more or less unregulatedbackpacking tourism is not one that the governmentof Bhutan wishes to pursue. In addition, Bhutan haslimited facilities and services (roads, hotels, airlineservices) and cannot cater to a large number oftourists.

Present Situation

Bhutanese tourism began only around 1974, whenseveral lodges were built for foreign dignitaries com-ing to Bhutan for the king’s coronation. It was given aboost in 1988, when the national airline, Druk Air,began its jet plane operation. Before this tourists hadto come into the country by road. Bhutan had only onetourism operator, the Bhutan Tourism Corporation,until 1991, when that company was privatized and themarket opened to private competition. At the time 35companies applied for tourism licenses, and after twowere canceled, 33 companies operated throughoutmost of the 1990s. In January 1999 the governmentfurther liberalized entry, dropping a requirement thattour operators provide a bank guarantee of Nu100,000 (a condition intended to ensure that only se-rious operators received a license), and the market

now consists of around 75 domestic tour operators.Not all are active players, however, and only a hand-ful are of any real size (see appendix table A4.1).

Growth of TourismAs a result of these policies and other factors, Bhutanreceives only a small number of tourists. Still, touristarrivals grew rapidly over the past decade, with ar-rivals by air increasing by an average of more than 17percent a year—though from a very small base (seefigure 6.1 and appendix table A4.2). In 2000, a recordyear, nearly 7,600 tourists came into Bhutan by air,and another 13,000 by road from India.

Despite the growth in tourism, most hotels remainsmall and underused. The country has an estimated560 hotel rooms, which should permit 204,400 roomnights to be sold annually. In 1997, however, the in-dustry sold at most 37,000 room nights (with 5,363tourists spending an average of seven nights each),assuming that each tourist stayed in a separate room.Even with this unrealistic assumption, occupancy rateswere less than 20 percent, against an industry bench-mark of 60 percent.

Anecdotal evidence suggests that tourists comingto Bhutan tend to be professionals or retirees. But staffof the Ministry of Trade and Industry’s Department ofTourism believe that this profile is slowly changing tothat of a family tourist. Although rankings havechanged over time, tourists from Europe, the UnitedStates, and Japan tend to be most important forBhutan. In 2000, for example, Europeans made up 38percent of tourists (Germans, 8.8 percent; British, 7.9percent; French, 5.3 percent; Dutch, 4.7 percent; andItalians, 2.1 percent), Americans 36 percent, andJapanese almost 12 percent (see appendix tableA4.3). Americans tend to stay for longer periods, andJapanese for shorter periods. Repeat tourism is ap-parently low, possibly because of the high cost of trav-eling to Bhutan and the relatively low quality of tourismservices (a recent study states that the average hotelin Bhutan “would struggle to reach 2-star status”).

6. Tourism 92

Recent DevelopmentsAn important recent development has been the ap-proval of two new joint ventures in the Bhutanese hotelindustry. In a first for the country, the foreign owners(both based in Singapore) will be permitted to hold amajority 60 percent share in the Bhutanese operation.Of the remaining 40 percent share, a minimum of 10percent will be sold on the local stock exchange andthe rest sold to a local promoter. The foreign investors,both involved in hotel chains in Asia, are expected toprovide high-cost, high-quality service in a chain ofhotels across the country (including in Bumthang,Paro, Phunaka, Thimphu, and Trongsa). This foreigndirect investment could well have a big impact in rais-ing standards in Bhutan (30 employees who will workin the new hotels are undergoing training in Sin-gapore) and shaking up the local industry. The hotelsare expected to begin operation during the Ninth Five-Year Plan period.

The tourism sector is overseen by the TourismDevelopment Committee. Chaired by the minister oftrade and industry, this multisectoral committee in-cludes representatives from the Finance Ministry, theHome Ministry, and the private sector, reflecting theimportance of the sector to the economy. A tourismdevelopment fund, raised through a one-time $10 levy

on tourists, is managed by the Department of Tourismfor the development of public goods in the industry.The department also provides training in such areasas trekking, cooking, and guide services.

The Department of Tourism is drafting a tourismpolicy, expected to be completed in early 2002. Atourism master plan is expected to be ready in time forthe Ninth Five-Year Plan. A challenge for Bhutan willbe to define a balanced national policy. This policyshould allow for a modest increase in tourists up to the total available hotel capacity throughout the year. Achieving this goal will require promotion cam-paigns to increase business, particularly during thelow season.

Legal EnvironmentWith tourism established less than 30 years ago, noformal laws have been enacted to regulate the sector.This offers some advantages in flexibility. But over thelonger term putting in place a comprehensive set oflaws governing tourism would be desirable. Othercountries offer many good legal precedents that couldbe researched through the World Tourism Organi-zation. And Bhutan has the outline of a regulatory sys-tem that could provide a partial basis for future laws.The regulations in force include the following:

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Figure 6.1 Tourist Arrivals, Bhutan, 1985–2000

6. Tourism 93

• Trekking in Bhutan Regulations, 1996, which spec-ify reasonable conditions and provide a good ap-proach to protecting the environment.

• Bhutan Filming Regulations, 1995, which take avery restrictive approach, with conditions that dis-courage visits by overseas film and televisioncompanies. In stark contrast, most other touristdestinations promote such visits.

• Rules for Familiarization Visits by Overseas TravelAgencies, 2000, which are restrictive and need tobe liberalized. Travel agency owners and counterstaff should be encouraged to visit Bhutan. In-deed, groups of up to 20 people, including travelwriters, should be encouraged to visit at the sametime.

• Bhutan Tour Handlers, which reflects greatly re-laxed rules for issuing licenses in recent years. Asa result of the liberalization, the number of tour op-erators has increased sharply relative to the vol-ume of business (31 operators managed between40 and 1,322 clients each, while 45 looked afterup to 40 clients each). A case now exists for halt-ing future license applications and encouragingsmaller tour handlers to merge and thus increaseprofitability.

EmploymentLike the rest of the private sector in Bhutan, thetourism industry reflects little organization of employ-ees or employers. Trade unions do not exist, and hote-liers are not yet fully organized. Data are available onemployment in the hotel sector (table 6.1) but not inother tourism activities.

Nonetheless, informal discussions with hotel own-ers and tour handlers gave some indication of the em-ployment situation in tourism. Employees earn verylow wages (a chef earns $0.83 an hour, and a porter$0.14) and work long hours (13 hours a day, 6 days aweek). The industry has an overreliance on untrainedstaff and provides virtually no formal training; mosttraining takes place on the job. For senior staff, train-

ing is limited to short courses overseas. As a result,establishing more formal training facilities in Bhutan isgenerally considered highly desirable.

Because many Bhutanese workers are reluctant toundertake menial work, such as cleaning, the industryrelies on Indian workers, who are prepared to bothwork for minimal wages and undertake menial tasks.

Contribution to the EconomyTourism receipts and royalty payments to the govern-ment provide an important source of revenue for thecountry and the government budget. In 2000 tourismproduced gross foreign exchange earnings of $10.5million—up 18 percent from the previous year, the ap-proximate growth rate for the 1990s. These earningsmake tourism Bhutan’s most important source of hardcurrency receipts from exports of goods and services.(While electricity brings in more foreign exchange, it issold in rupees, which are not considered a hard cur-rency. And while donor receipts are a significantlylarger source of hard currency resources, they are notof course export earnings.)

Moreover, these receipts exclude importantsources of hard currency earnings from tourism, in-cluding airfares on Druk Airlines and spending bytourists once they are in the country (on drinks, sou-venirs, handicrafts, and the like). Including these re-ceipts might almost double the hard currency earn-ings from tourism. In other countries similar in size toBhutan tourist spending on souvenirs alone commonlyexceeds 10 percent of gross earnings in the industry.

Type of staff Employees

General 678

Skilled 612

Unskilled 135

Total 1,425

Table 6.1 Employment in the Tourism Sector,Bhutan

6. Tourism 94

The government’s royalty share of these receiptsamounted to $4.1 million in 2000, purportedly makingtourism the fourth largest source of domestic revenueafter Chhukha Hydro Power, the Department of Power,and Telecommunications (table 6.2). Indeed, govern-ment receipts from tourism have been growing evenfaster than hard currency earnings—rising by 33 per-cent a year on average over the nine-year periodbetween 1991 and 2000. The government’s share ingross earnings from tourism has also been slowly in-creasing, reaching around 40 percent in 2000.

All these numbers on tourist arrivals and earningsexclude Indian tourists. Since Indians can enterBhutan without a visa and there is little control overtheir entry, it is difficult to collect data on Indians whovisit Bhutan and to differentiate between those whoenter as tourists and the many who enter daily forother reasons (such as work). Although the Depart-ment of Tourism estimates the number of Indian

arrivals as high as 13,000 a year, it has no data on their possible financial contribution to the tourismindustry.

Current Government PolicyThe government’s current policy on tourism is definedin the Rules and Regulations for Tour Operations,1999:

While tourism operations have been liberal-ized consistent with the overall objective ofstrengthening the private sector, sustainabletourism development based on high value,low volume shall remain the guiding principlefor all future tourism policies.

Bhutan maintains a low level of high-end tourismby imposing a high entry price. Tourists coming intothe country must pay, up front, $200 a day during

Government GovernmentGross earnings revenue revenue asfrom tourism from tourism a share of

Tourist (millions of (millions of gross earningsYear arrivals U.S. dollars) U.S. dollars) (percent)

1990 1,538 1.91 — —

1991 2,106 1.99 0.31 15.65

1992 2,748 2.97 0.98 33.10

1993 2,984 3.23 1.13 34.99

1994 3,971 3.97 1.39 35.00

1995 4,765 5.83 2.04 34.98

1996 5,138 6.52 2.32 35.64

1997 5,363 6.55 2.48 37.80

1998 6,203 7.98 3.02 37.83

1999 7,158 8.88 3.46 38.96

2000 7,559 10.50 4.10 39.05

— Not available. Note: Data exclude tourists from India.Source: Bhutan Ministry of Trade and Industry, Department of Tourism.

Table 6.2 Tourist Arrivals and Gross Earnings and Government Revenue fromTourism, Bhutan, 1990–2000

6. Tourism 95

the peak season (February–April and September–November) and $165 a day during the “lean season.”Tour operators are required to give the RoyalMonetary Authority 90 percent of these funds ($180 or$132 per day per tourist), which is exchanged for itsngultrum equivalent; the other 20 percent is used topay the foreign tour operator. These funds can becharged against meals, internal transport, accommo-dation, and guide services. But they do not covertravel to and from Bhutan, the cost of alcohol withinBhutan, or shopping and personal expenses.

The differential pricing policy was reintroduced in1999. But the Department of Tourism feels that de-mand is not sufficiently elastic for the policy to induceenough additional tourism during the lean season toiron out the intense seasonality.

But this lack of elasticity may also result from thesmall difference in price between the two seasons aswell as the government’s requirement for a royalty of$65 from every peak season tourist and $63 fromevery lean season tourist (these royalties are col-lected from the upfront payments). Since some touroperators are suspected of passing along packagesat prices lower than the advertised rates, this com-pulsory payment to the government may well be themore binding constraint. For this reason the Depart-ment of Tourism has recently recommended reducingthe government royalty for lean season tourists to$55.

For the future the government could considerthree possible options for pricing policy:

• Making no change in the arrangements.• Liberalizing the market entirely so that tourists can

gain access to Bhutan in the same way as anyother destination (with only a visa and passport re-quired) and freely choose travel routes, hotels,and meals.

• Striking a middle ground between the first twooptions.

The choice involves complex economic, cultural,and social issues—both positive and negative. Tohelp develop a solution that maintains the high-value,low-volume approach while maximizing revenues fromtourism and reducing seasonality, it is recommendedthat a special commission be established to researchthe issue and come up with recommendations for con-sideration by the government. Such a commissionshould include both public and private sector repre-sentatives as well as an internationally recognizedtourism expert nominated by the World TourismOrganization.

Toward a New Government PolicyThe government’s policy on tourism is at an importantstage. While the tourism industry is controlled by reg-ulations and precedent, the intention is to enact lawsdealing with all aspects of the industry in detail.

Meanwhile, the Department of Tourism has pre-pared an important document listing the issues thatneed to be tackled to put Bhutanese tourism on asounder footing. The document focuses on suchproblems as the lack of new products (new trekroutes), the extreme seasonality of tourism in Bhutan,the lack of private investment (especially in the east),the lack of community participation, the low and un-even standards of tourist accommodation, and thelack of clear policy guidelines and related legislation.To address these shortcomings, the document devel-ops a vision and mission for the sector with well-defined strategies and programs for its development,focusing on building institutional capacity, developingskills, developing and maintaining infrastructure, andstrengthening information and publicity.

But the approach lacks specificity. A more effec-tive strategy, developed after consultation with inter-ested parties, would describe the necessary actions,provide a timeline and estimated costs for implemen-tation, allocate personal responsibility for actions, andincorporate reporting and central monitoring systems.

6. Tourism 96


Comparative data on tourism costs in similar remotelocations in the region show that Bhutan does notcompete for tourist business on the basis of cost(table 6.3). Instead, it is a niche market with great ap-peal to clients seeking a unique experience.

Cost Structure and Revenue SharesMost hotels in Bhutan lose money or just break even,despite the relatively low wage levels, reasonably lowfood costs, and reasonably high room and foodcharges. The main reason is the low hotel occupancyrates, averaging no more than 20 percent annually. Incontrast, the largest tour handlers appear to be quiteprofitable, thanks to their ability to operate with lowoverhead and minimal capital investment.

Indicative data on the distribution of tourism rev-enue (not completely accurate because of assump-tions that had to be made) show that the governmentcollects a large share, 24.5 percent from royalties and

the business sales tax (table 6.4). This is in addition tothe 38.2 percent collected indirectly through Druk Air,the state-owned airline. In the longer-term interests ofthe tourism industry, the government should be en-couraged to calibrate the levy and invest some of thefunds earned from tourism in marketing and productimprovement.

Approximate costCountry (U.S. dollars)

Bhutan 1,260

Lao PDR 960

India 755

Cambodia 615

Nepal 546

Note: The data assume a shared twin room and include allmeals, transport, guide services, and the like but excludeairfare.Source: Various travel agents.

Table 6.3 Cost of a Seven-Day TourismPackage, Selected Countries, 2001

Share of Costtotal (U.S.

Component (percent) dollars)

Roundtrip airfare on Druk Air (Bangkok-Paro) 38.2 779.28

Government royalty 22.3 454.92

Hotel 13.1 267.24

Meals 6.6 134.64

Tour guide and transport 3.0 61.20

Business sales tax 2.2 44.88

Tourism development fund 0.5 10.20

Other costs, including tour operator’s profit 14.1 287.64

Total 100.0 2,040.00

Note: The data assume individual purchases of an all-inclusive Bhutan vaca-tion from an overseas retail travel agent based in Bangkok, travel during thepeak season, a group of eight people, and couples sharing a room.Source: Various tour operators.

Table 6.4 Breakdown of the Cost of a Seven-Day Visit to Bhutan, 2001

6. Tourism 97

Factors Critical for SuccessSeveral factors are critical to the competitiveness ofBhutan’s tourism sector, including the reputation of thecountry, its accessibility, the accommodation stan-dards, visitor attractions, and synergies between dif-ferent elements of the private sector development pol-icy. (See appendix table A4.4 for an assessment of thetourism industry’s strengths, weaknesses, opportuni-ties, and threats, and appendix table A4.5 for theresults of a small visitor survey undertaken for thisreport.)

Reputation of the Country. Many potentialtourists, even well-traveled professionals, are unawareof Bhutan’s location or its features. In line with the gov-ernment’s policy of high-value, low-volume tourism, agenerally low-key approach to marketing has beenadopted. Bhutan relies almost exclusively on the ef-forts of overseas retail travel agents to create touristbusiness for the country (table 6.5). Bhutanese tourhandlers make contact with these agents at tourismtrade fairs held annually in London and elsewhere.These efforts are assisted by the Department ofTourism and the Bhutanese Tour Operators Assoc-iation, which contribute toward travel costs and theleasing of space at the trade fairs. The low hotel oc-cupancy rates and the possibility of routing moretourists through land entry points (because of thelimitations of the Paro airport) suggest that a well-

organized, focused marketing campaign could in-crease business to close to current capacity.

The reputation of a country not only depends onits own efforts, however. It is also affected by events in other countries in the same region, as confirmed by events surrounding the 2001 World Travel Market(box 6.1).

Accessibility. As noted in chapter 3, access toBhutan is limited, particularly by air. To make the bestuse of the limited air travel resources, it is important tospread the tourist season more evenly through theyear. Several steps could be taken to do so, such asresearching patterns of tourism in similar destinationsto see how these countries spread the market, andidentifying features present in Bhutan in the low sea-son and promoting these to special interest groups,such as ornithologists and groups interested inBuddhism or traditional medicine.

Accommodation Standards. Standards of ac-commodation are generally poor, particularly for high-priced tourism. Improving standards is important (andthe new foreign-supported hotels will do so). But thereare ways to make basic accommodation a feature ofthemed vacations, with tourists traveling to differentparts of the country to stay in rustic accommodationsand eat food traditional to the area. And hotels couldupgrade services to compensate for poor physicalamenities.

Visitor Attractions. Tourism activity in Bhutan fo-cuses mainly on outdoor pursuits, such as trekking,touring, and cultural events. But complementary ac-tivities are increasing, including museums, craftshops, historical monuments, open air markets, andmusic and dance training institutions. All these en-hance visitors’ experience and greatly improve theprospects for low-season tourism. To increase tourismand help secure repeat visits, efforts to develop new

Location Agents

United States and Canada 10

United Kingdom 8

Germany 2

Other European countries 4

Australia 1

Source: Lonely Planet Guide

Table 6.5 Overseas Travel Agents ServingBhutanese Tourism, by Location

6. Tourism 98

products—such as a showcase monastery and a one-stop Bhutan experience center—should continue.

Synergies. Given Bhutan’s limited resources for de-veloping industry, whether tourism or manufacturing, itis important to seek synergies between different ele-ments of private sector development so that activitiesin one area develop opportunities in another. For ex-ample, tourists who had visited Bhutan could becomecustomers for its niche exports, and wood productscould be developed as souvenirs. In the Caribbeanwood handicrafts valued at $11.5 million are sold totourists each year.


Big advances have been made in developing tourismin recent years, but impediments to growth remain.These include the seasonality of the market, the lim-

ited access to Bhutan, weaknesses in the infrastruc-ture for tourism, and poor standards of accommo-dation. And the proposed new structure of theDepartment of Tourism could either stimulate the de-velopment of tourism or constrain it.

Seasonality of the MarketThe two main tourist seasons—spring (March–May)and autumn (September–November)—coincide withimportant festivals in Paro in March, in Thimphu andWangdue in late September and early October, andin Bumthang in November. The extremely bimodalpattern of tourist entries is further exacerbated by the monsoons in June–August and the colderweather in the Himalayas in December–February (figure 6.2). Also contributing to the seasonality,Bhutanese tourism is often sold as a package withvisits to India and Nepal, where tour operators havetraditionally targeted European and North Americantourists for spring and fall. Indeed, with its limited

In many countries the government and the private sectorwork together in marketing tourism. At one of the sector’sleading showcases, the World Travel Market in London, for example, private operators often exhibit in “nationalspace” that the exhibitors’ government has coordinated, ifnot partly funded. Bhutanese travel firms reported that theBhutanese government does less in this way than the gov-ernments of competing countries—a policy stance theylamented, particularly given the income the governmentearns from the sector.

Bhutanese firms represented at the World TravelMarket in November 2001 saw the show as a good op-portunity for the government to “fly the flag.” The timingwas good, they said, for capturing market share from othercountries in the region where political events have ad-versely affected business—and for filling the resultinggaps in the product offerings of tour operators specializ-ing in countries along the Himalayan chain.

International tourism specialists at the World TravelMarket supported the views of these private Bhutanesefirms, saying that at times of difficulty in the trade, it is es-sential for governments to support their private sector.And 2001, they confirmed, was just such an occasion,with the effects of the economic downturn in Europe andthe United States exacerbated by political conflicts. Theypointed to a need for general image building given thepublic’s scanty knowledge of the region and confusionover the location of Bhutan, Kashmir, Afghanistan, andNepal. And they cited the example of Ireland, whose gov-ernment, recognizing that 2002 would be a “very chal-lenging year for tourism,” allocated an additional $11 mil-lion for marketing.

Box 6.1 Public-Private Cooperation in Marketing Tourism

6. Tourism 99

tourism marketing, Bhutan is to some extent at themercy of the tour operators in these two neighboringcountries.

Limited Access to BhutanAccess to Bhutan is complicated in part becauseDruk Air is the only carrier flying into the country. Theauthorities claim that it is not their intention to excludeother carriers, but that regional and other carriershave very little interest. The lack of interest is due tothe intense seasonality of passenger traffic, the needfor special planes to negotiate the landing strip inParo, and the perceived lack of commercial viability ofsuch a route.

In 2001 access was further complicated becauseDruk Air, which normally operates two airplanes, hadhad one of its planes out of commission for more thana year. That meant that in September 2001 only one75-seat airplane was serving the country. While thatwould not be a problem during six months of the year,during the tourist season Druk Air can hardly handlethe volume of passengers with two airplanes. The re-sult has been delays and other inconvenience fortourists, which could damage Bhutan’s reputation as atourist destination.

During the spring 2001 season Druk Air chartereda 19-seat aircraft from Buddha Air, a private Nepalesedomestic airline, to help relieve the pressure. Greateruse of external airlines during the peak season couldbe one way to relieve the access constraints createdby Druk Air’s limited seating capacity. But the peakseason in countries such as Nepal, the most likelysource of the additional seating capacity, is likely tocoincide with the peak season in Bhutan, possibly lim-iting the availability of extra capacity.

Druk Air intends to purchase two new aircraft inthe foreseeable future (with a substantial impact onthe country’s holdings of foreign exchange reserves;the cost of the two aircraft is estimated at $35 million,more than 10 percent of the approximately $300 mil-lion in reserves). Tellingly, Druk Air, which has tradi-tionally operated at a loss, reportedly did better finan-cially during the 12 months in which it operated onlyone aircraft rather than two.

Inadequate Infrastructure for TourismThe quality of a country’s infrastructure has a profoundeffect on the development of its tourist industry. Bhutan’s infrastructure creates some impediments totourism.

0

500

1000

1500

2000

2500

Janu

ary

Febru

ary

March

AprilMay

June Ju

ly

Augus

t

Septem

ber

October

Novem

ber

Decem

ber

Arr

ival

s

1998

1999

2000

Note: Date exclude tourists from India.

Figure 6.2 Tourist Arrivals by Month, Bhutan, 1998–2000

6. Tourism 100

Roads. The construction and maintenance of Bhu-tan’s main and secondary roads pose formidable en-gineering challenges, mainly because of the country’sterrain. Upgrading the roads will take many years andsubstantial financial resources. The courtesy and gooddriving skills of most bus and truck drivers help allevi-ate the problems of poor roads. Nonetheless, poorroads and landslides can sometimes inconveniencetourists entering and traveling around the country.

Aviation. Druk Air operates in difficult circum-stances. It must contend with the challenge of flyinginto the high-altitude airport at Paro, the lack of facil-ities for night flying, the lack of a convenient alterna-tive airport for planes diverted by fog, the high fuelcosts of operating its two Aerospace 146 aircraft, andthe need to reduce seating capacity on its planeswhen temperatures are high. And it must contendwith what is known as the “Druk Air paradox”: itsbusiest flying times coincide with some of the worstperiods of unpredictable weather, making flying intoParo (which must be done visually) particularly diffi-cult. International aviation consultants with experi-ence in flying aircraft at high altitudes should adviseon issues relating to additional airport sites, types ofaircraft (including helicopters), landing pads, and thelike.

Telecommunications. Although Bhutan has mademajor investments in telephone and information tech-nology systems in recent years, standards fall short of international requirements. Hotel bedrooms lackdirect-dial telephones, international calls have poorsignal quality, there are no Web sites allowingprospective tourists to make Internet bookings, andthe mobile phone network is limited.

Emergency Services. Tourists and travel agentsexpect emergency services to be readily available inmost destinations—modern hospitals, ambulances

(including helicopters), traffic police, and emergencyphones along roads. Bhutan has few if any of theseservices. It is recommended that a committee, rep-resenting all the interests involved, be established to develop suggested actions for addressing this issue.

Internal Transport. Private transport services, re-lying mainly on minibuses, offer the main means oftransport from towns to more remote rural areas. Butonly a limited number of tourists, mostly among thoseoriginating from India, use this type of transport.Private bus operators cited several difficulties, includ-ing the government’s fixing of fares at uneconomiclevels, the requirement to operate particular serviceseven if there are no passengers, the loss of some ser-vices because of terrorism close to the Indian border,the growing competition from private car owners, andthe poor road conditions.

Finance and Banking. The two banks in Bhutanoffer an array of basic banking services. But the lim-ited acceptance of credit cards, and the extremelyhigh service fees charged where they are accepted,impose big limitations, particularly for making book-ings on the Internet. The lack of cash dispensing ma-chines, widely used by tourists in other countries, alsoposes difficulties.

Poor Standards of AccommodationHotel accommodations, generally viewed as poorvalue for money, need improvements. In addition, theinternal grading system for “international” hotels islimited: grades A, B, and C exist, but the differencebetween one category and the next is small. Most ho-tels would qualify for only a two-star internationalgrade. While bedrooms are generally adequate insize, shortcomings are apparent: beds are of poorquality, plumbing fixtures are substandard, many staffhave limited training, and the décor is often dull.

6. Tourism 101

Inefficient Management Structure of the Department of TourismThe institutional structure of the Department of Tourismis complex, with staff at different levels reporting to thedirector (figure 6.3). Moreover, the structure makes nospecific provision for marketing, a high priority.

A proposed new structure, based on commercialmodels that have worked in other countries, couldbetter serve the needs of the tourism sector (figure6.4). The proposed structure clarifies functions andemphasizes marketing rather than regulation. And if apublic-private tourist development board was estab-lished, the structure could easily be adapted for thatentity.

Organizations with interests in tourism and the en-vironment should have an advisory role in any newstructure. Such organizations include the BhutaneseTour Operators Association, the Natural EnvironmentCommission, the Royal Society for the Protection ofNature, the National Commission for Cultural Affairs,the Association of Hotel Owners, and the BhutanChamber of Commerce and Industry.


The following measures could enhance tourism inBhutan.

Support staff

AccountsSection

Visa and StatisticsSection

Director

Operation Division

Information andPublicity Section

Assistantprogram officer Assistant visa

officer

AccountantAccountant tourpayment

Assistantprogram officer



Staffingprogram officer

Infrastructure and HotelDevelopment Section

Nature and AdventureTourism Section; Tourism

Development Program

Plans and Program Division

Pool staff: office secretary, dispatcher, messenger, drivers (3)

Figure 6.3 Organogram of the Bhutan Department of Tourism

6. Tourism 102

Strategic Actions• Devise and implement a comprehensive master

plan for tourism, including product developmentand marketing. The plan should focus on devel-oping new marketing and sales arrangements,making maximum use of information technology,reducing seasonality by expanding activities forvisitors, raising annual hotel occupancy rates toup to 70 percent, providing training in tourism, of-fering more dependable air access, improvingroad standards, encouraging more travel by roadfrom India, and introducing new products.

• Restructure the Department of Tourism to conformwith international best practice.

• Establish a training resource, such as a training in-stitution or a partnership with a foreign training in-stitution, that could provide training in tourism witha Bhutanese orientation.

• Encourage the establishment of employers andemployees organizations in tourism, particularly inthe hotel industry.

• Seek the advice of an international consultant onBhutan’s aviation and airport needs.

• Seek the advice of a specialist group on the futureoperation of internal transport, including the pric-ing policy.

• Establish an advisory committee for developingemergency services.

Executive BoardChairman, minister of trade and industry

Subcommittee of government policymakers

Director Tourism Advisory Council

Division 6Division 5Division 4Division 3Division 2Division 1

Senior executiveAdministration

Senior executiveFinance andinformationtechnology

Senior executiveHuman resources

and training

Senior executiveNew product

development andimprovement

Senior executiveRegulations,standards,transport,and visas

Senior executiveMarketingand sales

Tourism InnovationCenter

Statistics andInformation

Note: Only the senior management line is shown. Another option would be to establish a tourism development board with this structure, though governed by an independent board (with government and private sector nominees).

Figure 6.4 Proposed Organigram of the Bhutan Department of Tourism

6. Tourism 103

• Further develop ecotourism as a major promo-tional element.

• Establish consultative mechanisms for all tourism-related organizations.

• Introduce an incentive scheme to encourage theupgrading of hotels.

• Further explore the potential of tourism related toBuddhism.

New Product Development• Develop an existing or purpose-built monastery as

an interpretive center (with actors and audiovisualfacilities) with the cooperation of the religious andother local authorities.

• Establish a new form of evening entertainment fortourists in an appropriate setting, with a meal,music, folklore, and dance.

• Develop new visitor attractions in Phuentsholing toextend visitors’ stay beyond one night (such asthe Buddhist temple in the town square, theKharbandi Monastery, and demonstrations ofpaper and incense making).

• Provide a one-stop Bhutanese experience centerto present art, music, folklore, history, religion (in-cluding scenes from religious festivals), themonarchy, and the future vision for Bhutan.

• Develop an international Buddhist research andconference center to promote the tantra ofBuddhism—the code for living and system of val-ues that still dominates nearly every aspect of lifein Bhutan, including the arts, annual festivals, lit-erature, and the laws of the land.

• Develop ecotourism products further along thelines suggested at the September 2001 workshoparranged by the Department of Tourism—includ-ing devising organizational strategies to coordi-nate all organizations involved; developing prod-ucts such as a protected habitat for black-neckedcranes and traditional medicine products andhealth centers; expanding domestic tourism; us-ing new marketing tools, particularly the Internet;

and developing human resources in the areasidentified.

• Continually upgrade attractions, including byadopting seven-day schedules, introducing cos-tumed guides, and the like.

Marketing• Devise and implement a comprehensive market-

ing and sales campaign—including developingan expanded database of potential overseas retailagents using the Internet and specialized directo-ries; publishing editions of Bhutanese Travel Newsin hard copy and on the Internet; using email forregularly disseminating special offers and infor-mation; sending ad hoc sales teams on regularvisits to overseas travel agents; inviting travel writ-ers from key markets to Bhutan; and developingtourism literature consistent in design, content, andquality.

• Liberalize regulations on filming in Bhutan and onfamiliarization trips by travel agents and writers.

• Create a comprehensive new database on tourismto measure and monitor all aspects of the industry.Some work is being done but needs to be streng-thened. The effort would benefit from recruiting aconsultant, ideally from a national tourism organi-zation, to design and establish a suitable monitor-ing system for the industry and to train local staffto manage and update it. The data should covertourists—their numbers and their country of origin,their reasons for choosing Bhutan, their incomelevel and age group, the activities they undertook,and their satisfaction with their experience—aswell as the industry—revenues, performancetrends, hotel occupancy rates, aircraft load fac-tors, and return on hotel and other investments.

• Undertake regular, comprehensive attitudinal sur-veys of tourists.

• Introduce travel reservation systems using theInternet and toll-free phone numbers, both ofwhich could be under the direct control of the

6. Tourism 104

Department of Tourism. The phone system couldhandle calls directly or through a call center, deal-ing with general inquiries and sending literature. AWeb site should allow customers to make real-time reservations, which could then be referred toaccredited overseas travel agents (an equitablearrangement could be devised for distributingbusiness).

• Participate fully in international events such as theUnited Nations International Year of the Mountains2002 or the International Year of Eco-Tourism2002. Some of these events would enable Bhutanto obtain useful technology, and some would alsoprovide opportunities for funded workshops onmatters important to the country, such as the roleof tourism in developing culturally distinct, high-altitude rural areas.

General• Introduce a formal accreditation system in the

tourism trade to foster good standards for promo-tional literature, profit margins, and knowledgeabout Bhutan among staff.

• Encourage banks and vendors to adopt creditcards and provide cash dispensing machines inprimary locations.

• Adequately regulate the Bhutanese tour handlingindustry and promote its rationalization throughmergers of smaller tour handlers.

• Arrange visits and short-term placements in othercountries for tourism professionals, to expose themto other tourism organizations and their practicesand products.

• Establish closer links with the World TourismOrganization (on general tourism issues, includingcomparative data), UNESCO (on cultural and en-vironmental issues), and the International Councilof Museums (on museum practice), all of whichcould support the transfer of new technologiesand methods of doing business.

• Ensure the availability of a range of technologytransfer mechanisms—such as retired executiveprograms, matching grant schemes, and foreigndirect investment—and develop awareness ofthese mechanisms in the tourism industry. In othercountries matching grant schemes have helpedtourism businesses undertake promotion cam-paigns, establish Web sites, develop new prod-ucts, and set up management information sys-tems. For hotels and craft shops, retired executivescould provide training and advice at a very modestcost. (For more information on technology transfer,see chapter 3.)

Information Technology 105


Opportunities 108

The Way Forward 110

7. Information Technology 106

The government of Bhutan sees information technol-ogy and the knowledge-based industries that it en-ables as ideal sources of future economic growth.Information technology both plays to Bhutan’sstrengths and avoids its major constraints. It takes ad-vantage of Bhutan’s disciplined, English-speakingworkforce and relatively developed telecommunica-tions network. Yet it is not limited by the country’smountainous terrain, extreme weather, or geographicisolation. Moreover, information technology servicesimpose little burden on the country’s natural re-sources, supporting the government’s goal of pre-serving the natural environment.

But while the information technology sector offersgreat promise, it is still in its infancy in Bhutan, and thecountry is unlikely to export significant informationtechnology services or knowledge-based products inthe near future. Bhutan has had a late start and mustovercome many challenges to become internationallycompetitive. If it concentrates on developing a com-puter culture and supporting the growth of the infor-mation technology sector, it could set the stage for fu-ture service exports. Meanwhile, rapid developmentof information technology could increase the produc-tivity and competitiveness of private enterprises andimprove the delivery of government services.

Present Situation

First introduced in Bhutan in 1984, computers are nowestimated to number more than 4,000, with most ingovernment offices. Most private firms surveyed alsohave computers, but they tend to underutilize them.Indeed, private firms appear to use computers mostlyas a labor-saving technology. With computers expen-sive and not widely available until recently, a com-puter culture—in which young people in the workforceare comfortable using information technology—hasnot yet developed. The recent reduction in import du-ties on computers and the efforts to make computers

more accessible to students are beginning to improvethis situation. But computer literacy and comfort withinformation technology remain low, and the privatesector still makes little effective use of informationtechnology services.

Among the sampled firms, about 70 percent hadcomputers, with most using them for simple functionssuch as word processing, basic accounting, andother office applications. Almost none had local net-works, used an automated inventory managementsystem, employed computer-aided design, or used in-formation technology in other sophisticated ways. Thenetworks that do exist are mostly in government agen-cies. Of the firms sampled, about 62 percent had ac-cess to email, yet most of these continue to communi-cate mainly by fax and telephone.

A mere 15 percent of firms, mostly in the tourist in-dustry, had Web sites. Outside the service sector ametal firm and a handicraft firm were the only compa-nies with Web sites. Notably, only a third of the com-panies providing information technology services hadWeb sites. That most information technology enter-prises see no value in establishing Web sites indi-cates just how limited computer penetration andInternet access are. All the sites are static—servingonly to advertise—and no company reported con-ducting business over the Web. A few of the more so-phisticated entrepreneurs reported using the Web todiscover new technology and communicate with over-seas vendors, but even this activity was rare.

Bhutan has one Internet service provider, thegovernment-run Druk Net, which began operations in1999. Druk Net provides dial-up service at 33.6 kilo-bits per second (kbps) for the price of a local callthroughout most of Bhutan. There are 64-kbps and128-kbps leased lines available—dedicated lines al-lowing rapid transmission of large amounts of data—but few customers take advantage of them. Of thosethat are taken, most are leased by government agen-cies. Even the banks have not leased lines, though fi-nancial institutions are among the heaviest users of


leased lines in many countries. Druk Net estimatesthat it hosts 30–35 Web sites, mostly for governmentagencies, and this number is unlikely to grow signifi-cantly in the near future. Druk Net maintains around800 accounts and estimates that there are more than 2,500 users.1 In mid-2001 the country had onlysix Internet cafes, four in Thimphu and two inPhuentsholing.

Asked why they don’t make more use of informa-tion technology, firms said they saw too few benefits tojustify greater investment. In manufacturing, mostfirms use old technology, where computerizationwould be inappropriate and would add little to pro-ductivity. The service sector also sees little value in in-vesting in information technology, since most busi-nesses are very small and few consumers haveaccess to computers or the Internet. Moreover, up-grading information technology capabilities involvesbig costs, because all hardware and expertise mustbe imported. Connectivity is another issue. While dial-up service is good and relatively inexpensive,Bhutan’s lack of a data network makes sending largeamounts of data problematic and linking geographi-cally dispersed units expensive.

But the biggest obstacle firms face in building in-formation technology capacity is the lack of skilledprofessionals. The private sector must bring almost allinformation technology professionals from India. Thisis expensive and, because of the strict immigrationprocedures, difficult. Private training institutions haverecently been established in the major towns. Butmost of these focus on training office workers in wordprocessing, accounting, and other basic office skills.Few offer training in programming, database manage-ment, Web site development, or other advancedtasks. Most of the students are school-leavers payingtheir own way to improve their job skills. Few firmssend workers for training, again reflecting the lowvalue most firms see in investing in information tech-nology. Almost all the trainers in the private institutionscome from India.

The Sherubste College has begun to graduate in-formation technology students, but the recently estab-lished Division of Information Technology estimatedthat the class of 2001 at less than 20. All these grad-uates were expected to go to government agencies,not the private sector. One local company reported of-fering a recent information technology graduate asalary more than three times the salary level in thegovernment. But the graduate rejected the offer, pre-ferring a secure government job over what is per-ceived as the risky private sector.

Besides Sherubste College, the Royal Institute ofManagement teaches database management andprovides some training in programming. But theDivision of Information Technology estimated that itwould produce only 12–13 students this year andagain expected most to find employment in the gov-ernment. Thus when private firms do have an interestin hiring computer professionals, they face difficultiesin finding candidates who are suitably trained and will-ing to work for them.

Potential online businesses face obstacles in thefinancial and regulatory systems. The lack of creditcards or other systems makes it impossible to makepayments electronically—even Druk Net is unable toaccept online payments. Banks reported that theyoffer no online services because the lack of demandmakes them uneconomic. Even if they were to offersuch services, foreign currency regulations wouldpose a big obstacle. Tourism often leads the growth of online business. But the requirement in Bhutan touse group travel arranged through registered travelagents reduces the need for interactive Web siteswhere tourists can make reservations. The lack of laws or regulations covering e-commerce and cyberfraud provides another disincentive to pursue onlinebusiness.

Because of the lack of demand, only a handful ofcompanies provide information technology services inBhutan, and most of these train office workers in basiccomputer skills. Fewer than five small firms provide


hardware or services, and their capabilities are limitedto designing simple, static Web sites and installingbasic networks. With little demand for other services,there is little incentive to develop more sophisticatedofferings. No firms export information technology ser-vices or are seriously considering doing so.

Opportunities

So, given the state of information technology servicesin Bhutan, what can be said about the government’sdesire to see an export industry develop? Informationtechnology export businesses in developing countriescan often be grouped in two general categories. First,small firms using skilled professionals to serve nichemarkets in programming, software development, Website design, or other specialized applications. Andsecond, bigger companies using large numbers ofless skilled workers to carry out such operations asdata entry, digital encoding, or call centers.

The competitiveness of small programming firmsrelies on low-cost skilled workers who can turn outhigh-quality products in a short time. These firms oftensubcontract for companies in industrial countrieswhere wages are extremely high. In Madagascar, forexample, a young industry is designing interactiveWeb sites for companies in Belgium and France. Thecost of good information technology professionals inMadagascar is only 10–20 percent of the cost inFrance and on par with that in India. And Madagascaris one of the few low-cost countries with a good-qual-ity, disciplined workforce that speaks French. Bhutanmight seek to play a similar role for English-speakingcountries.

But carving out a niche in this market will be diffi-cult—many low-cost countries with an English-speak-ing workforce are already competing in the market.Bhutan’s neighbor India is the biggest of these. Hiringthe information technology professionals Bhutan

would need from India would require paying Indianworkers sufficiently high wages to attract them toBhutan (as well as dealing with the immigration for-malities of bringing them in). Some of the training in-stitutions in Thimphu pay Indian instructors four timesthe wages they were receiving in Calcutta. These areskilled workers with five to seven years’ experiencewho are capable of constructing databases and sim-ple Web sites. More complicated programming wouldrequire more experienced workers and an even largerwage differential.

As Bhutan produces more information technologyworkers, the wage differential is likely to narrow, but itwill not disappear in the near future. Higher laborcosts will probably preclude Bhutan from entering theprogramming market unless it can establish a reputa-tion for very high quality or unique work. Given theartistic ability of Bhutanese designers, this is not im-possible, but turning native design talent into saleableinformation technology services will take time.

The wage rates of Indian and Bhutanese workersalong the border are closer, but even here Bhutaneseworkers demand slightly higher wages. With time thisgap may narrow. But the wages of information tech-nology professionals, even along the border, are un-likely to ever fall to a level competitive with those ininformation technology clusters like Bangalore andHyderabad. Moreover, enterprises in or near theseclusters benefit from a large pool of skilled workers,an ability to easily share recent advances in technol-ogy, and access to inexpensive support servicesfrom surrounding firms. Companies in Bhutan wouldhave to fill unique niches to compete against theseadvantages.

One advantage Bhutan offers is its friendlier busi-ness environment: customs clearance takes less time,corruption is far less, and taxes are more transparentthan in India. But this alone is unlikely to offset thecompetitive advantages offered by the huge pools oftrained labor, established infrastructure, and spillover

effects found in the information technology clusters inIndia, Malaysia, and elsewhere.

Bhutan might be able to build capacity more eas-ily in the second category—in data entry, encoding,and call centers—though even this capacity will take time to develop. Firms in industrial countriesoften subcontract data operations to firms in devel-oping countries such as India. The major costs in this work are labor and connectivity, areas whereBhutan has no special competitive advantage overIndia.

Large data entry firms depend on large numbersof inexpensive, literate workers. In countries such asGhana, India, and Madagascar firms have hired re-cent secretarial school graduates, given them basiccomputer training, and then had them enter data orfind Internet content. Among office workers in Bhutan,assumed to have equivalent training, Bhutanese work-ers earn substantially higher wages than their Indiancounterparts (table 7.1). In Phuentsholing Indianworkers earn less than half as much on average asequivalent Bhutanese workers do. To compete withlabor costs in surrounding English-speaking coun-tries, any information technology export industry inBhutan would have to rely on Indian workers—or findBhutanese workers with comparable skills and pro-ductivity who would accept wages on par with thoseof Indian workers.

Connectivity costs also pose an obstacle (table7.2). For large data entry firms, telecommunicationsconnectivity can account for as much as 40 percent

of costs, depending on the nature of the business.Bhutan has two 1-megabyte satellite links—one to theeast and one to the west—and no optical cable. Thesatellite links suffice to meet current demand, butthey will quickly become strained if a large number offirms begin demanding international links. Druk Netcharges for leased lines are higher than those inneighboring countries, but this cost could fall if alter-native links are developed as demand grows. Firmsmight be able to share connections by leasing satel-lite time from Indian users, for example.

No firms in Bhutan have their own satellite con-nections. It is estimated that a two-way, 64-kbps linkfrom Intelsat costs around $700 a month. Though thisis not much less than a Druk Net leased line, the fig-ure does not include the costs of hardware, mainte-nance, or software. Companies targeting the U.S.market would have to have an additional link or ac-cess to a cable network because data cannot betransmitted to North America on a single bounce from


Country and Costtype of connection (U.S. dollars)

Bhutan

64 kbps 600

128 kbps 1,500

France

512 kbps 20

India

64 kbps 476

128 kbps 734

Madagascar

28.8 kbps 800

Nepal

64 kbps 2,800

128 kbps 4,500

Source: World Bank interviews.

Table 7.2 Monthly Fees for Leased Lines,Selected Countries

Table 7.1 Average Monthly Earnings for Salesand Office Workers, by Nationality andLocation, Bhutan(ngultrum)

Nationality Phuentsholing Thimphu

Bhutanese 3,082 4,129

Indian 1,168 3,525



Bhutan. Establishing better international connectivityin Bhutan would be relatively easy, and costs will fallas demand increases. But the costs are unlikely to fallenough to become competitive with those in India andother countries where high demand creates low unitcosts for connectivity.

So to become competitive in exporting informationtechnology services, Bhutan will have to overcomecost disadvantages in labor and connectivity. Forsmall-scale, high-value operations like Web design, itwill have to increase the supply of skilled labor, andfirms will have to serve niche markets where theirskills, design quality, or service standards compen-sate for higher costs. For relatively large operationssuch as data entry, firms will initially have to operate inborder areas, where there are larger pools of inex-pensive, semiskilled labor.

No matter what type of information technology ser-vice industry develops, it will face many of the sameinfrastructure constraints as other industries. Ex-pensive transport is an important obstacle even forthe information technology sector. Firms must be ableto import parts and hardware cheaply and quickly.And they will need to periodically bring in mainte-nance personnel and other experts. The irregular aircargo service in Bhutan is also problematic, sincesome firms ship data using tapes or other digital stor-age devices when they have large amounts or whentheir network fails.

Bhutan is not without some important competitiveadvantages over its neighbors. Besides the friendlierbusiness environment, it also has a regular and con-sistent power supply, no labor unrest, and a govern-ment bureaucracy that appears to be both more effi-cient and less corrupt. Yet these advantages may notbe enough to overcome the competitive advantagesof the lower labor costs, less expensive connectivity,more efficient shipping, and spillover effects of largeinformation technology clusters in India, Singapore,and other countries.

The Way Forward

The challenges in establishing an information technol-ogy export industry in Bhutan suggest that focusinginitially on developing services to support the domes-tic private sector is most feasible. Greater use of in-formation technology could increase competitivenessin many ways—from improving productivity in manu-facturing to enhancing the effectiveness of marketingin the service sector. And building the infrastructure,training the workers, and creating the institutionalstructure needed to support the domestic private sec-tor could set the stage for exporting information tech-nology services in the future.

The government of Bhutan has already startedthis process by concentrating on first expanding in-formation technology services in government agen-cies. All government agencies are pushing to quicklyautomate and to provide more services online. Thehope is that this will not only help the government pro-vide better services, but also create incentives for in-formation technology service providers to expand andfor the private sector to automate and invest more ininformation technology. The government, however, inits desire to rapidly expand the use of new technology,is monopolizing the skilled labor, leaving few well-trained information technology professionals to workin the private sector.

Any attempt to foster information technology ser-vices in support of the domestic private sector mustaddress several key issues, including developinghuman resources, improving institutions and the pay-ments system, building a data network, and attractingforeign direct investment.

Developing Human ResourcesMost important is developing a domestic supply ofskilled information technology professionals. That re-quires not only nurturing institutions that train workersbut also creating a computer culture in which technol-


ogy is accessible and part of everyday life. Makingcomputers available in schools, putting more govern-ment services online, and subsidizing Internet ser-vices are important steps in creating such a culture.

But it is vital to recognize that building a reservoirof experienced information technology workers takestime. Training cannot substitute for years of practicalexperience. The only way to develop a supply of tal-ented Bhutanese workers is to bring in experiencedguest workers to train and work with locals for an ex-tended time. Today private firms find it difficult to ob-tain work permits, and once they do receive them,they have no confidence that the permits will be re-newed. If firms are to make large investments in newtechnologies, they must be confident that they caneasily bring in and retain the skilled information tech-nology workers needed to support the investments.

Improving Institutions and the Payments SystemCreating institutions and regulations to support onlinebusiness and other uses of information technology isanother important step. Supporting online financialservices will require improving the payments systemso that firms can conduct business online. Also nec-essary is to expand the acceptance of credit cards,create online access to bank accounts, and revise for-eign exchange controls so that they do not interferewith online business activity. And it is important to care-fully examine the legal environment and laws relatingto such issues as online fraud, unauthorized access,and confidentiality. The need for legal and regulatoryreform has been clearly identified in the Bhutanesegovernment’s Information Technology Master Plan.

Building a Data NetworkMuch work is needed to improve the infrastructure.The voice network is good, and dial-up access is

available in most areas. But transmitting large vol-umes of data remains difficult. As suggested in theInformation Technology Master Plan, a data networkneeds to be built that will overlay the voice network,making it easier to span the country. Such a networkcould significantly improve the management systemfor shippers, helping to reduce the delays and highcosts caused by the rugged terrain and poor trans-port network.

Attracting Foreign Direct InvestmentMany of these issues can be addressed through jointventures. Foreign investors bringing with them the lat-est production techniques will expect up-to-date infor-mation technology services. The demand they createwill spur the development of the sector. And any ser-vices that are lacking they will provide. For example,large multinationals will bring skilled professionals ca-pable of training workers, and will have sufficient cap-ital to buy the hardware needed to improve bandwidthand solve connectivity issues. Foreign partners willalso bring market contacts and buyers, solving one of Bhutan’s biggest challenges in developing exportmarkets.

But deriving these benefits for the informationtechnology sector will first require creating the condi-tions to attract foreign investment. While foreign in-vestors might view Bhutan favorably because of itspolitical stability and absence of labor unrest, the cur-rent lack of transparency and difficulty in getting jointventures approved reduce Bhutan’s attractiveness asan investment destination.

Notes

1. Bhutan Information Technology Master Plan, p. 10.

Need for Foreign Direct Investment in the Priority Sectors 113

Present Constraints to Foreign Direct Investment 114

Proposed Regime for Foreign Direct Investment 116

Remaining Issues 119

8 Foreign Direct Investment 112

8. Foreign Direct Investment 113

To promote the development of the private sector inBhutan, the government embarked on a program inthe 1980s to gradually liberalize trade, industrial, andfinancial policies. An important part of the liberaliza-tion has been the development of national policiesalong with transparent and streamlined rules and pro-cedures. Efforts to rationalize policy continue in differ-ent sectors, and development of a foreign investmentpolicy is one part of the ongoing reforms.

Beyond traditional trading, the private sector hasno real history of entrepreneurial activities. ThusBhutan largely lacks the foundations for an active pri-vate sector that contributes strongly to economicgrowth—such as management skills and market links.As a result, a “bootstrap” approach to private sectordevelopment, while not necessarily destined for fail-ure, seems likely to achieve only slow and limitedprogress.

Foreign direct investment can be expected to helpclose some of the gaps. Foreign capital attracted toinvestment opportunities in Bhutan is likely to embodysuch critical factors as technology, managementskills, and familiarity and links with export markets. Byattracting productive foreign direct investment, thegovernment will thus create opportunities for acceler-ating economic development in Bhutan—and therebygenerating employment, raising incomes, and in-creasing welfare through greater choice for con-sumers—in ways consistent with the country’s goal ofpreserving its natural and cultural heritage.

Need for Foreign Direct Investment in the Priority Sectors

The government, in its private sector developmentstrategy, identified four sectors that it sees as havinggood potential for development along internationallycompetitive lines. If attracting foreign direct invest-ment is to be an important part of the private sectordevelopment strategy, it will need to contribute to de-

velopment in those sectors: agroprocessing, woodand wood-based industries, tourism, and informationtechnology.

AgroprocessingAgroprocessing has three potential areas of devel-opment in Bhutan—import substitution, exporting toniche markets, and large-scale processing of im-ported raw materials for export. Foreign direct invest-ment (or at least some kind of foreign involvement)could be an important catalyst in promoting the sec-ond and third of these. While production of importsubstitutes for the local market may not need to meetinternational quality standards in the short term, pro-duction for the export market clearly will.

Indeed, the food products that Bhutan will be ableto sell in niche markets internationally are likely tohave high value relative to weight (to overcome hightransport costs), superior quality (and quality control),and superior packaging, so that premium prices canbe secured. Achieving these standards will require in-ternational best practice at all stages of production—from harvesting to distribution. Bhutan is unlikely tohave this knowledge or to be able to acquire andapply it successfully without significant foreign in-volvement. It will also need to learn what markets suchproducts can be sold in and how those markets canbe accessed.

Export processing of imported agricultural rawmaterials in the border areas close to India will alsoneed substantial foreign inputs. The scale of produc-tion envisaged for these operations is well beyond anyexperience in the domestic private sector. Successwill require high-turnover, low-margin operations (thehallmark of export processing operations whereverthey are), suggesting that the effective managementthat foreign investors could bring is likely to be criticalin determining profitability. And since this activity willfocus on the Indian market, the companies bestplaced to profit from it will be those already estab-lished in India, which will see investment in Bhutan


as a lower-cost alternative for serving their existingmarket.

Wood and Wood-Based IndustriesIn the wood and wood-based industries profitability islikely to be directly correlated with the level of tech-nology, at least for the more processed products.While the strong demand from India for wood maymean that traditional extraction and production cancontinue to be profitable, the outputs from wood-based industries are much more like manufacturedproducts than commodities—thus the need for inter-national inputs of technology, management, and mar-keting skills. The government’s concern for addingvalue to forest resources before their export, and thebelief that this requires a series of technology-basedsteps, suggests that the government’s long-term ob-jectives for this sector can be met only with significantforeign involvement. Encouraging investment byexperienced foreign companies—through joint ven-tures or independently—is one way to promote suchinvolvement.

TourismIn tourism, where investing in capital developmentand services offers many opportunities, foreign directinvestment could contribute in several ways. At thesame time the sector involves greater cultural and en-vironmental sensitivities than most other sectors, re-flected in the government’s policy of high-value, low-volume tourism. Under this policy one strategy forincreasing benefits is to attract more visitors at thecurrent price level and offer improved tourism prod-ucts to also create a higher-value market. Attractingmore visitors at current prices may simply require ad-justing government policy, improving marketing, andthe like. But upgrading products for a higher-valuemarket will almost certainly require foreign capital andexpertise. Indeed, the government’s recent decisionto permit two majority foreign-owned hotel companiesto invest in Bhutan implicitly recognizes this.

Information TechnologyTwo main opportunities for growth have been identi-fied for the embryonic information technology sectorin Bhutan—increasing the use of information technol-ogy in the private sector and developing small-scaleexports of information technology services (such asdata entry and call centers). Each will depend on sub-stantial inputs of foreign expertise, most likely to comefrom foreign investment.

Expanding the use of information technology inthe private sector will require increasing the aware-ness of the benefits this offers and upgrading skillsand support services. Foreign direct investment coulddo much to accelerate progress in building up skillsand support services.

The opportunities for exporting information tech-nology services are undoubtedly limited. But Bhutandoes have a resource that, though far from unique, isincreasingly prized in information technology indus-tries—a young, well-educated, English-speakingworkforce. While India will always be a major com-petitor, the strength of its information technology skillsneed not be seen as an insurmountable barrier. Still,the competitive environment does suggest that at-tracting foreign direct investment will be essential fordeveloping the information technology sector inBhutan. Success in building an export market for in-formation technology services will depend not only onthe operating environment offered but also on the skillwith which the country promotes its opportunities.These factors are likely to be more important than thepotential scale of activity relative to that in India.

Present Constraints to Foreign Direct Investment

Clearly, a major constraint today to attracting foreigninvestment to Bhutan is the lack of a legislative frame-work for such investment. The government is wellaware of this, however, and has begun establishing


the necessary legislation, regulation, and administra-tive systems (see the following section). Issues in thegeneral business environment that will not be affectedby the proposed law on investment could also beseen as important constraints by potential foreign in-vestors. Most of these act as constraints to privatesector development in general and are discussedelsewhere in this report. But some will assume greaterimportance for potential foreign investors and thus de-serve more attention if the government is to attract for-eign direct investment at the levels it has targeted.

TaxationMany aspects of the tax system will be seen as ob-stacles by foreign investors, particularly those inter-ested in export-oriented businesses. The tax system’sapparent unsuitability for enterprises with foreignownership is not surprising, since it was developed toserve the interests of a government taxing a privatesector dominated by small enterprises, focused onthe domestic market, and involved mainly in small-scale production and service industries. Enterpriseswith foreign ownership are likely to be substantiallydifferent.

Aspects of the tax system likely to be seen as im-pediments by foreign investors include the limits onthe amounts of individual salaries that businesses canclaim as deductions, the limits on the deductibility ofsome business expenses, the taxation of assumedcapital gains created through asset revaluation, theprovisions on tax deducted at source, and the lack ofdouble taxation agreements with other countries.

Limits on Business Deductions of Salaries.Since personal income tax is now levied on salaries,there seems to be no logical reason for imposing anylimit on the levels of salaries that businesses candeduct. Moreover, the current limit of Nu 60,000 amonth is only a small share of the salaries that inter-national investors would expect to pay their seniormanagers Paying tax on amounts over this limit would

greatly reduce the profitability of investments. (It is un-derstood that exceptions can be made, but only bythe Ministry of Finance on a case-by-case basis.)

Limits on Deductions of Business Expenses.The limits on deducting costs incurred for such activ-ities as market development, advertising, and qual-ity control will have varying effects, depending onwhether companies are producing for the local market(where advertising may be more important) or for theexport market. But foreign companies would see allsuch costs as normal business expenses. In somecases these costs would account for a large share oftotal costs—and in all cases they would exceed thelevels at which companies could easily absorb themand still remain competitive.

Taxation of Assumed Capital Gains. The taxa-tion of assumed capital gains created through assetrevaluation will act as a deterrent in two ways. First,foreign investors are much more likely than domesticfirms to follow international accounting standards andthus more likely to use updated asset values, particu-larly where they seek to borrow to finance expansionor other capital spending. Paying capital gains tax onthe assumed capital gain would be a burden.

Second, most Bhutanese investors wanting to par-ticipate in a joint venture with a foreign company arelikely to offer land and fixed assets (such as buildings)at current market value as their equity contribution.Having to pay capital gains tax on any assumed cap-ital gain would be a severe penalty, one that coulddeter many potential candidates from forming jointventures. And without local partners, fewer foreign in-vestors would be able to invest in Bhutan, since jointventures are mandatory.

Tax Deducted at Source. While the tax deductedat source can be used as an offset against annual cor-porate tax liabilities, this provision is of no benefit tocompanies making losses. Indeed, for these compa-


nies, such tax payments only heighten the losses.That could be a significant deterrent for foreign directinvestment, since foreign investors, particularly thosein manufacturing, typically expect to make lossesearly on as they gear up to full production, developmarkets, identify lower-cost supply sources, and copewith unexpected startup costs. This startup scenariodiffers from those of most domestic investors, whichgenerally start out with less capital and expect to beproducing profits earlier.

Double Taxation Agreements. Another tax-related issue is the lack of double taxation agree-ments with the countries from which most investmentis likely to come. Without such agreements, invest-ment in Bhutan will be far less attractive to foreigncompanies. If the Bhutanese government plans tomove to a corporate tax rate lower than that in India,negotiating a double taxation agreement with Indiamay be advantageous. Such an agreement wouldallow Indian companies (which could well be thebiggest investors in Bhutan) to benefit from the lowertax rates in Bhutan even if India moves to taxation ofworldwide income.

Indeed, Bhutan would benefit from a double taxa-tion agreement with any industrial country from whichsignificant investment is expected and whose corpo-rate tax rate exceeds that in Bhutan. Such agreementsare particularly important if any investment incentive isintroduced to lower the effective rate for investors.Without them, the tax incentive merely transfers rev-enue from Bhutan to the government of the sourcecountry for the investment.

Other ConstraintsThe regulations on access to foreign exchange for im-ports are also likely to affect the attractiveness ofBhutan as an investment location. Under these regu-lations foreign exchange is automatically available toan enterprise only if it has earned the currency re-quired—Indian rupees or hard currency—through ex-

porting. Since India is likely to be the dominant marketfor exports from Bhutan, foreign investors expecting touse imports from hard currency countries will see thissystem as an impediment.

The services and skills in the banking sector couldhave effects particularly for exporters. But the inflexi-bility of interest rates could affect a wider range of in-vestors—at least to the extent that they want to borrowlocally, for example, for their working capital needs.

Finally, as in many developing countries wherelandownership is a sensitive national issue, restric-tions on access to land by foreign investors could alsoact as an impediment in Bhutan.

Proposed Regime for Foreign Direct Investment

Recognizing the potential benefits, the Bhutanesegovernment has recently developed a policy for open-ing the economy to foreign direct investment. It hasworked slowly in developing the policy, out of a desireto closely examine the issues in introducing foreign in-vestment for the first time and to structure the invest-ment in a way that avoids threatening important char-acteristics of the society and economy.

Goals of the PolicyThe draft policy is understandably cautious. It hasbeen prepared with an explicit understanding thatchanges will be made once the government hasgained greater experience. There has also been an ex-plicit understanding that it is far better to err on the sideof caution—and accept the risk of smaller inflows of for-eign investment than hoped for—than to have foreigninvestment lead to outcomes that will be regretted.

The policy defines three broad objectives of en-couraging foreign investment in Bhutan:

• Broadening employment and training opportuni-ties for the people.


• Benefiting from the transfer of technology andskills.

• Broadening the revenue base and enhancing for-eign exchange earnings.

These are modest and sensible goals for a firstentry into a complex and competitive market, andthey should prove to be consistent and mutuallysupportive.

Key Elements of the PolicyMuch of the detail defining the operation of the policywill be available only after the regulations and proce-dures have been developed. But some of the more im-portant elements of the proposed policy regime are al-ready clear:

• Definition of a foreign investment. At 20 percent ofthe equity in a company, the trigger point for de-termining foreign direct investment is twice theinternational norm. That means that foreign in-vestors will be able to take significant financialpositions in Bhutanese companies without be-coming subject to the new law on foreign directinvestment.

• Commitment to using a simple, transparent, andautomatic registration system. In adopting thisstance, the government has moved directly to in-ternational best practice, a move that will be wel-comed by those interested in investing in Bhutan.

• Minimizing competition for Bhutanese small andmicro investors. With little history of modern entre-preneurial activity, the private sector in Bhutan isnot in a position to compete effectively with entre-preneurs from surrounding countries, particularlyin trading, services, and simple manufacturing forthe domestic market.

• Positive list of sectors open to foreign direct in-vestment. By choosing this option, the govern-ment has limited foreign direct investment to sec-tors in which it believes Bhutan has potential

competitive advantage and in which such invest-ment would be beneficial.

• Mandatory joint ventures. The foreign equity sharein a company will be limited to 70 percent.

• Nonequity foreign involvement. Unlike with equityinvestments, for which approval will be automatic(against defined criteria), proposals for nonequityforeign involvement must be submitted for consid-eration by the Board of Investment.

• Equal treatment. Foreign investors will receive thesame treatment in the application of relevant laws,regulations, and procedures as local investors en-gaged in the same business.

• Remittance of profits and dividends. Profit anddividend remittances will be allowed only to theextent that net foreign exchange earnings in thecurrency involved are available.

• Taxation. For companies with foreign investment,just as for other private companies in Bhutan,worldwide income provisions will not apply.

• Imports. Subject to the requirement that the for-eign investor provide the necessary foreign ex-change, all imports of industrial plant, machinery,spare parts, and raw materials will be exempt fromsales tax and customs duty.

• Employment. Enterprises with foreign investmentwill be automatically entitled to a designated num-ber of work permits based on the size of the in-vestment. Additional employment of expatriateswill be approved where shortages of appropriatelyskilled Bhutanese can be demonstrated, but thesepositions will have to be converted to local jobsthrough a training program.

The proposed policy is an admirable attempt todevelop a compromise between the liberal conditionsthat would make Bhutan a more attractive location forforeign direct investment and the understandableconcern about the possible adverse effects on theeconomy and culture of inappropriate investment proj-ects or excessive investment levels, particularly in key


sectors. The compromise involves a risk, of course,that some of the objectives of the policy may not berealized. Indeed, some of the policy choices appearto limit the attractiveness of investment in the four pri-ority sectors.

Three policy choices will have a significant effecton the extent to which foreign direct investment con-tributes to private sector development in Bhutan: thechoice of a positive list approach to determine whereinvestment is allowable, the requirement for local eq-uity in each enterprise with foreign investment, and,possibly to a lesser extent, the stipulation of minimumproject size. Two others that may also have an effectare the limits on the remittance of profits and divi-dends and the requirement for training nationals andconverting positions to local jobs.

Positive List Approach. The decision to define apositive list of sectors for investment will incur costs intwo ways. First, since it is impossible to anticipate allthe projects that foreign investors might identify as at-tractive—some of which might be in sectors thatwould be uncontentious but still fall outside the posi-tive list—Bhutan may be denied investment it wouldhave been happy to accept. Even if such projectswere allowable under a negative list approach, theminimum project size requirement might precludemany of them. That suggests that a move from a pos-itive to a negative list approach might need to be ac-companied by a reduction in the minimum equity re-quirements to generate a significant impact. Such achange may be feasible once the government hasgained greater confidence in the foreign direct invest-ment process.

Second, the positive list approach will involveadministrative costs. Investment proposals will con-stantly require interpreting the positive list to determinewhether it includes the sector involved—particularlysince the list defines sectors broadly, for example,“light industries, including electronic industries” and“engineering and power-intensive industries.”

Local Equity Requirement. The requirement forlocal equity of 30 percent seems likely to be the mostcostly impediment to foreign direct investment, partic-ularly when combined with the minimum project sizerequirement. Again there are two kinds of costs. First,the local equity requirement limits the population ofpotential investors interested in a country. Around theworld most foreign investment takes the form of 100percent foreign-owned projects, because most in-vestors have a strong preference for this kind of in-vestment. While some favor joint ventures in some cir-cumstances, and others will agree to seek a localpartner when this is the only option, many will not in-vest in joint ventures.

Second, given its stage of private sector develop-ment, Bhutan is unlikely to be able to offer more thana handful of local companies with the technical andmanagerial capacity to be viewed as acceptable (letalone attractive) joint venture partners. Add to this theminimum project size requirement—with a minimum of30 percent of projects required to be at least $1.0 mil-lion in manufacturing and $0.5 million in services—and the field of potential partners is narrowed evenfurther. Thus even foreign investors willing to considera joint venture may have great difficulty identifying po-tential partners. Projects well above the minimum sizewill be even harder to structure unless the governmentsteps in as the local equity partner—which would ap-pear to be counter to the private sector developmentstrategy.

Related to this is the question of the developmentimpact. Evidence from many developing countriesshows that where the private sector is poorly devel-oped, imposing local equity requirements leads to theemergence of a small number of large, powerful, mul-tisector conglomerates. This outcome is understand-able: forced into joint ventures, foreign investors willtry to link themselves with the companies offering thebest prospects for success. Often these will not becompanies that can bring relevant industrial experi-ence, but companies with the management capacity


and financial strength to contribute to the relationship.Thus the same companies (or individuals) appeartime and again as partners in new enterprises with for-eign investment, severely limiting the benefits for pri-vate sector development that the policy was intendedto produce. In the starkest terms, a local equity re-quirement can easily lead to a small number of rela-tively affluent businesspeople benefiting substantiallywhile a much larger number of workers remain joblessbecause potential foreign investors were deterred bythe joint venture requirement.

Minimum Project Size Requirement. The min-imum project size requirement will have effectsbeyond those already mentioned. One of these willbe to limit the “osmosis effect”—the absorption ofbetter business practices by the domestic privatesector through its interaction with the foreign privatesector. The extent to which the osmosis effect occurswill be determined largely by the number of enter-prises with foreign investment that are created, ratherthan their size or value. So limiting foreign investors to what are fairly large investments relative to theBhutanese economy will also limit the benefits fromthis effect.

Moreover, the fact that the minimum project sizesare relatively large is likely to preclude a range ofsmall projects that would be beneficial to the economyand nonthreatening to the local private sector. Indeed,this outcome is likely in two of the priority sectors,agroprocessing and information technology. Ex-porting high-value processed food products to nichemarkets offers much potential. As argued earlier inthis chapter, such export projects are likely to developonly through foreign direct investment, yet these proj-ects are likely to be relatively small and would cer-tainly be so in their startup phase. Similarly, informa-tion technology service providers are likely to be smallin terms of capital investment, since human resourceswould be the main input.

Remittance of Profits and Dividends. Much ofthe foreign direct investment attracted to Bhutan canbe expected to be export oriented. But some will beaimed at domestic sales, including potential invest-ment in the priority sectors. For this investment, limit-ing the remittance of profits and dividends to net earn-ings in the foreign currency required for the remittancewill be a major impediment. In the priority sectors thislimit will affect information technology services for thedomestic economy and agroprocessing for the do-mestic market, with the second affected perhaps evenmore if projects require imported inputs. Even whereprojects focus on export markets, non-Indian in-vestors wanting to sell in the Indian market may findthemselves short of the hard currency needed forremittances.

Conversion of Positions to Local Jobs. Thedraft policy leaves unclear how the requirement fortraining nationals and converting positions to localjobs will be implemented. But the hope is that marketforces, rather than regulation, will play a major part.Given the limited training now carried out in the pri-vate sector in Bhutan, there is a good case for intro-ducing fiscal incentives to encourage companies totrain staff and so accelerate the rate at which employ-ment becomes local without adversely affecting theefficiency of enterprises with foreign investment.

Remaining Issues

In early October 2001 the minister of trade and indus-try submitted the final draft of the foreign investmentpolicy to the government for consideration. Legislationbased on the draft policy was expected to be submit-ted to the National Assembly for consideration in July2002. Regulations can be prepared concurrently—with adjustments as needed to reflect changes madeto the legislation by the National Assembly—so that


they will be ready as soon as the legislation is ap-proved. But even with the legislation and regulationsin place, Bhutan will not yet be ready to start operat-ing its foreign investment system. Procedures willneed to be developed (including for monitoring the in-vestment activity), responsibilities for administeringthe system assigned, and staff trained.

Once the administrative system is in place, Bhu-tan will need to address two other elements of its strat-egy for foreign direct investment. First, it will need tocreate capacity for investment promotion. With Bhutanvirtually unknown as a potential location for foreign in-vestment, targeted publicity about the decision toallow foreign direct investment—and the opportunitiesavailable—would help ensure that the country can ef-fectively exploit the opportunities created by the newpolicy. At the same time prospective investors willneed facilitation services from the government as theyseek information needed to decide whether an invest-ment is feasible and as they seek registrations, ap-provals, and licenses needed once they decide to in-vest. Creating an investment promotion agency willrequire decisions about the agency’s position withingovernment, about the mandate and functions itshould be given, and about the recruitment and train-ing of staff and a range of other capacity buildingmeasures.

Second, Bhutan will need to create a system formonitoring and reviewing the foreign direct investmentregime and its impact. The government will need toperiodically conduct reviews of this regime, which willrequire quantitative data on the sources of potentialand actual investment and on the sectoral interestsand intended scale of operations of prospective andactual investors. These reviews will also require quali-tative information on the attractiveness of Bhutan asan investment location, which the investment promo-tion agency should be able to collect through its fre-quent contacts with the foreign investor community.

Arrangements are being developed for providingthe Bhutanese government with external assistance inconverting the investment policy statement into draftlegislation and supporting regulations. It is proposedthat the Foreign Investment Advisory Service providesome of the assistance, funding the effort jointly withthe United Nations Development Programme. Fol-lowing the approval of the legislation by the NationalAssembly and the promulgation of the regulations, asecond phase of external assistance from the ForeignInvestment Advisory Service is planned, to cover theoutstanding tasks described above. The governmentis now seeking cofinancing for this project.

Governance and Regulation 122

Labor, Skills, and Employment 123

Finance 124

Competitiveness and Technology 125

Infrastructure 127

Public-Private Dialogue 128

Challenges and Opportunities in the Priority Sectors 128

A Vision for the Development of the Private Sector 130

Main Recommendations 131

9. Conclusions and Recommendations 121


Absorbing the rapidly expanding pool of educatedlabor and raising living standards for the general pop-ulation in Bhutan will require that the private sectorgradually replace the government as the engine ofeconomic growth. With the government capable ofproviding suitable employment for only a limited num-ber of people, the private sector must play an increas-ing role in investment, production, and employment.But to grow substantially and expand into new mar-kets, Bhutanese industry must become much morecompetitive—by cutting costs, improving quality, up-grading technology, and raising productivity. Indeed,given the dramatic changes wrought by trade liberal-ization and the gradual loss of preferential access tothe Indian market, Bhutanese industry must becomemore competitive just to maintain existing markets.

The poor competitiveness of Bhutanese industryis reflected in the high ranking of lack of demandamong the biggest business problems faced by sur-vey respondents. Bhutan may have relatively low con-sumer purchasing power, but it is next door to one ofthe world’s biggest consumer markets and still haspreferential access to that market. Moreover, domes-tic demand for consumer imports is growing rapidly.That Bhutanese firms cannot tap these markets suc-cessfully means that they are not competitive. Thusthe challenge for the government is to provide an en-vironment that will allow industry to become interna-tionally competitive. The following sections discusssome of the main cross-cutting areas of concernemerging from the survey.

Governance and Regulation

Because the private sector has only recently begun to develop in Bhutan, much of the business con-ducted—by the public as well as the private sector—has not been undertaken systematically. Books of ac-counts are not maintained, external audits take placeirregularly, applications for foreign direct investment

are approved case by case, tax concessions aresometimes granted in an apparently nontransparentway, and so on. This situation can be traced largely tothe closed economy and the small size of businessnetworks. Bhutan has suffered little from these ad hocbusiness arrangements. But as firms venture into newand more complicated areas of business, they needto operate in a system based more on rules than onrelationships. And so does the government.

The survey revealed evidence of concern in thisarea, with more than a quarter of firms perceiving thegovernment as unpredictable. Regulations need to beclear, transparent, and consistently interpreted to en-able firms to concentrate on their business. They alsoneed to take into account the legitimate needs of in-dustry. But firms have little belief that this is happen-ing: more than half expect regulatory changes that willnot take their needs into consideration. That suggeststhat the Bhutan Chamber of Commerce and Industryand other industry associations (though still embry-onic) need to more actively lobby the government onissues of interest to the private sector. Supportingthem in more effectively representing the views of in-dustry and providing services to members deserveshigh priority.

The survey not only pointed to concerns abouthow regulations are implemented but also revealed is-sues relating to particular areas of regulation:

• Labor regulations, including minimum wage regu-lations, regulations on employing nonnationals, theproposed new labor regulations, and the need forincentives to invest in training.

• Tax regulations, including tax deductions atsource, deductible expenses, double taxationagreements, asset revaluations, and annual taxassessments.

• The need for regulations to support online busi-ness and other uses of information technology, en-compassing such issues as online fraud, unautho-rized access, and confidentiality.


• Wood sector regulations, including the ban on ex-ports of semifinished products and provisions inthe regional trade agreements that prevent ex-ports of wood products to Bangladesh.

• Regional regulations requiring the unreasonabletransshipment of goods from one freight hauler toanother at border crossings.

• Regulations relating to business startup and de-velopment, including the ban on new business li-censes in Phuentsholing.

• The unavailability of visas on arrival, particularlyfor foreign technicians and buyers, who oftenneed to make unplanned visits.

• The case-by-case approach to approving appli-cations for foreign direct investment.

Bhutan appears to be standing at an importantcrossroads. It can structure government regulationsand business practices in a way that ensures consis-tency and transparency—or it can continue the adhoc and opaque operating methods that will take thecountry down the path toward greater rent seeking,following much of the rest of South Asia. Taking a firmstand on good governance will be critical for avoidingthe corruption endemic in other developing countriesand building a strong private sector. Uncertainty isanathema to the private sector. The more clearly therules of the game are laid out and the more transpar-ently and consistently they are applied, the greater thechance that the private sector will be able to operateeffectively.

But in moving to an increasingly rules-based sys-tem of regulation, the government needs to avoidoverburdening the private sector with bureaucracyand red tape. In developing countries introducing newregulations intended to support the private sector, of-ficials have sometimes ended up impeding its devel-opment. Where officials lack a clear understanding ofrules and regulations, opportunities open for varied in-terpretations, bureaucratic impediments, and corrup-tion. South Asia is replete with examples of govern-

ment bureaucracy and regulations resulting in longdelays and rent seeking by public officials. The chal-lenge in Bhutan will be to establish an appropriate bal-ance between a system based too little on rules andone based too much on bureaucracy.

Labor, Skills, and Employment

As a growing number of Bhutanese leave school andenter the workforce, those with higher education con-tinue to find it relatively easy to get jobs, while thosewho have not completed high school or gone on totertiary education are finding it increasingly difficult.These workers have high expectations for wages andfor the type of work they will undertake, and an aver-sion to menial, difficult, dirty, or labor-intensive occu-pations. These mid-level workers—with some educa-tion but no tertiary qualifications—are those most likelyto face unemployment in the future. And in 2002–10around 65,000 more Bhutanese are expected to leaveschool without a tertiary education to join this group.

At the same time the private sector employs alarge number of Indian workers—both in menial jobsshunned by the Bhutanese and in high-level, skilledoccupations for which the domestic workforce has notyet developed adequate skills. Nonnationals arethought to account for around half of all formal sectoremployment and perhaps 60–80 percent of all formalprivate sector employment.1 The wages for unskillednonnational workers are among the lowest in theworld, but those for skilled nonnational workers com-pare favorably with wages for comparable workers inother countries.

Faced with growing unemployment, the govern-ment understandably wishes to reduce the number ofnonnational workers employed in Bhutan. But theBhutanese school-leavers most likely to be seekingemployment over the next decade are unlikely to wantto undertake the menial jobs at the low end of theskills spectrum or to be able to perform the jobs at the


high end of that spectrum. Meanwhile, the privatesector needs a comprehensive range of skills if it is tooperate effectively and to grow.

Thus if Bhutan is to strengthen its ability to com-pete in a rapidly globalizing world—producing cost-competitive products for both domestic and exportmarkets—it will need to retain the cost advantagesconferred by its access to low-cost, nonnational laborwhile simultaneously increasing the productivity ofBhutanese workers. Indeed, improving the productiv-ity of Bhutanese workers, rather than arbitrarily reduc-ing the nonnational workforce, is the key to graduallyreplacing nonnational workers.

Adopting appropriate technologies is one way toenhance worker productivity. And in Bhutan, wheremost firms rely on old technology from India, introduc-ing new technologies could substantially improve pro-ductivity. But it is important that the private sector notbe forced to abandon more appropriate labor-inten-sive production methods for excessively capital-inten-sive ones. In an environment where labor is relativelycheap and capital relatively expensive (in comparisonwith the region), pursuing an overly capital-intensivestrategy of private sector development makes littlesense. Moreover, this strategy would work against in-creasing employment.

Another important way to improve worker produc-tivity is to train workers. Even more important is to trainmanagers: few entrepreneurs in Bhutan have experi-ence in industry, know the latest techniques, or un-derstand their firm’s training needs. But today fewBhutanese firms provide training.

Managers cited several reasons for not trainingworkers:

• Managers see no need to provide training.• The government provides no incentives for

training.• Trained workers will leave the firm, preventing it

from recouping the costs (Bhutanese workers areconsidered “too mobile”).

• The firm cannot afford to provide training.• Bhutan lacks training providers.• Indian workers, whom firms expect to be phased

out, make up a large share of the workforce.

As firms increasingly specialize to penetrate nichemarkets and achieve economies of scale, they willneed workers with specialized skills as well as a gen-eral work ethic. Individually or in groups, firms willneed to provide many of these specialized skillsthrough a mix of formal and on-the-job training. Thegovernment can support these efforts by closelyaligning the education system with the needs of theprivate sector and by sharing the costs of trainingthrough carefully designed incentives.

Finance

The rudimentary state of Bhutan’s financial sector hasmade it difficult for private firms to obtain the fundsthey need for investment: more than 40 percent offirms claimed to be credit constrained. The underde-veloped financial system also leads to high costs ofdoing business, because of inefficient service, highservice fees, and, most important, high interest ratesrelative to those in competitor countries. With the fi-nancial system limited to two banks and two nonbankinstitutions—and dominated by the state—there is lit-tle competition or innovation. And high liquidity levelshave perpetuated the lack of creativity in the sector.

Limited Access to—and Demand for—CreditThe particularly large share of firms (around 30 per-cent) without access to bank finance can be attrib-uted in part to the private sector’s lack of sophistica-tion and its unwillingness to take on debt to make themost of its productive potential. But it can also be at-tributed to the banking system’s conservatism and itsinability to support the private sector in developingbankable projects. Although some welcome signs


of innovations were evident, they were few and farbetween.

Uncompetitive Banking SystemThe lack of competition in Bhutan’s financial sector isevidenced by the absence of even simple and well-accepted innovations such as introducing automatedteller machines and wide use of credit cards. It is alsoreflected in the inflexibility of interest rates, whichshow no change with shifting economic conditions.The banks do reasonably well without competing onmargins and without trying to attract a new and possi-bly more difficult customer base. An important objec-tive for the immediate future should be increasingcompetition, possibly through nonbank sources of fi-nance such as leasing, finance, and venture capitalcompanies.

Lack of Financial InstrumentsDeveloping innovative new instruments tailored tomeet private sector demands will be an importantchallenge for the banking system in the medium term.Leasing finance is almost entirely absent in Bhutan,despite being ideally suited to support small andmedium-size businesses. Only one example of factor-ing (providing credit against receivables) was turnedup by the survey, though factoring can offer particularadvantages to companies needing injections of work-ing capital to meet immediate production demands.Venture (risk) capital is barely evident in the market.And the high cost and low penetration of credit cardsimpede sales growth, slow transactions, hamper ven-tures into e-commerce, and hinder development ofsome aspects of the tourism industry.

Slow Payments SystemThe payments system is slow and cumbersome.Transferring funds within the same bank betweenThimphu and Paro can take more than a week (andeven longer for more remote parts of the country). Theabsence of automated teller machines, credit card

systems, and other electronic means of payment addsto the problems. The weak payments system slowsthe operations of the private sector and reduces itscompetitiveness with other world producers. And itimpedes the growth of e-commerce in Bhutan.

Competitiveness and Technology

As noted, firms’ complaints about lack of demand re-flect their lack of competitiveness and inability to winmarket share. Firms in all sectors often cannot com-pete on price, which tends to be a big factor in initiallypenetrating markets. Bhutanese firms are not compet-itive on price for a range of reasons—low productivity,lack of economies of scale, inadequate infrastructure,expensive capital, and geographic isolation—all ofwhich increase costs relative to those of competitors.

But the lack of competitiveness is not just a matterof price. Bhutanese firms also have problems com-peting on quality and delivery.2 Firms have not de-veloped the capability to assure quality or producepopular designs. And problems in infrastructure andthe payments system make it hard to meet deliveryschedules.

These failings can often be solved if firms adoptappropriate technology—broadly defined to includemanagement capability, equipment and processes,and marketing and design. To become internationallycompetitive, companies will in some cases have tolook beyond the Indian technologies on which theyhave traditionally relied and adopt international bestpractices. But the learning mechanisms that compa-nies use to acquire new technologies are extremelyweak in Bhutan. So if Bhutanese industry is to grow,strengthening these mechanisms will be vital.

Management CapabilityManagers’ lack of relevant experience and technicalqualifications acts as a big constraint on productivityand competitiveness. Many Bhutanese entrepreneurs


have spent a large part of their career working in thegovernment—and almost no entrepreneurs haveworked in industry outside Bhutan or for foreign-owned firms. Lacking familiarity with best practices orthe demands of international trade, they have difficultytransferring relevant technology to their firms. Evenwhen firms have no immediate aims to export, suchexposure is crucial. As the global economy liberal-izes, firms must know the competition to defend theirmarkets. As a result of their lack of experience andtechnical knowledge, managers also often have diffi-culty choosing appropriate production and marketingpersonnel as well as employees with other skillsneeded. Improving management capabilities is thuskey to increasing competitiveness.

Equipment and ProcessesMany companies in Bhutan operate with outdated andineffective equipment and production processes.Many sawmills use decades-old technology fromIndia, for example, and most firms still do not use evenrudimentary information technology as a businesstool. This report often refers to the need to leapfrogIndian technology to develop niche products capableof penetrating international markets. But acquiringand absorbing new technology takes a long time forall firms and poses particularly severe challenges forsmall firms that lack adequate capital or externalconnections.

Unable to research the market to forecast de-mand, firms often have difficulty determining the ap-propriate capacity of machinery to purchase. Theyoften cannot afford modern equipment and must usesecond-hand machinery instead. Acquiring and ab-sorbing a new production technology may take twiceas much time and money as planned. In addition,production managers often have difficulty adapting tothe new technology—maintaining the equipment, ob-taining spare parts, and estimating the raw materialsneeded. Similar problems occur in absorbing newtechnologies: the vendors may fail to provide good

training, lack the skills to develop or customize soft-ware, and provide inadequate after-sales service.

Marketing and DesignJust as firms in agroprocessing can compete interna-tionally if they focus on niche markets with high-value,low-volume products, so can firms in other sectors. Intourism, for example, there is great potential for de-veloping a high-end market in such areas as raftingand high-altitude trekking, where Bhutan has a com-parative advantage. For all these niche markets thereare well-defined needs, prices, and channels of dis-tribution. Yet in all the sectors surveyed marketing skills are weak as a result of Bhutan’s isolation and thedominance of the government and India in marketrelationships.

Also important are product delivery and packag-ing. Products will need to be developed that have alow transport cost, and packaging must be designedto facilitate transport as well as appeal to consumers.In addition, products often must conform to interna-tional standards, and retail packaging must includemandatory information. Firms commonly have to im-port packaging technology not only to break into ex-port markets but also to defend local markets fromimports.3

Learning MechanismsTo stay competitive in existing markets and to enterniche and other high-value markets, firms must up-grade their technology of all types—including man-agement, production, marketing, and design—whileensuring that the technology adopted is appropriate.But the mechanisms that help firms with the difficultand expensive task of finding and absorbing technol-ogy are weak in Bhutan. The country lacks networks ofsuppliers or international buyers to teach firms aboutnew technologies. It has few consultants or technicalexperts, and Bhutan’s isolation makes it difficult forfirms to find them abroad. And foreign direct invest-ment, one of the most important ways of transferring


technology between countries, is almost nonexistentin Bhutan.

Establishing matching grant schemes, makingvisas for technical experts easier to obtain, providingtax incentives for technical improvements, and, mostimportant, liberalizing foreign direct investment are allactions that the government could take to help firmsimprove their technology, raise their productivity, andincrease their competitiveness.

Infrastructure

The survey confirms that most infrastructure in Bhutanis good compared with that in other countries in the re-gion and adequate to meet current needs in mostareas. But in more remote parts of central and easternBhutan infrastructure remains a significant problem,especially the provision of electricity. And road and airtransport poses problems nationwide.

Road TransportWith on-time delivery a key determinant of success ininternational markets, transport has become particu-larly important. Transport problems slow incoming de-liveries of raw materials and intermediate goods anddelay shipments of goods out of the country. Theseproblems become both worse and more expensiveduring the monsoon season, which coincides with thefruit harvesting season. During the monsoon seasonthe cost of transport can double and there are delaysin getting trucks. The lack of loads for return tripsleads to further delays and cost increases.

Trucking firms put much of the blame on theroads, observing that their poor condition increasestransport costs by around 30 percent. Law and orderproblems, particularly in the Indian state of Assam,have also increased costs. Costs for hauling goodsfrom Phuentsholing to Sarpang have tripled recently,for example, because trucks used to travel throughIndia but now must travel within Bhutan. On- and off-

loading at the border, required by such regulations asaxle-weight restrictions, also leads to delays andhigher costs.

Transport infrastructure will influence the locationand development of industry. Expensive and unreli-able road transport will, for example, constrain the de-velopment of agroprocessing firms that use high-altitude crops. Since hardwoods grow along theborder areas, making high-value hardwood productsis costly in central Bhutan. Twice as many touristsenter Bhutan from the lowlands than from the high-lands, but the main attractions—festivals and trekkingroutes—are in the highlands. Such anomalies need tobe taken into account in devising policy for privatesector development—and they call for strong coordi-nation among ministries responsible for transport, in-dustry, tourism, and agriculture.

Air TransportAir service, also a major target of complaints from theprivate sector, will become a greater issue as firmsmove to higher-level technology, requiring technologyas well as parts and engineers to be flown in. Movingto high-value exports in niche markets will also in-crease reliance on air cargo, as is the case for thefishing flies exported by Yangphel Handicrafts.Improving the reliability of air service, particularlycargo service, is therefore critical. For passengertransport, reducing the seasonality of tourism or de-veloping charter tourism could lessen the strain onDruk Air.

Other InfrastructureElectricity is cheap and reportedly plentiful, but poweroutages cause some difficulties. It is not uncommonfor firms to report production losses of 2–6 percentdue to such outages—losses unsustainable for low-margin firms and those producing time-sensitivegoods. These problems were most notable in Phuent-sholing during the rainy season. A lack of water is alsoa constraint for some firms, particularly in Phuent-


sholing during the monsoon season. The telecommu-nications system is relatively good, though there is nodata network.

So while the government has established a stronginfrastructure base, it will be important to extend thisbase to cover more and more of the country and tocontinually upgrade the infrastructure to meet themore sophisticated demands that will be placed on itas the economy grows.

Public-Private Dialogue

Establishing a strong, continuing dialogue betweenthe government and the private sector is a necessaryfirst step in addressing concerns raised by the privatesector. The private sector needs to be involved inidentifying impediments to its development, in estab-lishing their relative priority, and then in designing pol-icy prescriptions. If the private sector does not haveinput, policies and solutions, no matter how well in-tended, may hamper rather than aid its growth.

In this dialogue the private sector needs a strongvoice that can put forth its concerns confidently andcompetently. The natural candidate for this role is theBhutan Chamber of Commerce and Industry alongwith the local chambers and the trade associations.The government has been supportive of the BhutanChamber of Commerce and Industry, but in the eyesof many of its members, this support has led to itsbeing nearly co-opted by the government. Many pri-vate sector managers do not believe that the chamberpresents their views strongly enough. The regionalchambers and industry trade associations, newlyformed and not yet strong enough to have a large im-pact, nonetheless promise to develop into good rep-resentatives of the private sector. The private sectorneeds to make greater efforts to organize andstrengthen local chambers and trade groups and topush the Bhutan Chamber of Commerce and Industryto become more responsive to its needs.

Challenges and Opportunities in the Priority Sectors

The cross-cutting issues that concern the private sec-tor are evident in the four priority sectors, along withsector-specific issues.

AgroprocessingBhutan’s agroprocessing industry faces many imped-iments. Raw materials are uncompetitive because ofpoor land use, low crop yields, low productivity, andhigh transport costs. Value adding activities arehampered by a lack of scale, old technology, badpackaging, a lack of branding, and costly freight.And management lacks the skills and experience to offset these higher costs through innovation andmarketing.

If the agroprocessing industry could overcomethese impediments to growth, it has potential in twoareas:

• High-value, low-volume products (incense, mush-rooms, essential oils, traditional medicines) in nichemarkets, based on such competitive advantagesas Bhutan’s biodiversity, organic production, andrange of microclimates.

• Large-scale businesses with foreign ownership inborder areas, based on the competitive advan-tages of a flexible labor force, a stable politicalenvironment, and competitive infrastructure andusing mainly imported raw materials.

With processed foods the fastest-growing compo-nent of world agricultural and food trade—accountingfor 75 percent of this trade and worth $384 billion in1996—the potential could be enormous.

To exploit this potential, firms will need a timelysupply of competitive, consistent, and high-qualityraw materials; supportive policy on labor, transport,and investment; innovation in products, processes,packaging, and product positioning; and productivity


improvements based on better management, pro-cesses, and labor skills.

Wood-Based IndustriesWood-based industries also face many constraints.Management lacks adequate qualifications and expe-rience, technology levels are low, and labor is un-skilled, resulting in low productivity. The sector has noeconomies of scale, with firms tending to make a di-verse range of products for walk-in clients. The gov-ernment, which buys up to 60 percent of the sector’soutput, drives down quality and margins. The govern-ment has also affected the sector through its policies.A 1999 ban on the export of logs encouraged firms tomove downstream to add value, but an extension ofthe export ban to semifinished products in mid-2000put an end to some of the new value adding activities.And the requirement that firms buy timber in auctionlots of mixed species means that they cannot get aconsistent supply of the type and quality of wood theyneed.

The sector has the potential to serve regional mar-kets, particularly Bangladesh, in specialist categoriesnot adequately served by local producers or by thegrowing imports from Europe and Southeast Asia.And the sector could penetrate some niche marketswith easily transported, high-value, low-volume prod-ucts. But realizing this potential will require somechanges. Firms must gain access to single-speciestimber in appropriate sizes and quality. The ban onsemifinished products needs to be relaxed so thatfirms can gain experience and gradually move down-stream to more finished products. Productivity mustbe raised through better management, the use of ap-propriate equipment, and properly trained labor.Firms’ market awareness and marketing skills need tobe improved. And in the medium term Bhutaneseforests should be certified as being sustainably man-aged to provide a selling point for Bhutanese woodproducts.

TourismThough tourism has grown rapidly over the pastdecade, annual hotel occupancy rates remain low, inpart because the market is highly seasonal, and thereis little repeat tourism. A key issue is the pricing pol-icy, which requires tourists to make sizable upfrontpayments from which the government collects royal-ties, with both determined by the season (peak ornonpeak). Better calibration of these payments—par-ticularly the government royalty—in nonpeak seasonscould encourage a steadier stream of tourists intoBhutan throughout the year.

Tourism marketing is weak. The private sectorlacks resources, and the government plays a passiverole. Moreover, the country is concerned about main-taining a balance between generating revenues andprotecting its cultural heritage. Vacations in Bhutan arerelatively expensive, but service is not commensurate.The service in hotels is usually friendly, but it is of poorquality and amenities are lacking. Part of the reason isthat there is little competition to drive up standards,since tourists must pay before arriving and have littlechoice once they enter Bhutan. (Two recently approvedSingapore-based joint ventures in the hotel industry arelikely to influence its development, however.) Moreover,the range of tourism products is limited, though someimprovements have recently been introduced. And ac-cess to Bhutan, particularly by air, can be difficult, withthe problems exacerbated by seasonality.

Tourism in Bhutan has much growth potential bothbecause of the country’s competitive advantages andbecause of problems in other potential destinations in the region. Realizing this potential will require de-veloping an unambiguous strategy with appropriatepolicies and regulations, adjusting pricing policy (par-ticularly nonpeak pricing), undertaking more activemarketing (by both firms and the government), im-proving access to Bhutan, addressing seasonality is-sues, developing new products, and improving stan-dards of accommodation and service.


Information TechnologyInformation technology can boost the economy in twoways—as a business tool used in firms and as a trad-able service. The information technology sector inBhutan faces several constraints, however, includingcomparatively high connectivity charges, a lack of in-formation technology professionals (most must comefrom India), undeveloped regulatory and financial sys-tems (online banking is not yet possible, for example),and comparatively high labor costs.

Other developing countries are targeting two mainkinds of opportunities: small niche firms selling suchservices as software development and larger firmsselling data entry or call center services. But Bhutan’sinformation technology sector is still in its infancy, andseveral challenges have to be overcome before it candeliver internationally competitive services. These in-clude increasing the use of information technology inthe public and private sectors, developing a pool ofskilled information technology workers, introducingappropriate regulations (to support online business,for example), and building a data network.

A Vision for the Development of the Private Sector

With accession of Bhutan and its main trading part-ners to the World Trade Organization, barriers to tradeare falling. Several of Bhutan’s traditional markets inIndia have already been successfully penetrated bythird-country exporters. Bhutanese producers facecompetition in the Indian market for wood panels fromboth European producers with higher labor costs andSoutheast Asian producers with lower labor costs.And Bhutan confronts growing competition from Chinaand Southeast Asia in the Indian markets for cement,calcium carbide, and ferro-silicon—the main productsof Bhutan’s three largest private companies—as wellas other traditionally important product markets.

The global integration of markets means thatBhutan and the wider Indian market have to face im-ports made by producers with cheap inputs and largeeconomies of scale. But it also means that Bhutan hasaccess to inputs and technology as advanced as anyin the world. And while global integration bringsgreater competition, it also provides opportunities—allowing a growing number of consumers to learnabout, and to buy, niche market products in whichlarge-scale producers may have no interest.

Global integration, along with the dictates of ge-ography in Bhutan, suggests that the best strategy fordeveloping the country’s private sector is to follow adual track. Areas along the border could continue toexploit industries with large labor and transport costcomponents. Proximity to large markets in India forraw materials, intermediate inputs, and finished prod-ucts and access to cheap, low-skilled, nonnationallabor allow Bhutan to make the most of its other con-siderable advantages—good governance, politicalstability, lack of labor unrest, and abundant, low-costelectricity. These attributes should permit Bhutan toproduce cost-competitive products for export to Indiaand beyond. Developed further, these heavy indus-tries could support import substitution activities andhelp extend and diversify export markets. They couldalso form a growing market for services provided bybusinesses in central Bhutan.

In the central part of the country, where laborcosts are comparatively high and transport costsoften prohibitive, efforts to develop cost-competitiveindustries need to focus on services (such as trans-port, tourism, and information technology) along withniche markets (mushrooms, wasabi, artifacts, essen-tial oils, medicinal herbs, intermediate products, andthe like). Bhutan has many attributes needed to be aniche market player producing high-value, low-volume exports, particularly its small size, distinctidentity, diverse microclimates, and potential syner-gies between its positive attributes. Further develop-


ment of such services as information technology (ini-tially for the domestic market) and expansion oftourism also offer much promise, as does continuedreliance on other fast-growing service industries, suchas transport and construction.

To succeed in this strategy, it is critical that Bhutanmaintain and exploit its potential while at the sametime avoiding creating any impediments to privatesector development. Depending on the actions ittakes during the Ninth Five-Year Plan period, Bhutancould become an important, though small, player inworld markets, creating opportunities for its increas-ingly educated population—or it could continue to lan-guish as an irrelevant player, with all the implicationsthat has for employment for its growing population.

Several factors will be critical in developing bothadditional heavy industries in the southern part of thecountry and the service and niche industries in cen-tral Bhutan. First, greater worker productivity, whichwill require worker training, management training,and the adoption of new and appropriate technolo-gies. Second, the development of a more competitiveand innovative financial sector, one that can providenew financial instruments to support the increasinglycomplex private sector. Third, appropriate technol-ogy links and better management in all stages ofproduct development, production, design, and mar-keting. All these goals can be supported by encour-aging appropriate inflows of foreign direct invest-ment. And key prerequisites of continued growth ofthe private sector are good governance and a trans-parent policy environment.

Main Recommendations

Realizing this vision for private sector development willrequire a series of support measures. The main mea-sures recommended in support of private sector devel-opment under the Ninth Five-Year Plan are as follows:

• Training. Establish a transparent system of tax re-lief and possibly a system of industry levies tosupport radically increased worker and manage-ment training and thus greater productivity.

• Labor. Develop a transparent, time-bound policyfor recruiting nonnational workers to ensure thecontinued cost competitiveness of Bhutaneseindustry.

• Finance. Encourage the development of innova-tive financial instruments and payment meansbased on the Asian Development Bank’s financialsector study—including leasing finance, factor-ing services, automated teller machines, andgreater use of credit cards (with lower transac-tion fees)—while promoting greater competitionin the financial sector and more flexible interestrates.

• Technology. Support technology transfer by im-mediately establishing a matching grant schemeas well as others (such as those relying on retiredexecutives) and by providing incentives such astax breaks for research and development.

• Foreign direct investment. Ensure that the newforeign direct investment law is finalized andapproved in the next session of the NationalAssembly and that supporting regulations are putin place shortly thereafter, and actively encourageforeign direct investments that could have a largeimpact in the early phase of implementation.

• Export incentives. Immediately implement a dutydrawback system for imported raw materials usedin producing exports (including exports to India)and begin a dialogue with the banks on providingpre- and postshipment finance to the private sector.

• Policy environment. Within the context of the NinthFive-Year Plan, develop a clear, consistent, andtransparent policy environment for the private sec-tor that takes into account its views, and ensurethat laws and regulations affecting the private sec-tor are clearly and properly codified.


• Auditing and accounting. Gradually expand theauditing net to include a broader group of privatecompanies—both to encourage greater use of fi-nancial information as a management tool and toassist the tax authorities.

• Industrial estates and dry ports. Establish indus-trial estates in locations strategic for the privatesector and dry ports at strategic border locations.

• Dialogue. Bring in experienced professionals fromexternal chambers of commerce and the privatesector to strengthen mechanisms for represent-ing private sector interests (such as the BhutanChamber of Commerce and Industry and tradeassociations).

Notes

1. Although nonnational workers accounted for only36 percent of employees in the firms surveyed,this reflects in part the bias against interviewing alarge number of construction firms, which domi-nate the list of registered companies. These firmstypically have very large shares of nonnationalemployees, often more than 90 percent.

2. In a survey of 500 U.S. importers, 95 percentranked on-time delivery as the most importantbuying criteria.

3. When the Zimbabwe market was liberalized in theearly 1990s, firms realized the importance of retailpackaging after generic biscuits imported fromSouth Africa started to penetrate the local marketdespite being three times the price of locally pro-duced biscuits.

APPENDIXES

Appendix 1: Registered Companies in Bhutan, 2001 135

Appendix 2: Tax Regime and Trade Policies 139

Table A2.1 New Personal Income Tax Rates Effective as of 2001 139

Appendix 3: Quantity and Value of Cash Crops in Bhutan, 1995–98 142

Table A3.1 Quantity and Value of Cash Crops in Bhutan, 1995–98 142

Appendix 4: Tourism Data and Analysis 143

Table A4.1 Tourist Arrivals by Tour Operator and Month, Bhutan, 2000 143

Table A4.2 Tourist Arrivals by Month, Bhutan, 1984–2000 146

Table A4.3 Tourist Arrivals by Economy of Origin, Bhutan, 1995–2000 147

Table A4.4 SWOT Analysis of the BhutaneseTourism Sector 148

Table A4.5 Results of Pilot Visitor Survey, Bhutan, 2001 149



Post Registration Date ofCompany box Location number registration

1 Bhutan Polythene Company — Phuentsholing 1 27-12-902 Penden Cement Authority Ltd. — Gomphu 2 27-12-903 Bhutan Development Finance Corporation — Thimphu 4 27-12-904 Forest Development Corporation — Thimphu 5 27-12-905 Handicrafts Development Corporation — Thimphu 6 27-12-906 Bhutan Board Products Ltd. — Phuentsholing 7 27-12-907 Druk Japan Himalayan Co. — Thimphu 8 27-12-908 Bhutan Engineering Co. Pvt. Ltd. — Thimphu 9 27-12-909 Bhutan Carbide and Chemicals Ltd. — Phuentsholing 10 27-12-9010 Bhutan Ferro Alloys Ltd. — Phuentsholing 11 27-12-9011 Bhutan Fruit Products Ltd. — Phuentsholing 12 29-03-9112 Bhutan Marble & Minerals Ltd. — Thimphu 14 10-04-9113 Druk Air Corporation Ltd. — Thimphu 15 16-04-9114 Bank of Bhutan — Phuentsholing 16 1-05-9115 Chhukha Hydro Power Corporation — Chhukha 17 2-07-9116 Royal Insurance Corporation — Phuentsholing 18 11-10-9117 Bhutan Agro Industries Ltd. 329 Thimphu 20 24-10-9118 Yangzom Cement Industry Ltd. — Samtse 21 3-12-9119 Zana Bliss International Pvt. Ltd. 145 Phuentsholing 23 7-01-9220 Bhutan Tourism Corporation Ltd. — Thimphu 25 22-04-9221 Food Corporation of Bhutan — Phuentsholing 27 8-07-9222 Dangling Company Ltd. 105 Trashigang 28 3-07-9223 Etho Metho Tours & Treks Ltd. — Thimphu 29 14-08-9224 Malo Corporation (P) Ltd. 145 Phuentsholing 30 1-09-9225 Chapcha Engineering Co. Ltd. 641 Thimphu 31 21-09-9226 Charry Engineering Company — Thimphu 32 29-10-9227 Woodcraft Center 581 Thimphu 34 30-11-9228 Chimi Wangchuk Construction Co. — Thimphu 35 11-11-9229 Lomnekha Construction Co. — Chhukha 36 30-12-9230 Tandin Import & Export (P) Ltd. 455 Thimphu 37 22-01-9331 Environment Friendly Construction Co. — Bumthang 38 2-03-9332 Mindu Company (P) Ltd. — Thimphu 39 16-04-9333 Radag Company — Wangdue 40 28-04-9334 Druk Lothuen Company Ltd. — Thimphu 41 12-05-9335 Druk Stone & Mineral Export Co. Ltd. 230 Phuentsholing 42 3-06-9336 Lama Tours & Treks Pvt. Ltd. 704 Thimphu 43 14-06-9337 Gahsel Pharmaceutical Pvt. Ltd. 495 Thimphu 44 17-06-9338 Rigsar Construction Co. (P) Ltd. — Samdrup Jongkha 45 27-07-93


39 Royal Securities Exchange of Bhutan Ltd. 154 Thimphu 46 18-08-9340 Jomo & Shaykhar Co. Ltd. — Trashigang 47 18-08-9341 Kuenphen Wangchuk Co. — Trashigang 48 18-08-9342 Gangri Tours & Treks Ltd. 607 Thimphu 50 20-08-9343 Daga Kuenphen Enterprise — Phuentsholing 51 20-08-9344 Drook Securities Ltd. — Thimphu 52 2-09-9345 Pagsam Company Ltd. — Lhuntse 53 4-10-9346 BNB Securities Ltd. — Thimphu 54 12-10-9347 Yurung Company Pvt. Ltd. 235 Samdrup Jongkha 55 12-10-9348 Druk Satair Corporation Ltd. — Samdrup Jongkha 56 14-10-9349 Chituen Construction Co. Ltd. 470 Thimphu 57 18-10-9350 Lhomen Tours & Trekking Co. Ltd. 341 Thimphu 58 21-10-9351 Etho Metho Construction Co. 341 Thimphu 59 22-10-9352 Lhaki Cement Pvt. Ltd. — Gomphu 60 17-11-9353 Army Welfare Project 92 Phuentsholing 61 18-11-9354 Bank of Bhutan Securities Ltd. — Thimphu 62 8-12-9355 RICB Securities Ltd. 77 Phuentsholing 63 8-12-9356 H & K Company 74 Phuentsholing 64 27-12-9357 Bhutan Dairy Ltd. 196 Phuentsholing 65 27-12-9358 Bhutan Adventure Pvt. Ltd. 231 Thimphu 66 28-12-9359 Druk Petroleum Corporation Ltd. 298 Phuentsholing 67 25-01-9460 Yeti Tours & Trekking Pvt. Ltd. 456 Thimphu 68 25-01-9461 Shongar Construction Co. Ltd. — Mongar 69 16-02-9462 National Construction Co. Ltd. 398 Thimphu 70 28-04-9463 Chhukha Construction Co. Ltd. — Chhukha 71 10-05-9464 Kinga Tours & Treks Ltd. 635 Thimphu 72 23-05-9465 Ratna Transport Co. Pvt. Ltd. 149 Samdrup Jongkha 73 5-07-9466 Gayjur Construction Co. — Mongar 75 29-07-9467 Eastern Bhutan Coal Co. — Samdrup Jongkha 76 3-08-9468 Druk Norlha Co. 631 Thimphu 77 8-08-9469 Hotel Kelwang Pvt. Ltd. 350 Thimphu 78 18-08-9470 Kelwang Consultancy & Construction Ltd. 350 Thimphu 79 24-08-9471 Nansay Company — Galephu 80 7-09-9472 Perfection Engs. & Consultants Ltd. — Gomphu 81 29-09-9473 Bhutan Shangri-La Adventure Ltd. 532 Thimphu 82 27-10-9674 Phuensum Import & Export Co. Ltd. 772 Thimphu 83 30-11-9475 RSA Pvt. Ltd. 321 Phuentsholing 84 9-05-9576 International Tours & Treks Ltd. — Paro 85 25-07-95



77 Druk Construction Company 204 Thimphu 86 26-07-9578 Kuensel Corporation — Thimphu 87 16-08-9579 Tsenphu Company — Mongar 88 20-09-9580 Phub Bro’s Construction Co. — Thimphu 89 16-10-9581 Namgail Cement Co. Ltd. 138 Phuentsholing 90 30-10-9582 Stade Trading Corporation of Bhutan — Phuentsholing 91 5-03-9683 Dragon Nest Ltd. — Wangdue Phodrang 92 29-03-9684 Phuensum Construction (P) Co. — Thimphu 93 29-07-9685 Bhutan Broadcasting Service 101 Thimphu 94 15-08-9686 Goendrap Eng. Company — Punakha 95 6-09-9687 Bhutan National Bank — Thimphu 96 2-09-9688 Bhutan Postal Corporation — Thimphu 97 25-10-9689 National Transport Company — Thimphu 98 9-12-9690 Sakteng Health Club & Saloon Ltd. 825 Thimphu 99 8-01-9791 T&K Construction Co. 881 Thimphu 100 4-03-9792 Bhutan Tours & Travel Pvt. Ltd. 224 Thimphu 101 18-04-9793 Himalayan Plastic & Chemicals — Thimphu 102 21-04-9794 Yarkay Oxygen Ltd. 134 Phuentsholing 103 22-04-9795 Green Wood Mfg. Corporation — Phuentsholing 104 28-04-9796 United Construction Co. Pvt. Ltd. — Thimphu 105 29-04-9797 Alpine Builders — Thimphu 106 28-05-9798 Bhutan Polymers Co. Ltd. 321 Gomphu 107 12-06-9799 Kubera Tours & Treks Pvt. Ltd. — Thimphu 108 13-06-97100 Bhutan Board Exports Ltd. — Phuentsholing 109 3-07-97101 Druk Silicon Carbide Ltd. — Thimphu 110 11-07-97102 Choden Chemical & Industry Ltd. — Samdrup Jongkha 111 21-07-97103 Rabsel Construction Co. Ltd. 488 Thimphu 112 1-08-97104 Namcha Construction Pvt. Ltd. — Thimphu 113 8-10-97105 Royal Society for the Protection of Nature — Thimphu 114 29-10-97106 Bhutan Construction Co. Ltd. — Thimphu 115 5-02-98107 Euchok Construction Co. — Thimphu 116 11-05-98108 Bumthang Brewery Ltd. — Bumthang 117 29-05-98109 Hotel Druk-Yul — Thimphu 118 30-07-98110 Gongphel Construction Co. Pvt. Ltd. — Thimphu 119 16-12-98111 Pinewood Builders — Thimphu 120 8-01-99112 Goong Construction — Phuentsholing 121 23-02-99113 Lhaki Wood Industries Ltd. — Thimphu 122 —114 Rainbow Tours & Travels Pvt. Ltd. — Thimphu 123 28-04-99



115 Osang Electrical Company Pvt. Ltd. — Thimphu 124 16-06-99116 Druk Chlorate Company — Thimphu 125 9-08-99117 Peljorekhang Pvt. Ltd. — Thimphu 126 9-08-99118 Tshungmed Solar Inc. — Thimphu 127 13-08-99119 N.D. Construction — Thimphu 128 25-08-99120 Hotel Riverview Pvt. Ltd. Thimphu — Thimphu 129 22-12-00121 Pelchen Randin Real Estate — Thimphu 130 10-04-01122 BTB Pvt. Ltd. Thimphu — Thimphu 131 8-05-01123 Singye Group of Companies Pvt. Ltd. — Thimphu 132 —124 Bhutan Agrotech Research and Development — Thimphu 133 14-05-01

— Not available.



Corporate and Personal Income Tax

The corporate income tax regime has the followingkey features:

• Resident companies are taxed 30 percent of netprofit.

• Nonresident companies are taxed 3 percent ofturnover, a tax withheld at source.

• Business expenses are allowable deductions aslong as they are supported by documentary evi-dence. Ceilings apply on salaries, donations, andentertainment expenses.

• Depreciation of assets within the maximum pre-scribed limit is allowed according to a straight linemethod.

A personal income tax replaced the salary tax in2001. The tax on salary is charged at rates rangingfrom 10 to 25 percent (table A2.1). No tax is payableon individual incomes below Nu 100,000 a year.

In 2001/02 the corporate income tax was forecastto generate government revenues of Nu 939 million(20.4 percent of total revenue); the business incometax, revenues of Nu 201 million (4.4 percent); and thesalary tax, Nu 62 million (1.3 percent).

Tariffs

Import duties range from 0 to 30 percent except forsome higher tariffs on imports of beer, other alcoholicbeverages, and tobacco products. Under the long-standing free trade arrangement with India, these tar-iffs are applied only on imports from third countries.Tariffs in Bhutan tend to be lower than correspondingrates in India.

The trade liberalization program in Bhutan has re-duced the number and level of tariffs. The 2001/02budget abolished tariffs on a wide range of electricalappliances for the home, with the expectation thatrural electrification will allow people in rural areas totake advantage of these time- and labor-saving de-vices. It also abolished tariffs on computers, reflectingthe growing importance given to developing informa-tion technology in Bhutan.

Business Sales Tax

Trade is also affected by the business sales tax, orig-inally imposed on imports from India (and on sales byselected hotels and restaurants and cement sales byPenden Cement Authority) but in September 1998 ex-

Gross annual salary Tax rate

Up to Nu 100,000 None

Between Nu 100,000 and Nu 250,000 10 percent

Between Nu 250,000 and Nu 500,000 Nu 10,000 plus 15 percent on income over Nu 250,000

Between Nu 500,000 and Nu 1,000,000 Nu 25,000 plus 20 percent on income over Nu 500,000

More than Nu 1,000,000 Nu 65,000 plus 25 percent on income over Nu 1,000,000

Table A2.1 New Personal Income Tax Rates Effective as of 2001


tended to imports from countries other than India aswell. Indian exporters to Bhutan can claim the busi-ness sales tax as a rebate against the Indian salestax, and Indian authorities have not treated the busi-ness sales tax as an import tariff. Since producers ofimport substitutes in Bhutan do not pay this tax, it hasa protective effect similar to that of a tariff. The busi-ness sales tax ranges from 0 to 20 percent (withhigher rates for beer, other alcoholic beverages, andtobacco), so the actual duties on imports from coun-tries other than India range from 0 to 50 percent ratherthan the 0 to 30 percent in the import tariff schedule.The business sales tax contributes 7.2 percent of totalgovernment revenue.

The business sales tax accounts for most of thetaxes collected on imports. In the medium term con-sideration will be given to reducing this tax except ona few items such as vehicles and alcohol or tobaccoproducts. This would eliminate much of the protection-ist element of a business sales tax imposed on importsbut not on sales of domestically produced goods. Itwould also eliminate the trade diversion effects that re-sult from the present system because India has a re-bate system for the sales tax and most other countriescharge no sales tax on exports. The medium-term goalis a commodity tax system based on a business salestax applied on a nondiscriminatory basis to importsfrom India as well as from other countries.

In the longer run consideration will be given to im-posing an excise tax on domestically producedgoods at the point of production. With a relatively uni-form business sales tax applied to imports from Indiaand other countries and an excise tax of a similar rateimposed at the factory gate, Bhutan will have an effi-cient, low, and relatively uniform commodity tax sys-tem in place.

The structure of import duties—tariffs and thebusiness sales tax—shows the normal cascading,with rates generally highest on final products (exceptfor some essential goods), lower on intermediateproducts, and lowest on raw materials. This cascad-

ing effect can give high levels of effective protectionto activities competing with imports. Thus, for exam-ple, a 50 percent tariff on a final product in which animported input with a 20 percent tariff accounts forhalf the production costs results in an effective rate ofprotection of 90 percent. Since there is much scopefor waiving duties on intermediate products and rawmaterials as an incentive, effective protection ratescan often be even higher.

Export Taxes

Some export taxes are in effect, but these contributeonly a small share of government revenue (0.3 per-cent) and the government has decided to eliminatethem. Export bans exist on timber, antiques, and ani-mals and plants classified as endangered species(including their parts and products).

Excise Taxes

Excise taxes are restricted to sales of alcoholic prod-ucts by the Army. Still, they are a relatively importantsource of government revenue, contributing 10 per-cent of the total, and are the most important indirecttax in Bhutan.

State Controls on Trade

There are, in general, no quantitative restrictions onimports, though some exceptions exist. Import li-censes are required, and there is supposed to be au-tomatic approval of licenses for importing all com-modities outside a narrow negative list for whichspecial permission is required.

Although import licensing is supposed to be auto-matic, there are some complaints from the privatesector that this is not so. The government’s concern


about exacerbating the trade deficit with hard cur-rency countries plays a part in this. Some business-people complain about long delays in getting importlicenses for inputs from hard currency areas, espe-cially if these inputs are to be used in producinggoods for export to India. Investors also complain ofdifficulties in getting approval for investment projects

in which imported inputs from hard currency areas willbe used to produce exports for India.

The government maintains an effective monopolyon imports of rationed goods such as fertilizer,kerosene, and liquefied petroleum gas (LPG), provid-ing these goods to domestic users at subsidizedprices.

Appendix 3: Quantity and Value of Cash Crops in Bhutan, 1995–98 142

19

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ps

in B

huta

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995–

98


Operator Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total

1 Bae Yul Excursion 0 0 43 21 20 3 0 25 6 51 26 1 196

2 Bhutan Adventure 0 0 0 0 0 0 0 0 0 0 0 0 0

3 Bhutan Expeditions 0 0 0 0 0 0 0 0 10 0 0 0 10

4 Bhutan Cultural Tours 0 0 1 0 0 0 0 0 0 0 1 0 2

5 Bhutan Dorji Holidays 0 0 0 0 0 0 1 5 3 0 0 0 9

6 Bhutan Heritage 0 8 7 0 5 0 2 0 0 0 22 1 45

7 Bhutan Himalaya Tours 7 0 0 3 0 0 0 1 0 0 0 0 11

8 Bhutan Holiday Tours 0 0 0 0 0 0 2 3 3 10 14 9 41

9 Bhutan Lhayul 0 0 5 0 0 0 0 0 0 0 2 0 7

10 Bhutan Mandala Tours 0 17 65 71 11 26 34 34 68 31 3 25 385

11 Bhutan Millennium 0 0 0 0 0 0 0 0 0 0 0 0 0

12 Bhutan Tours and Travels 0 0 0 0 0 0 0 0 0 0 0 0 0

13 Bhutan Travel Service 0 0 0 1 1 1 2 3 1 31 2 0 42

14 Bhutan Treks and Tours 0 0 19 6 0 1 0 0 0 0 0 0 26

15 Bhutan Vacation Inc. 0 0 0 0 0 0 1 0 0 4 0 0 5

16 Bhutan Travel Bureau 2 5 10 8 1 5 0 12 15 44 4 4 110

17 BTCL 1 22 143 137 56 4 2 17 83 331 96 17 909

18 Chundu Tours 2 2 22 21 6 3 1 0 8 77 23 4 169

19 Dechen Cultural 0 0 16 0 0 0 0 0 0 20 0 7 43

20 Deodgu Yangkhil 0 0 0 0 7 0 0 0 0 0 0 0 7

21 Discovery Bhutan 0 0 0 0 6 0 0 3 2 4 2 1 18

22 Dragon Tours 0 0 19 18 0 31 0 14 3 17 0 0 102

23 Druk Adventure 0 0 5 0 0 0 0 0 0 0 0 0 5

24 Eagle Tours 0 0 0 0 0 0 0 0 0 0 7 0 7

25 Equator Expeditions 0 0 2 0 3 0 2 0 4 59 32 0 102

26 Etho Metho Tours 11 57 197 172 114 18 34 43 110 406 121 39 1,322

27 Exotic Destination 0 0 0 1 3 0 0 0 2 0 0 4 10

28 Ezekiel Tours 0 0 3 0 0 0 0 0 0 0 5 0 8

29 Gangri Tours 0 3 44 75 5 18 3 11 74 149 48 0 430

30 Himalayan Adventure 0 0 0 0 0 0 0 0 0 3 0 0 3

31 Himalayan Kingdom 0 2 0 11 0 0 0 2 0 0 2 0 17

32 International Tours 8 14 120 102 43 24 19 35 34 272 105 31 807

33 Jamphel Tours 0 0 0 19 0 0 0 2 2 15 0 2 40

34 Khuju Tours 0 0 1 6 0 0 0 0 0 0 0 0 7

35 Kinga Tours 0 0 0 0 0 0 0 0 0 0 0 0 0

36 Kubera Tours 0 0 3 0 0 0 0 0 0 0 0 0 3

37 Lama Tours 0 0 0 0 0 0 0 0 4 19 19 0 42

Table A4.1 Tourist Arrivals by Tour Operator and Month, Bhutan, 2000

continued . . .


Table A4.1 Tourist Arrivals by Tour Operator and Month, Bhutan, 2000 (continued)


38 Lotus Tours 0 0 0 1 0 0 0 0 0 0 0 0 1

39 Lhomen Tours 0 0 4 16 6 2 0 2 13 13 5 0 61

40 Lingkor Tours 3 3 15 1 1 3 2 2 0 30 18 5 83

41 Masagang 2 0 0 3 4 5 0 0 0 2 3 4 23

42 Namsey Tours 0 0 16 25 6 0 3 0 7 8 38 0 103

43 Osang Tours 0 0 0 0 2 0 0 0 0 0 0 0 2

44 Prestine Yul Druk 0 0 2 0 0 0 0 0 0 0 0 0 2

45 Rabsel Tours 2 5 2 1 4 0 6 3 11 36 8 5 83

46 Rainbow Tours 0 2 9 8 21 3 25 0 6 20 6 3 103

47 Ratna Tours 0 0 0 0 0 0 1 0 2 0 9 0 12

48 Riki Tours 0 0 0 3 0 0 0 0 0 0 0 0 3

49 Rinchen Tours 0 0 0 11 0 0 0 0 0 30 0 0 41

50 Sakten Tours 3 0 27 14 7 5 6 7 10 24 52 8 163

51 Shangrila Tours 0 0 4 5 1 0 0 1 9 5 5 0 30

52 Siddarth Tours 0 0 0 0 0 0 0 0 0 0 0 0 0

53 Sky Travels 0 0 0 0 0 0 0 0 1 7 0 2 10

54 Snow Leopard 0 4 0 31 14 0 0 0 17 67 8 0 141

55 Sophun Tours 0 0 0 0 0 0 0 0 0 0 0 2 2

56 Taktsang Tours 8 8 0 0 0 0 0 0 0 0 0 0 16

57 Tara Tours 0 0 0 0 0 0 0 0 0 0 0 0 0

58 Tashi Delek Tours 0 0 0 0 0 0 0 0 0 0 0 0 0

59 Tashi Tours 0 15 30 69 0 0 0 44 14 23 58 0 253

60 Thimphu Tours 0 0 0 0 0 0 0 0 1 0 0 0 1

61 Thoesam Tours 0 16 10 19 2 2 0 1 19 18 3 0 90

62 Thunder Dragon 0 15 25 32 2 0 0 0 21 35 37 1 168

63 Travel Bhutan 0 0 0 0 0 0 0 0 0 0 0 0 0

64 Thunder Bolt 0 0 0 0 0 0 0 0 0 3 0 0 3

65 Vajra Tours 0 0 0 0 0 4 3 0 0 0 0 0 7

66 White Lotus Tours 0 0 0 0 0 0 0 0 0 0 13 2 15

67 White Tara Tours 0 0 4 1 0 0 0 0 0 0 0 0 5

68 Wangchuk Tours 0 0 0 0 4 0 0 0 0 0 0 0 4

69 Wings Tours 4 5 14 5 3 3 6 27 11 2 4 6 90

70 Wild Horse Tours 0 0 4 0 2 0 1 1 6 5 4 0 23

71 Yangphel Tours 4 11 100 50 31 4 4 6 59 249 103 19 640

72 Yarkey Tours 0 0 2 0 0 0 0 0 0 2 3 0 7

73 Yeti Tours 1 1 5 1 0 2 0 1 14 29 25 4 83

74 Yodsel Tours 4 5 24 19 6 3 2 0 3 31 38 1 136

continued . . .



75 Yudruk Tours 3 2 44 5 15 17 0 2 27 63 22 6 206

76 Expatriate guests 0 0 0 0 3 0 0 0 0 2 0 0 5

77 Tab guests 0 1 0 3 0 0 0 0 0 0 0 0 4

Total pax 65 223 1,066 995 415 187 162 307 683 2,247 996 213 7,559

Total fams 4 4 5 5 5 8 1 2 12 16 4 0 66

Total focs 0 0 3 3 1 1 0 0 0 0 0 1 9

Actual fax 61 219 1,058 987 409 178 161 305 671 2,231 992 212 7,484

Note: Data exclude tourists from India.Source: Bhutan Ministry of Trade and Industry, Department of Tourism.

Table A4.1 Tourist Arrivals by Tour Operator and Month, Bhutan, 2000 (continued)


19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

Janu

ary

3540

4359

2621

3525

9167

101

120

133

108

9614

865

Feb

ruar

y76

3945

6343

3934

8211

813

917

513

430

425

415

432

222

3

Mar

ch91

237

409

122

390

250

146

270

346

232

643

341

605

1,06

254

21,

145

1,06

6

Ap

ril40

621

417

246

623

011

826

515

226

558

727

41,

022

689

662

1,16

760

499

5

May

114

130

134

145

140

8799

110

140

124

373

337

215

275

267

395

415

June

5222

4916

3138

1232

6860

115

8191

9097

108

187

July

6294

9291

6232

4447

118

5199

119

160

123

152

132

162

Aug

ust

208

182

306

235

147

133

8418

111

716

130

118

330

623

134

034

830

7

Sep

tem

ber

204

237

338

253

298

164

262

402

355

494

465

466

788

276

1,10

71,

069

683

Oct

ober

459

452

573

709

670

375

249

426

701

426

787

1,16

81,

128

1,48

81,

329

1,85

62,

247

Nov

emb

er13

416

011

226

811

817

920

526

830

047

541

859

950

864

067

884

199

6

Dec

emb

er59

8813

297

4444

103

111

144

168

220

195

211

154

274

190

213

Tota

l1,

900

1,89

52,

405

2,52

42,

199

1,48

01,

538

2,10

62,

763

2,98

43,

971

4,76

55,

138

5,36

36,

203

7,15

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559

Ann

ual g

row

th (

per

cent

)—

–0.2

626

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4.95

–12.

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2.70

3.92

36.9

331

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615

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Trek

kers

——

——

—

—

—

——

——

—

1,

851

746

1343

830

926

Cul

tura

l tou

rists

——

——

—

—

—

——

—

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3,

287

4,61

74,

860

6,32

86,

633

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(mill

ions

of U

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rs)

Gro

ss e

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ngs

——

——

—

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1.91

1.99

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3.23

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ernm

ent r

even

ue—

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310.

981.

131.

392.

042.

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Dat

a ex

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huta

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try,

Dep

artm

ent o

f Tou

rism

.

Tab

le A

4.2

Tour

ist

Arr

ival

s b

y M

onth

, B

huta

n, 1

984–

2000


Economy of origin 1995 1996 1997 1998 1999 2000Japan 1,192 1,211 1,173 1,032 1,102 875

United States 865 963 910 1,471 2,122 2,754

Germany 500 722 533 520 574 662

United Kingdom 418 358 642 686 646 595

France 338 331 229 366 236 399

Italy 202 242 186 218 276 156

Austria 200 156 156 270 197 131

Thailand 57 181 140 19 71 92

Switzerland 220 161 186 170 296 137

Netherlands 100 131 234 370 362 359

Australia 142 71 121 64 131 179

Belgium 79 77 75 95 107 95

Canada 55 57 89 82 149 194

Spain 22 49 33 109 118 141

Korea, Rep. of 0 41 31 11 14 3

Norway 0 43 6 12 33 7

Singapore 0 45 78 77 26 31

Taiwan, China 0 32 83 135 179 175

Denmark 42 26 61 45 13 30

Finland 8 15 21 0 5 60

Nepal 0 15 32 23 23 50

Portugal 0 13 11 0 43 19

Luxembourg 0 11 14 0 0 2

Sweden 45 7 18 58 37 48

Israel 0 0 0 81 80 68

Poland 0 0 0 45 35 26

Russian Federation 0 0 0 36 17 13

New Zealand 0 0 0 28 22 31

Turkey 0 0 0 0 49 34

Philippines 0 0 0 0 20 13

Brazil 0 0 0 27 14 10

Czech Republic 0 0 0 24 0 12

Greece 0 0 0 16 0 25

China 0 0 0 12 11 10

Argentina 0 0 0 11 12 29

Ireland 0 0 0 0 16 10

South Africa 0 0 0 0 12 7

Mexico 0 0 0 0 49 37

Malaysia 0 0 0 0 0 16

Others 280 180 301 90 61 24

Total 4,765 5,138 5,363 6,203 7,158 7,559

Trekkers 0 1,851 746 1,343 830 926

Cultural tourists 0 3,287 4,617 4,860 6,328 6,633

Note: Data exclude tourists from India.Source: Bhutan Ministry of Trade and Industry, Department of Tourism.

Table A4.3 Tourist Arrivals by Economy of Origin, Bhutan, 1995–2000


Strengths

• Unique destination

• Natural beauty

• Moderate climate

• Friendly people

• History

• A monarchy

• Scope for fine-tuning the visitor experience with

product enhancements

• Professionalism and skills of Bhutan Tourism

Corporation and other tour operators

• Opportunity for outdoor activities (fishing, trekking,

bird watching)

• Great opportunity for cultural tourism, including

towns, history, museums, collections, monastic

buildings, costumes, folklore, and music and

dance

• Close proximity to the important Indian market

• Established tourism plan, including such services as

guides, access, internal transport, restaurants,

accommodation, and outdoor and cultural tourism

activities

Threats

• Conservatism of tourism industry and the government

• Sensitive balance required between demand and

available resources

• Virtual absence of repeat business

• Safety fears generally and relating to international air

transport

• Political instability in adjoining countries

Table A4.4 SWOT Analysis of the Bhutanese Tourism Sector

Weaknesses

• Undue growth in numbers of visitors could damage

the tourism industry because of the sensitive nature of

the product

• High-priced destination, but support services below

expectations

• Insufficient attention in some hotels to customer

service

• Absence of information literature for tourists

• Undue emphasis on tour groups, to the detriment of

individual travelers

• Poor range of books, postcards, and souvenirs

available

• Range of visitor accommodations limited to those with

two-star ratings and below (a situation being corrected)

• Government royalty on visitors not reinvested in tourism

• Unduly complex trade and state structures for tourism

• Absence of focused, well-financed state body to con-

centrate on overseas tourism marketing and product

development

• Access limitations, including complex booking

arrangements, air service with poor capacity, and un-

reliability arising from weather conditions

Opportunities

• Promoting limited growth in visitors

• Increasing the focus on top-market, high-spending

visitors

• Attracting more internationally recognized hotels to

Bhutan

• Devising a tourism master plan

• Establishing a national tourism training organization

• Undertaking ongoing market research, particularly

customer satisfaction surveys


Share of Share ofrespondents respondents

Item Respondents (percent) Item Respondents (percent)

Country of origin Occupation

United States 7 41 Professional 5 29

United Kingdom 4 24 Retired 6 35

Israel 3 17 Management 4 24

Italy 2 12 Technical 1 6

Norway 1 6 Millworker 1 6

Income What influenced your visit?

More than $100,000 10 59 Personal recommendations 10 59

$50,000–100,000 4 23 Been to region before 5 29

Less than $50,000 1 6 Brochures 2 12

No answer 2 12

Traveling in Bhutan Kind of tour package

In group 15 88 Cultural 10 59

With friend or relative 2 12 Cultural and trekking 5 29

Cultural and adventure 1 6

Biking 1 6

Enjoyment of visit Fulfillment

Excellent 13 76 Met expectations 8 47

Exceptional quality 2 12 Exceeded expectations 7 41

Satisfactory 2 12 Did not meet expectations 2 12

Obligatory regulations Value for money

Reasonable 11 65 Reasonable 8 47

Not acceptable 4 23 Expensive 5 29

Fully acceptable 2 12 Excellent 2 12

Very, very expensive 1 6

No answer 1 6

Arrangements in Bhutan Quality of meals

Excellent 10 59 Satisfactory 5 29

Good 4 23 Poor 1 6

Poor 2 12 Good 9 53

Faultless 1 6 Excellent 2 12

Table A4.5 Results of Pilot Visitor Survey, Bhutan, 2001

continued . . .




Type of accommodation Quality of hotel services

Hotel 14 82 Satisfactory 5 29

Guesthouse 1 6 Excellent in superior room;poor in standard room 5 29

Various 2 12 Excellent 1 6

Good 2 12

Very unsatisfactory 1 6

Poor 2 12

Mixed 1 6

Quality of internal transport Visit Bhutan again?

Satisfactory 6 35 Yes 15 88

Excellent 8 47 No 2 12

Poor 3 18

Recommend Bhutan to a friend? Highlights

Yes 15 88 Festivals 5 29

No 2 12 n.a. (visit uncompleted) 6 35

Terrain 2 12

People and landscape 2 12

Biking through countryside 1 6

Punakha Monastery beingrebuilt 1 6

Items purchased Amount spent (U.S. dollars)

Textiles 3 17 200 8 47

Arts 1 6 1,000 1 6

Souvenirs 1 6 1,500 1 6

Handicrafts 2 12 500 2 12

Books and stamps 1 6 90 1 6

Textiles, weaving, paintings, paper, jewelry 5 29 50 1 6

Car rings and bells 1 6 0 2 12

Nothing 3 18

Table A4.5 Results of Pilot Visitor Survey, Bhutan, 2001 (continued)

continued . . .




Objective of visit How arrived in Bhutan?

Culture 6 35 By air 5 88

Nature 1 6 By road 2 12

Nature, religion, and culture 1 6

Culture and trekking 4 24

Culture and philosophy 2 12

Religion and culture 1 6

Everything except trekking 1 6

General comments by visitors

Improve the hotels Limited choice for meals and accommodation

Reduce the number of dogs Prices fixed, but standards vary

Organize tours better Undue restrictions on photography

Communications too costly and quality poor No public access to most religious buildings

Buses poor

Tourist information should be in rooms

n.a. Not applicable.

Table A4.5 Results of Pilot Visitor Survey, Bhutan, 2001 (continued)

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