Though the 1949 Treaty with India is still sometimes misinterpreted to mean that India controls Bhutan's foreign affairs, Bhutan today handles all of its foreign affairs itself including the sensitive (to India) border demarcation issue with China. Bhutan has diplomatic relations with 22 countries, including the European Union, with missions in India, Bangladesh, Thailand and Kuwait. It has two UN missions, one in New York and one in Geneva. Only India and Bangladesh have residential embassies in Bhutan, while Thailand has a consulate office in Bhutan.
By a long standing treaty, Indian and Bhutanese citizens may travel to each other's countries without a passport or visa using their national identity cards instead. Bhutanese citizens may also work in India without legal restriction. Bhutan does not have formal diplomatic ties with its northern neighbour, China, although exchanges of visits at various levels between the two have significantly increased in the recent past. The first bilateral agreement between China and Bhutan was signed in 1998, and Bhutan has also set up consulates in Macau and Hong Kong. Bhutan’s border with China is largely not demarcated and thus disputed in some places. [9]
On November 13 2005, Chinese soldiers crossed into Bhutan under the pretext that environmental conditions had forced their retreat south from the Himalayas. The Bhutanese government allowed this incursion (after the fact) on humanitarian grounds. Soon after, the Chinese began building roads and bridges within Bhutanese territory. Bhutanese Foreign Minister Khandu Wangchuk took up the matter with Chinese authorities after the issue was raised in Bhutanese parliament. In response, Foreign Ministry spokesman Qin Gang of the People's Republic of China has said that the border remains in dispute (completely ignoring the original official pretext for the incursion) and that the two sides continue to work for a peaceful and cordial resolution of the dispute [10]. Neither the Bhutanese nor Indian governments (India still handles some foreign affairs for Bhutan) have reported any progress regarding this matter (peaceful, cordial or otherwise), and the Chinese continue to this day building infrastructure and increasing their military garrison within Bhutan. An Indian intelligence officer has said that a Chinese delegation in Bhutan told the Bhutanese that they were "overreacting." The Bhutanese newspaper Kuensel has said that China might use the roads to further Chinese claims along the border. [11]
http://en.wikipedia.org/wiki/Bhutan#Military_and_foreign_affairs
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Appreciated. Very informative.