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Papua New Guinea

Author(s):
International Monetary Fund
Published Date:
May 2011
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INTRODUCTION

1. Papua New Guinea has enjoyed 10 years of positive economic growth. This unprecedented achievement for the country owes much to greater political stability, sound macroeconomic policies, and improved public finances. Higher commodity prices and the construction of a liquefied natural gas (LNG) project—a 190 percent of GDP investment—are boosting an economy facing capacity constraints. As a result, rising consumer and asset price inflation is threatening macroeconomic stability. To lower the risk of overheating, firm fiscal and monetary policies are required. This may be challenging with elections upcoming in 2012.

2. Rich natural resources provide an opportunity to raise long-term growth and living standards. To ensure that the opportunity is not wasted, sound policy frameworks and implementation will be essential. In particular, strict adherence to the allocations in the 2011 budget, close coordination of monetary and fiscal policies, and the integration of a sovereign wealth fund (SWF) into the macro framework should help maintain macroeconomic stability. Improvements in public financial management and structural reforms are needed to ensure that development objectives are achieved.

RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK

3. Economic growth increased in 2010. The economy has weathered the global recession relatively well and real GDP growth is estimated to have picked up from 5½ percent in 2009 to 7 percent in 2010. The turnaround in the mineral sector was due to the start of production at new mines and slower-than-expected decline in oil and gas extraction on the back of higher commodity prices. Banks continued to finance a dynamic nonmineral economy, which got an additional boost from construction, transport, and communication related to the LNG project. Responding to high demand and rising food prices, agriculture production rebounded. However, the country’s infrastructure—roads, ports, and utilities—shows signs of capacity constraints, and bottlenecks have appeared in the markets for skilled labor and land (Figure 1).

Figure 1.Papua New Guinea—Macro Performance

Sources: Bank of Papua New Guinea; International Financial Statistics, World Economic Outlook, and IMF staff calculations.

4. Strong domestic demand, the pick-up in international food prices, and the depreciation of the kina fuelled inflation in 2010. Headline inflation reached 7.8 percent in December. Underlying inflation has been trending upward since mid-2009 to 6 percent and is increasingly driven by domestic demand and higher labor costs. Moreover, inflation is likely to be underestimated in official data, which take inadequate account of rental increases and are based on an outdated consumption basket.

Staff’s Views

5. Near-term growth is projected to remain strong. Staff expects real GDP growth of 9 percent in 2011 as activity is boosted by the construction of the large LNG project, buoyant commodity exports, the start of production at the Ramu Nickel and Hidden Valley mines, and strong investor confidence. In 2013/14, real GDP growth is projected to slow down sharply as LNG construction and extraction from maturing oil fields and from the largest copper mine wind down. LNG production starts in 2015, leading to a 20 percent level jump in GDP. In the absence of further LNG plants and new mines, GDP growth is expected to converge to a 3–4 percent long-run trend rate. Nonmineral GDP growth per head is projected to continue at a moderate pace (Table 6).

Table 1Papua New Guinea: Selected Economic and Financial Indicators, 2007–11

Nominal GDP (2009):

US$8 billion 1/

Population (2009):

6.3 million

GDP per capita (2009):

US$1,272

Quota: SDR 131.6 million

2007200820092010

Est.
2011

Proj.
Real sector(Percent change)
Real GDP growth7.26.65.57.09.0
Mineral−0.1−1.4−1.74.39.3
Nonmineral8.17.66.37.38.9
CPI (annual average)0.910.76.96.08.4
CPI (end-period)3.211.25.77.89.5
Central government operations(In percent of GDP)
Revenue and grants37.332.627.532.533.4
Expenditure and net lending28.330.137.132.832.4
Overall balance (including grants)9.02.5−9.6−0.31.0
Nonmineral balance 2/−5.0−7.4−13.4−7.3−7.7
Gross public debt33.631.732.126.521.9
Domestic16.918.519.215.812.3
External16.613.212.910.79.7
Money and credit (percentage change)(Percent change)
Domestic credit5.615.737.34.719.9
Credit to the private sector34.329.515.117.925.0
Broad money27.87.821.310.022.6
Interest rate (182-day T-bills; period average)4.45.97.26.4
Balance of payments(In millions of U.S. dollars)
Exports, f.o.b.4,8225,8174,3895,8248,298
Of which: Mineral3,6734,2633,4034,6366,607
Imports, c.i.f.−2,629−3,140−2,871−4,455−5,480
Current account (including grants)208808−649−2,255−2,420
(In percent of GDP)3.310.1−8.0−23.7−21.2
Exceptional financing (net)0.00.00.00.00.0
Gross official international reserves2,0872,0952,6233,0923,459
(In months of nonmining imports, c.i.f.)1411161110
(In months of goods and services imports)55755
Public external debt
Public external debt-service-ratio (percent of exports) 3/42321
Public external debt-to-GDP ratio (in percent) 3/1713131110
Exchange rates
US$/kina (period-average)0.3370.3700.3630.375
NEER (2000=100, end-period)77.795.083.378.3
REER (2000=100, end-period)98.7135.2116.1113.2
Nominal GDP (millions of kina)18,79821,59422,20825,42131,162
Sources: Papua New Guinea authorities; and IMF staff estimates and projections.

Based on period average exchange rate.

Measured from above the line in the fiscal accounts.

Includes central government, central bank external debt, and statutory authorities.

Sources: Papua New Guinea authorities; and IMF staff estimates and projections.

Based on period average exchange rate.

Measured from above the line in the fiscal accounts.

Includes central government, central bank external debt, and statutory authorities.

Table 2Papua New Guinea: Summary of Central Government Operations, 2008–16(In percent of GDP)
200820092010201120122013201420152016
Est.BudgetProj.Proj.Proj.Proj.Proj.Proj.
Revenue and grants32.627.532.532.333.431.429.525.217.616.9
Revenue28.023.527.027.028.427.025.421.314.914.5
Tax revenue26.722.425.325.526.625.324.020.514.514.2
Mineral taxes9.13.15.85.67.46.65.22.10.60.5
Nonmineral taxes17.519.319.520.019.218.718.818.413.913.7
Nontax revenue1.31.11.71.41.81.61.40.80.40.4
Of which: mineral nontax revenue0.80.61.21.01.31.20.90.40.10.1
Grants4.64.05.55.35.04.44.13.92.72.4
Total expenditure and net lending30.137.132.832.332.431.029.928.621.318.4
Recurrent expenditure17.518.816.418.417.816.016.015.612.712.5
National departments10.510.89.712.011.510.010.110.08.58.4
Salaries and wages4.34.44.25.95.64.54.64.43.23.1
Arrears payments0.30.20.30.20.20.20.20.20.20.1
Goods and services5.25.54.65.15.04.74.74.74.74.7
Other0.70.70.70.70.70.60.60.60.40.4
Provinces4.04.84.13.93.73.63.83.62.52.4
Salaries and wages3.13.63.12.72.82.62.72.61.91.8
Goods and services0.30.60.50.50.50.40.40.40.30.3
Conditional grants0.50.60.60.60.50.60.70.60.40.3
Statutory authorities1.21.21.11.11.11.11.11.10.80.8
Interest1.82.01.41.51.41.31.00.90.80.9
Domestic1.41.81.21.31.01.00.70.70.60.8
Foreign0.40.30.20.20.30.30.30.30.20.2
Development expenditures and net lending12.618.316.413.814.615.013.912.98.65.9
Development expenditure12.618.316.413.914.615.013.912.98.65.9
Foreign financed5.04.45.96.76.05.55.35.13.53.0
Project grants4.64.05.55.35.04.44.13.92.72.4
Project concessional loans0.40.40.41.41.01.11.11.20.80.6
Nonconcessional loans0.00.00.00.00.00.00.00.00.00.0
Domestically funded7.613.910.67.28.69.58.67.85.12.8
Of which: “Additional Priority Expenditures” 1/5.310.73.20.04.04.03.63.01.90.0
Net lending0.00.00.00.00.00.00.00.00.00.0
Overall balance (from above the line)2.5−9.6−0.30.01.00.4−0.4−3.4−3.7−1.4
Residual deficit1.34.10.90.00.00.00.00.00.00.0
Overall balance (from below the line)3.8−5.60.60.01.00.4−0.4−3.4−3.7−1.4
Financing−3.85.6−0.60.0−1.0−0.40.43.43.71.4
External financing (net)−1.7−0.4−0.40.60.30.40.50.60.40.2
Disbursements0.40.40.41.41.01.11.11.20.80.6
Amortization−2.1−0.8−0.8−0.7−0.8−0.7−0.6−0.6−0.4−0.4
Domestic financing (net)−2.15.9−0.2−0.6−1.3−0.8−0.12.73.31.2
Memoranda items:
Nonmineral overall balance (above the line)−7.4−13.4−7.3−6.6−7.7−7.4−6.5−5.9−4.4−2.0
Nominal GDP (in millions of kina)21,59422,20825,42128,71831,16236,02138,77143,12964,49372,779
Trust accounts closing balance15.06.77.24.54.23.73.41.90.00.0
Sources: Data provided by the Papua New Guinea authorities; and IMF staff estimates.

Includes spending from trust accounts.

Sources: Data provided by the Papua New Guinea authorities; and IMF staff estimates.

Includes spending from trust accounts.

Table 3Papua New Guinea: Balance of Payments, 2008–16(In millions of U.S. dollars)
200820092010201120122013201420152016
Est.Proj.Proj.Proj.Proj.Proj.Proj.
Current account balance808−649−2,255−2,420−1,868−1,078−7871,3242,343
Mineral1,7438287971,4571,8361,8261,8114,0355,188
Nonmineral−935−1,477−3,052−3,877−3,704−2,905−2,598−2,712−2,845
Trade balance2,6771,5191,3682,8173,4733,5893,4216,4247,817
Exports (f.o.b.)5,8174,3895,8248,2988,7958,2417,92410,81512,201
Mineral4,2633,4034,6366,6077,0976,5926,2819,20710,635
Nonmineral1,5559861,1871,6901,6981,6491,6421,6081,565
Imports (c.i.f.)−3,140−2,871−4,455−5,480−5,322−4,652−4,503−4,391−4,383
Mineral−934−890−1,002−1,180−1,247−1,264−1,311−1,426−1,501
Nonmineral−2,207−1,981−3,453−4,300−4,075−3,388−3,191−2,965−2,882
Services−1,388−1,655−2,291−2,744−2,811−2,555−2,342−2,311−2,039
Income−644−625−1,610−2,782−2,769−2,300−2,031−2,941−3,551
Current Transfers163112277288238187166151116
Official130318521568548519522519494
Private33−207−244−280−310−332−357−368−379
Capital and financial account balance−8201,1622,7242,7872,2431,4351,1531,068672
Direct investment−314221,8031,9351,494862629506326
Other investment−789740921852749573524562346
Medium- and long-term loan−4958121273340275320485351
Official (net)−65−59−33325463827851
Private capital flows (net)16117154241285212238406299
Commercial banks−110988976534525−50−95
Other−63158371050335725317912790
Net errors and omissions20150000000
Overall balance85294693673753563652,3923,014
Financing−11−333−469−367−375−356−365−2,392−3,014
Reserve assets−8−529−469−367−375−356−365−2,392−3,014
Use of IMF credit000000000
Other foreign liabilities−21960000000
Memorandum items:
Current account (in percent of GDP)10.1−8.0−23.7−21.2−15.2−8.6−5.96.911.4
Mineral21.710.28.412.814.914.613.621.125.2
Nonmineral−11.7−18.3−32.1−34.0−30.0−23.2−19.5−14.2−13.8
Net international reserves (end-year)
In millions of U.S. dollars2,0932,4262,8953,262,6373,9934,3596,7509,764
Gross official reserves (end-year)
In millions of U.S. dollars2,0952,6233,0923,4593,8344,1904,5566,9479,962
In months of imports of goods and services5.16.75.34.95.56.77.711.917.7
Public external debt-service-exports ratio (in percent) 1/2.02.61.81.31.21.31.41.00.9
Public external debt-GDP ratio (in percent) 1/13.212.910.79.79.49.79.77.26.9
Sources: Data provided by the Papua New Guinea authorities; and IMF staff estimates and projections.

Public external debt includes central government, central bank external debt, and statutory authorities.

Sources: Data provided by the Papua New Guinea authorities; and IMF staff estimates and projections.

Public external debt includes central government, central bank external debt, and statutory authorities.

Table 4Papua New Guinea: Summary Accounts of the Depository Corporations, 2008–11
2008200920102011
Proj.
Bank of Papua New Guinea(In millions of kina; end of period)
Net foreign assets5,5666,5547,6529,249
Foreign assets5,6087,0918,1709,808
Foreign liabilities42536518559
Net domestic assets−3,946−4,741−5,636−6,991
Domestic credit−1,774−220−639−475
Net credit to government−1,827−2611,3851,300
Claims107333367406
Central government deposits−1,934−5931,019894
Credit to other sectors53401313
Other items, net−2,172−4,520−4,997−6,517
Of which: Central Bank Securities (CBBs)2,1364,1174,5945,632
Reserve money1,6201,8142,0162,258
Currency in circulation8501,0021,1931,462
Deposits of other depository corporations767808810783
Required reserves303369514635
Excess reserves464440296148
Other deposits331313
Depository Corporations Survey(In millions of kina; end of period)
Net foreign assets6,1477,9248,96110,854
Net domestic assets3,5533,8463,9815,011
Domestic credit4,8546,6656,9798,370
Net credit to central government−400574−205−559
Claims on other sectors5,2546,0917,1848,929
Claims on the private sector5,1285,9026,9598,697
Other items, net−1,301−2,820−2,998−3,359
Broad money9,70011,77012,94215,865
Narrow money5,5206,2337,7039,997
Currency outside other depository corporations6767899541,069
Demand deposits4,8445,4446,7498,928
Quasi money4,1815,5375,2395,867
(Annual percentage change)
Net foreign assets−12.628.913.121.1
Net domestic assets81.08.23.525.9
Net domestic credit15.737.34.719.9
Of whiichi: Private sector29.515.117.925.0
Broad money7.821.310.022.6
Memorandum items:
Reserve money (percentage change)−12.011.911.112.0
Gross international reserves (in millions of US dollars)2,0952,6233,0923,459
Nominal nonmineral GDP/Broad money1.61.51.51.5
Sources: Data provided by the Papua New Guinea authorities; and IMF staff estimates and projections.
Sources: Data provided by the Papua New Guinea authorities; and IMF staff estimates and projections.
Table 5Papua New Guinea: Indicators of External Vulnerability, 2007–11(In percent of GDP, unless otherwise indicated)
20072008200920102011
Est.Proj.
Financial indicators
Gross public debt 1/2/33.631.732.126.521.9
Broad money (percent change, 12-month basis)27.87.821.310.022.6
Private sector credit (percent change, 12 month basis)34.329.515.117.925.0
Interest rate (182-day T-bills; period average)4.45.97.26.4
External indicators
Exports (percent change, 12-month basis in U.S. dollars)9.920.6−24.532.742.5
Imports (percent change, 12-month basis in U.S. dollars)32.119.4−8.655.223.0
Current account balance3.310.1−8.0−23.7−21.2
Capital and financial account balance (millions of U.S. dollars)314−8201,1622,7242,787
Of which: Inward foreign direct investment462−314221,8031,935
Gross official reserves (millions of U.S. dollars)2,0872,0952,6233,0923,459
Central Bank short-term foreign liabilities (millions of U.S. dollars)4123197
Commerical bank foreign assets (millions of U.S. dollars)458264578577659
Commerical bank foreign liabilities (millions of U.S. dollars)4847718192
Gross official reserves (months of nonmineral imports, c.i.f.)13.611.415.910.79.7
Broad money to gross reserves (ratio)1.51.71.71.61.6
Total short-term external debt to reserves (percent) 3/2.32.22.72.62.7
Public external debt to GDP ratio (in percent)16.613.212.910.79.7
Exchange rate (per U.S. dollar; period average)3.02.72.82.7
Financial market indicators
Foreign currency long-term government debt rating 1/
Standard & PoorsB+B+B+B+
Sources: Department of Treasury; Bank of Papua New Guinea; and IMF staff estimates and projections.

End of period.

Includes central government, central bank external debt, and statutory authorities.

Covers only banking system short-term external debt.

Sources: Department of Treasury; Bank of Papua New Guinea; and IMF staff estimates and projections.

End of period.

Includes central government, central bank external debt, and statutory authorities.

Covers only banking system short-term external debt.

Table 6.Papua New Guinea: Medium-Term Scenario, 2008–16
200820092010201120122013201420152016
Est.Projections
Growth and prices (change in percent)
Real GDP6.65.57.09.05.52.04.020.05.0
Mineral−1.4−1.74.39.313.8−3.215.3151.17.3
Nonmineral7.66.37.38.94.62.62.94.84.3
CPI (period average)10.76.96.08.48.77.56.56.36.8
CPI (end-period)11.25.77.89.58.07.06.06.57.0
Central government operations (in percent of GDP)
Total revenue and grants32.627.532.533.431.429.525.217.616.9
Total revenue28.023.527.028.427.025.421.314.914.5
Of which: Mineral tax revenue9.13.15.87.46.65.22.10.60.5
Grants4.64.05.55.04.44.13.92.72.4
Total expenditure30.137.132.832.431.029.928.621.318.4
Primary balance 1/5.6−3.62.02.41.70.6−2.4−2.8−0.5
Nonmineral balance 2/−7.4−13.4−7.3−7.7−7.4−6.5−5.9−4.4−2.0
Overall balance 1/3.8−5.60.61.00.4−0.4−3.4−3.7−1.4
Domestic financing (net) 3/−2.15.9−0.2−1.3−0.8−0.12.73.31.2
Foreign financing (net)−1.7−0.4−0.40.30.40.50.60.40.2
Gross public debt (in percent of GDP) 4/31.732.126.521.918.318.319.814.513.8
Domestic18.519.215.812.39.08.610.17.36.8
External13.212.910.79.79.49.79.77.26.9
Balance of payments (in millions of U.S. dollars)
Exports, f.o.b.5,8174,3895,8248,2988,7958,2417,92410,81512,201
Of which: Mineral4,2633,4034,6366,6077,0976,5926,2819,20710,635
Imports, c.i.f.−3,140−2,871−4,455−5,480−5,322−4,652−4,503−4,391−4,383
Current account808−649−2,255−2,420−1,868−1,078−7871,3242,343
(In percent of GDP)10.1−8.0−23.7−21.2−15.2−8.6−5.96.911.4
Overall balance (including exceptional financing)85294693673753563652,3923,014
Net official reserves (in millions of U.S. dollars)2,0932,4262,8953,2623,6373,9934,3596,7509,764
(In months of goods and services imports, c.i.f.)5.16.25.04.65.26.47.311.517.4
(In months of nonmining imports, c.i.f.)11.414.710.19.110.714.116.427.340.7
Public external debt service-export ratio (in percent) 3/2.02.61.81.31.21.31.41.00.9
Memorandum items:
Nominal GDP (in millions of U.S. dollars)7,9978,0609,52011,40112,32912,54313,32119,09120,568
Assumed commodity prices: 5/
Gold (U.S. dollars per ounce)8729731,2251,4271,4461,4781,5301,5961,670
Copper (U.S. dollars per ton)6,9635,1657,5389,8839,8389,3308,3307,8307,830
Oil (U.S. dollars per barrel)976279107108106105105106
Sources: Department of Treasury; Bank of Papua New Guinea; and IMF staff estimates and projections.

Measured from below the line in the fiscal accounts.

Measured from above the line in the fiscal accounts.

Includes changes in check float.

Includes central government, central bank external debt, and statutory authorities.

March 2011 WEO projections.

Sources: Department of Treasury; Bank of Papua New Guinea; and IMF staff estimates and projections.

Measured from below the line in the fiscal accounts.

Measured from above the line in the fiscal accounts.

Includes changes in check float.

Includes central government, central bank external debt, and statutory authorities.

March 2011 WEO projections.

6. Inflation is expected to accelerate in 2011. Domestic demand is increasingly becoming a major driver of core inflation, and headline inflation could temporarily rise into double-digits pushed by international food and energy prices. Inflationary pressures are exacerbated by increases in public spending, higher wage costs—resulting from a shortage of skilled labor—and rapidly increasing prices associated with the use and development of land. Moreover, staff sees a risk that high inflation becomes entrenched in expectations. However, the impact of recent increases in international food prices on consumers is likely muted by a strong domestic supply response by peri-urban food producers (Box 1).

7. Risks to growth and inflation are tilted to the upside. Upside risks include an increase in mining activity related to high commodity prices, an early start of a second LNG project, stronger-than-expected private sector investment, and additional fiscal spending from trust accounts. Downside risks include possible disruptions in mining and delays in the LNG project, mainly related to land disputes, social tension that may be created by rising income inequality, and a possible correction of very high real estate prices in Port Moresby and Lae.

Authorities’ Views

8. The authorities broadly agreed with staff’s assessment of the economic outlook and inflation. Reflecting high volatility and uncertainties surrounding projections of commodity prices and production, their outlook is based on conservative assumptions. Like staff, their projections include only new mining and LNG projects with an approved development plan, but unlike staff, the authorities assume commodity prices to return gradually to recent lows. They agreed that official CPI measures are understating inflation. The 2010 household income and expenditure survey will be used to improve the quality of data, including the CPI basket. Real estate prices are about to peak, but any correction is likely to be muted.

Box 1The Impact of Food Price Movements on the Poor in PNG

Food price increases over the past year were moderate. In 2010, the prices of imported foods increased faster than those of domestically produced items. Nonetheless, urban households, in particular the landless urban poor, benefited from low-priced rice imports. Rural households living near major cities such as Port Moresby have become important food suppliers to the urban population.1 Their incomes increased moderately in 2010 and less than they had done during the food price surges of 2008. They cut back on imported foods, which represent a small portion of their diet, but an important source of protein.2 Subsistence farmers, and households further away from urban centers, were largely unaffected by increases in urban prices of domestically produced items.

Growth in Food Price Indices

(In percent)

Sources: IMF staff calculations using BPNG CPI data, 1996 HIES weights.

Percentage of Change in Import Prices Passed Through to Domestic Prices
Pt. MoresbyGorokaLaeMadang
Short run (3 quarters)−9694455
Long run25722437
Source: Mellor (2009).
Source: Mellor (2009).

Higher world demand for agricultural commodities has benefited rural regions, which export these products. Coffee price increases have increased cash income of the Eastern and Western Highlands, while high cocoa prices have benefited East New Britain and Bougainville. Oil palm production areas, such as the Hoskins project in New Britain, have enjoyed a price boom.

An elastic domestic supply response by substitute foods producers will mitigate the effect of projected increases in international food prices. Econometric analysis by Mellor (2009) suggests a weak and temporary pass-through from import prices to domestically produced goods prices in the major cities apart from Goroka.3 The likely channel is a high propensity for peri-urban farmers to substitute between subsistence and market production in response to price changes.

1 “Feeding Port Moresby Study,” Fresh Produce Development Agency (FPDA, 2008).2 “Food and Agriculture in Papua New Guinea,” Bourke and Harwood (2009).3 “Social Impact of Commodity Price Volatility in Papua New Guinea,” Mellor (2009).

POLICY THEME #1—MANAGING THE RISK OF OVERHEATING

A. Fiscal Policy

9. The large fiscal stimulus in place in 2009 was unwound in 2010. Windfall mineral revenues during the commodity price boom in earlier years were largely saved in trust accounts to pre-finance development expenditure or used to reduce public debt. However, in 2009 when the global financial crisis hit and commodity prices were low, the government relaxed restrictions on spending from trust accounts, and the fiscal balance moved into a deficit of 9½ percent of GDP. In 2010, global commodity prices rebounded and mineral revenue recovered, at the same time trust-account spending slowed. As a result, budget balance was almost achieved and the fiscal stance tightened.

10. Over the past 8 years, gross public debt fell from about 70 percent of GDP to below 30 percent of GDP. Public debt is approaching a sustainable level and is below the average of low income countries in the Asian-Pacific region. Moreover, for the first time the government has allocated funding to meet its annual obligations with superannuation funds and settled some of its arrears.

Staff’s Views

11. For 2011, the government targets a balanced budget. However, the government’s target does not include spending from trust accounts. Staff includes additional spending out of trust accounts, and assumes that trust-account spending remains just below the Medium-Term Fiscal Strategy (MTFS) ceiling of 4 percent of GDP— though with national elections in the offing, this assumption might be optimistic. In addition, it is unclear how much of the 2009 withdrawals from trust accounts has actually been spent or is still in the banking system, waiting to be spent during the election period. On the other hand, staff assumes higher commodity prices than the authorities, leading to higher-than-budgeted mineral revenue. As a result, staff expects a budget surplus of 1 percent of GDP.

12. Despite the surplus, the pace of overall public spending risks exacerbating inflationary pressures at a time when LNG construction peaks. Staff expects no further fiscal tightening to materialize and total public expenditure to increase faster than nominal GDP in 2011, resulting in a fiscal stimulus of about 3 percent of nonmineral GDP.

13. Tight budget implementation is needed to reduce demand pressure. Budget allocations should be strictly adhered to. Moreover, savings opportunities should be rigorously exploited and the typical year-end spending rush avoided. Instead, under-spent resources could be reallocated next year if needed. Some development projects are currently facing inflated prices as they are competing for scarce resources with private sector construction activities. Delaying these projects until the LNG construction phase is over, would lower demand pressures, raise value for money, and help achieve better service delivery.

14. Further reductions in public debt would reduce PNG’s vulnerability to shocks. The steady reduction in public debt over the past decade is commendable. However, none of the windfall revenues was used for debt reduction in 2010, in contrast to the previous MTFS rule to use 30 percent of above-normal mineral revenues for this purpose. Instead the government modified the MTFS rule to allow 100 percent of above-normal revenues to be devoted to public investment in future budgets, as long as debt stays below 30 percent of GDP. In light of falling oil and copper production over the medium term and the high uncertainties about the timing of future LNG revenues, staff noted it would be prudent to lower this threshold to 25 percent of GDP (around current levels) and include contingent liabilities in the calculation of the debt ceiling. Moreover, with mineral output falling, normal revenues from minerals should decline until LNG revenues commence.

Figure 2Papua New Guinea—Fiscal Performance

Sources: Papua New Guinea authorities; APDLISC, and IMF staff calculations.

15. Staff advised that further net debt reductions below the current level can be achieved by:

  • Saving any windfall revenues that may accrue, should market expectations of higher-than-budgeted mineral prices be realized, and setting aside some of these savings for debt reduction or to cover future liabilities related to participation in the LNG project.
  • Developing a payment schedule for the remaining unfunded superannuation liabilities.

16. Expectations about future mineral income need to be well managed. Once public revenues from LNG are affirmed, there may be some limited room for additional borrowing for well-identified development projects. To avoid excessive lending, gross and net public debt-to-GDP ratios of below 25 percent could serve as medium-term fiscal anchors.

Table:Public Debt and Liabilities (In percent of GDP)
20062007200820092010

Est.
2016

Proj.
Public debt39.733.631.732.126.513.8
Of which: public domestic debt18.216.918.519.215.86.8
Of which: public and publicly guaranteed (PPG) external debt21.516.613.212.910.76.9
Public liabilities 1/8.69.38.728.524.48.5
Of which: LNG equity finance19.416.95.9
Of which: superannuation arrears8.69.38.79.27.52.6
Gross public debt and liabilities48.342.840.460.650.922.3
Government financial assets 2/8.512.516.830.929.77.0
Net public debt 3/39.930.323.629.721.115.3
Memorandum items
Nominal GDP (Kina, billions)16.918.821.622.225.472.8
Sources: PNG authorities and IMF staff calculations.

Does not include guarantees to state-owned enterprises (SOE), which were estimated at 2.5 percent of GDP in 2008 (no updates available).

Includes government equity stake in the LNG project.

Gross public debt and liabilities less government financial assets.

Sources: PNG authorities and IMF staff calculations.

Does not include guarantees to state-owned enterprises (SOE), which were estimated at 2.5 percent of GDP in 2008 (no updates available).

Includes government equity stake in the LNG project.

Gross public debt and liabilities less government financial assets.

Authorities’ Views

17. The authorities noted that the 2011 budget strikes a balance between fiscal restraint in an economy that faces capacity constraints, pre-commitments, and development needs. For Ministers to agree on a balanced budget in a pre-election year was challenging. Moreover, there are many developing needs and funding of public services has been eroded in recent years, including for security, education, health, and maintenance and rehabilitation of infrastructure. Prudent revenue assumptions are appropriate, given PNG’s past experience with commodity price booms and uncertainties surrounding new LNG and mining projects.

B. Monetary Policy

18. The BPNG has kept its policy rate constant at 7 percent since end-2009. In 2010, the BPNG issued new central bank bills (CBB) totaling about 2 percent of GDP and increased the cash reserve requirement in October from 3 to 4 percent to absorb excess liquidity and reduce credit expansion by the banking system. Nonetheless, total liquidity in the banking system increased by almost 12 percent, mainly due to foreign exchange inflows, including mineral taxes and dividends. As a result, net foreign reserves increased by 19 percent and CBB and Treasury bill rates fell by about 3 percentage points. A weaker exchange rate and falling treasury rates indicate that monetary conditions have eased while excess liquidity in the banking system continues to reduce monetary-policy effectiveness.

Staff’s Views

19. High inflation rates are costly and difficult to reduce. Staff expects headline inflation to approach 10 percent in the short run and to stay elevated in the medium run. Moreover, measured inflation is likely to substantially underestimate true inflation. Such high inflation harms households on fixed incomes (e.g., retirees and minimum wage workers), distorts price signals, and reduces savings incentives. Over the medium term, higher inflation rates may be associated with greater inflation volatility and weakened central bank credibility. Once embedded in expectations, high inflation is difficult to reverse.

20. Monetary policy needs to be tightened to contain inflationary pressures and reduce the risk of higher inflation becoming entrenched in expectations. Monetary policy would work through three main channels:

  • Interest rates. Raising the Kina Facility Rate (KFR) 3 to 4 percentage points above expected core inflation would provide an important signal. However, the policy interest rate seems to have only limited sway over market rates as long as liquidity remains abundant.
  • Liquidity. The increase in the cash reserve requirement to 4 percent goes in the right direction and further increases should be considered. Liquidity could be reduced further by raising the CBB rate gradually back to just below the KFR.
  • Exchange rate. Tighter macroeconomic policies would help mitigate real appreciation. Raising the KFR and letting markets determine the Kina exchange rate could shift the real exchange rate adjustment from inflation to nominal exchange rate appreciation. The pass-through of exchange rates to domestic prices is strong in PNG (see last year’s Selected Issues, Chapter III).

Figure 3.Papua New Guinea—The Monetary Stance

Sources: Bank of Papua New Guinea; International Financial Statistics, and IMF staff calculations.

21. The decision to move all new trust accounts to the Bank of Papua New Guinea (BPNG) facilitates fiscal and monetary policy coordination. It gives the BPNG better control over liquidity in the banking sector and market interest rates. Monetary policy will become more effective and the net cost to the public reduced by limiting the need to use high-cost central bank bills to mop up excess liquidity.

Authorities’ Views

22. The BPNG broadly shared staff’s inflation forecast. They agreed that inflation risks are on the upside and pointed to the need for fiscal restraint to reduce demand pressures. However, they were reluctant to increase interest rates because this could restrain private sector growth. The BPNG considered inflation below 10 percent tolerable at a time of high economic growth. With underlying inflation seen as stable, they considered the current monetary policy stance appropriate. However, the BPNG indicated they stood ready to tighten, should inflation exceed their comfort zone.

23. The authorities shared concerns about excess liquidity. The BPNG welcomed the decision to move new trust accounts to the central bank and suggested to manage them in offshore bank accounts. Further increases in the cash reserve requirement were also being considered.

C. Exchange Rate Assessment and External Stability

24. Following several years of surpluses, the current account shifted into deficit amidst weak commodity prices in 2009. Despite the recovery in commodity prices and exports, staff estimates the deficit to have widened to 24 percent of GDP in 2010, reflecting LNG-related goods and services imports and income deficits, mainly due to higher compensation of foreign employees, and higher dividend payments associated with increased mining profits from strong commodity prices (Table 3). However, current account deficits are largely financed by FDI and equity investments of the LNG partners. Foreign reserves are estimated to be around US$3.2 billion by March 2011 and cover almost five months of imports of goods and nonfactor services. The increase in reserves reflects strong inflows associated with mineral taxes and foreign investment.

25. The nominal effective exchange rate (NEER) depreciated by more than 7 percent in 2010. PNG is classified as a floating exchange rate regime. Over a longer horizon, the NEER remained roughly flat, while a positive inflation differential with main trading partners led to an appreciation of the real effective exchange rate by 20 percent since early 2008.

Staff’s Views

26. Due to a fall in oil and copper production, current account deficits will continue until 2015 when LNG production is expected to start. From 2015, LNG production and current-account surpluses are likely long-lasting. Nevertheless, a debt sustainability analysis shows a moderate risk of debt distress under a combination of negative shocks. This strengthens the case for a prudent approach to borrowing and enhanced fiscal discipline.

27. The real exchange rate is broadly in line with macroeconomic conditions in 2010, but moderately undervalued when projected LNG exports are factored in (Box 2). Uncertainties surrounding the estimation of equilibrium exchange rates imply, however, that the standard exchange rate assessment provides only rough guidance, in particular given uncertainties about the timing and scale of future LNG production and the lack of reliable data on local wages and prices of non-tradables.

Figure 4.Papua New Guinea—The External Position

Sources: Bank of Papua New Guinea; Bloomberg; Information Notice System; and IMF staff calculations.

Authorities’ Views

28. The authorities agreed that the Kina is likely to appreciate due to the LNG and other mineral projects. While the authorities do not target a specific exchange rate, they are concerned that a rapid Kina appreciation hurts traditional exporters and the rural population. Therefore they favored a more gradual exchange rate adjustment. Central bank reserves have been increasing largely due to the payment of mineral taxes into government accounts at the central bank, while the BPNG has been a net seller of U.S. dollars on the spot markets.

Box 2Exchange Rate Assessment

Papua New Guinea’s real effective exchange rate remained stable throughout 2010. After appreciating by 4.7 percent in 2009, it rose by only 0.5 percent in 2010.

Staff estimates point to an undervaluation of the Kina relative to medium/longer-term fundamentals. Standard CGER methodologies are tailored to advanced and emerging market countries, and should be treated with caution when applied to PNG. To evaluate the distance from medium-term fundamentals, projections for 2017 (when PNG’s output gap is expected to close) are used. We use an amended MB approach taking into account the effects of LNG production on the trade balance and conclude that the REER is undervalued by about 20 percent relative to its projected value after LNG production begins. This is consistent with the assumed real exchange rate appreciation by 2015 in the government’s 2011 budget. The ERER approach yields only a slight undervaluation. However, it does not account for the structural break in the PNG economy due to LNG production.

Exchange Rate Assessment: Baseline Results 1/
CA/GDPREER
NormProj. 2/Overvaluation
MB approach 3/10.414.7−21.4
ERER approach 4/−2.1
Source: Fund staff estimates.

All results are expressed in percent.

Staff projection of the underlying CA/GDP in 2017.

Based on a semi-elasticity of the CA/GDP with respect to the REER of −0.2.

Overvaluation is assessed relative to December 2010.

Source: Fund staff estimates.

All results are expressed in percent.

Staff projection of the underlying CA/GDP in 2017.

Based on a semi-elasticity of the CA/GDP with respect to the REER of −0.2.

Overvaluation is assessed relative to December 2010.

POLICY THEME #2–SECURING SUSTAINABLE GROWTH AND RAISING LIVING STANDARDS

D. Managing Resource Revenue

29. Broad consensus has been reached for the establishment of a sovereign wealth fund (SWF). The planned SWF consists of a consolidated pool of offshore funds with three coordinated and integrated funds: a savings fund, a stabilization fund, and an infrastructure fund. All mineral revenues are to be automatically deposited, with LNG tax and other mineral and petroleum taxes and dividends allocated to savings and stabilization funds and LNG dividends to the infrastructure fund. Drawdown arrangements are currently under discussion. To oversee its establishment, the government created a Secretaries Committee and interdepartmental working group, chaired by Treasury.

Staff’s Views

30. Staff supported the authorities’ decision to manage all resource revenues through an SWF. In many countries, such an arrangement has been helpful to manage the volatility of mineral revenues and contain real exchange rate appreciation, improve transparency, accountability, and good governance. Implementation of the Generally Accepted Principles and Practices–Santiago Principles would help overcome the “poor state of accounting and record keeping” reported by the Auditor General.

31. The coordination of drawdown arrangements from three funds will be challenging. Spending should be guided by the absorptive capacity of the economy, the requirements of cyclical stabilization, and intergenerational equity. Treasury and the BPNG will have to play a lead role in determining annual spending limits consistent with the absorptive capacity of the economy and its cyclical position. To ensure consistency, it would be helpful to reach annual Ministerial agreement on overall spending amounts linked to the budget process. The spending limits of the MTFS could serve as a preliminary guidepost for medium-term drawdown limits.

E. Development Strategy

32. The government’s new development plan focuses on addressing current supply constraints, while raising the effectiveness of core service delivery. In an important advance, the Medium-Term Development Plan (MTDP) shifts PNG’s planning process from expenditure-based to policy-focused, with line agencies made accountable for achieving sector targets (Box 3).

Staff’s Views

33. Addressing current supply constraints requires a more supportive environment for the private sector and a revival of the structural reform agenda. The government has taken steps to do this. It is investing considerable resources in land titling and making more land available for economic activity. It is also improving state-owned enterprises’ capacity to respond to current strong demand growth. However, more competition needs to be introduced in this sector and overall security improved to attract business.

34. Realizing the MTDP’s goals will also require marked gains in the effectiveness of public spending. Final spending, especially from trust funds, is often not monitored by central agencies and can differ markedly from budgeted purposes, as audits repeatedly report. The government is addressing these issues, including through investments in stronger financial management, monitoring, and reporting systems. Meanwhile, skilled staff retention is a growing constraint to achieving this agenda.

Figure 5.Papua New Guinea—Income Gap

Sources: Authorities and IMF APDLISC database.

Box 3The New Development Plans

The Development Strategic Plan 2010–2030 (DSP) targets broad-based private-sector-led economic growth. To create a level playing field, tax concessions and subsidies are to be reduced.

The DSP envisages Papua New Guinea to become a middle-income country by 2030. This requires an annual average growth rate of about 8½ percent. Main DSP targets are to triple GDP per capita, create two million additional jobs, and convert 20 percent of land into bankable assets. In addition, the DSP sets specific growth targets for key economic sectors.

The Medium-Term Development Plan 2011–2015 (MTDP) identifies seven key priority areas, called enablers. The enablers focus on unlocking land for development; improving law and order; establishing quality economic corridors to link rural populations to markets and services; providing higher and technical education and universal access to basic education; providing key utilities such as electricity, water, and communications; and improving health outcomes.

F. Financial Stability and Development

35. Papua New Guinea’s financial sector has weathered the global financial crisis well. The three large banks are mostly funded domestically, and their total deposits have increased by almost 20 percent since 2009. Two of them have well-performing Australian parents; the largest one, Bank of South Pacific, is domestically owned. All three are well capitalized and highly profitable. The banking sector’s loan-to-deposit ratio is low at about 49 percent, and its liquidity ratio is high at 57 percent of total assets. Non-performing loans (NPL) fell from 2.7 percent in June 2009 to 1.8 percent of total loans in September 2010. Nonetheless, provisioning almost doubled to over 200 percent, while profitability recovered to pre-crisis levels. Profitability of the largest superannuation fund, which was hit by the global financial markets downturn, has improved by more than 45 percent in 2010. However, 85 percent of the population lacks access to financial services.

Staff’s Views

36. The FSAP found the overall financial sector soundness satisfactory. Regulation and supervision has been strengthened. The main recommendations are: complete the set of prudential standards and enhance the available supervisory tools; move to a more risk-based approach in supervision and make compliance with prudential standards compulsory; formalize bank liquidity support arrangements and establish a discount window; reform payment and settlement systems; develop the local-government securities market; and improve access to financial services (Appendix 4).

37. Financial institutions are highly exposed to property markets. Banks and Authorized Superannuation Funds (ASF) are vulnerable to corrections in urban property markets, in particular in Port Moresby and Lae. Moreover, it will be important that banks maintain high lending standards as credit demand, associated with the LNG project and the expansion of the mining sector, is likely to rise. Nonetheless, stress-tests, undertaken during the 2010/11 FSAP missions, indicate that the banking system should be able to withstand moderate shocks.

38. The absence of a liquid domestic government debt market and the concentration of bank assets in government securities represent risks to banks’ balance sheets. Moreover, the expansion in the mineral sector is likely to spur foreign interest in PNG’s bond market and increased integration into the global economy requires new vehicles to manage foreign currency risk and new banking products.

Authorities’ Views

39. The authorities noted that financial institutions are taking appropriate steps to lower their exposure to property markets. Financial institutions have responded to higher perceived risk by tightening lending standards rather than raising lending rates. In addition, all ASFs comply with prudential norms and the two largest ones have lowered their housing and property market exposure. In cooperation with multilateral institutions, such as the World Bank, the authorities started a National Payments project to strengthen the clearance and settlement infrastructure.

Figure 6Papua New Guinea—The Banking Sector

Sources: Bank of Papua New Guinea; International Financial Statistics, and IMF staff calculations.

STAFF APPRAISAL

40. We commend the authorities for their commitment to a medium-term fiscal framework. The framework has helped increase macroeconomic stability by insulating the budget from volatility in mineral revenue and reducing public debt to more sustainable levels. However, the slippages in 2009 have shown that the implementation of the MTFS needs to be strengthened.

41. Tighter fiscal policies during the construction phase of the LNG plant are needed to reduce inflationary pressures. Reaching Ministers’ agreement on a balanced 2011 budget was an appreciable achievement, given the expenditure pressures in a pre-election year. Nevertheless, a tighter fiscal stance is necessary and can be achieved by limiting spending out of trust accounts to well below the 4 percent of GDP limit; using saving opportunities during budget implementation, including windfall mineral revenues; and lowering the assumption of normal mineral revenue to 3 percent until revenues from LNG production commence.

42. The government’s decision to allocate funds to meet its superannuation obligations should be implemented as planned. A payment schedule for the rest of its arrears would raise policy credibility and put finances in better position to respond to future challenges.

43. A tighter stance of monetary policy is required to contain inflationary pressures and reduce the risk of higher inflation becoming entrenched in expectations. Inflation remains high and risks are clearly on the upside. Raising the policy rate well above expected core inflation would provide an important signal. Further increases in the cash reserve requirement and higher CBB rates would be helpful, and further foreign exchange accumulation should be avoided to limit liquidity creation. Moving to a more market-determined exchange rate, would help cushion the impact of large demand shocks, and a market-driven appreciation of the Kina would help reduce inflationary pressures from import prices.

44. The decision to move all new trust accounts to the BPNG should be implemented fully. It will give the central bank better control over domestic liquidity and market interest rates and reduce the net cost to the public sector by limiting the need to use central bank bills to remove excess liquidity. The BPNG should be allowed to manage these accounts offshore.

45. Plans to manage all resource revenues through a sovereign wealth fund are welcome. It will be important to invest its assets offshore; fully integrate withdrawals into the budget process; and ensure transparency, accountability, and good governance by adopting the internationally accepted Santiago Principles. To effectively achieve development objectives, the SWF needs to be integrated into the macro framework and supported by strong fiscal institutions, such as the MTFS and the Fiscal Responsibility Act.

46. The projected widening in the current account deficit is largely financed by FDI and is not expected to threaten external stability. The exchange rate is estimated to be undervalued by 2–20 percent and reserves remain adequate to address potential balance-of-payments needs.

47. The LNG and other resource projects provide an opportunity to notably raise long-term growth and living standards. Better social services—in particular health, education, and basic infrastructure—need to be delivered so that the benefits from the mineral boom are more evenly spread and living standards improved for everyone. To achieve higher nonmineral growth it will be essential to better align public spending with policy priorities and reinvigorate the reform process. Improvements to security and the business environment would also yield significant benefits.

48. The financial sector remains sound. However, to safeguard financial health, banks should be encouraged to maintain strict lending standards. Furthermore, all financial institutions need to guard against overexposure to the property sector. The FSAP recommendations should be implemented.

49. Staff recommends the next Article IV consultation be held on the standard 12-month cycle.

Table 7Papua New Guinea: Millennium Development Goals Progress, 1990–2009
19901995200020052009
Goal 1: Eradicate extreme poverty and hunger
Target 1. A: Halve, between 1990 and 2015, the proportion of people whose income is less than $ 1 a day
Poverty gap at $1.25 a day (PPP) (%)..12......
Poverty headcount ratio at $1.25 a day (PPP) (% of population)..36......
Income share held by lowest 20%..5......
Target 1.B: Achieve full and productive employment and decent work for all, including women and young people
Employment to population ratio, 15+, total (%)7069707070
Employment to population ratio, ages 15-24, total (%)5753555454
Target 1. C: Halve, between 1990 and 2015, the proportion of people who suffer from hunger
Malnutrition prevalence, weight for age (% of children under 5)......18..
Goal 2: Achieve universal primary education
Target 2. A: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling
Literacy rate, youth female (% of females ages 15-24)....64..69
Literacy rate, youth male (% of males ages 15-24)....69..65
Primary completion rate, total (% of relevant age group)4852......
Total enrollment, primary (% net)65........
Goal 3: Promote gender equality and empower women
Target 3.A: Eliminate gender disparity in primary and secondary education, preferably by 2005, and in all levels of education no later than 2015
Proportion of seats held by women in national parliaments (%)00211
Ratio of female to male enrollments in tertiary education..4355....
Ratio of female to male primary enrollment84878684..
Ratio of female to male secondary enrollment6067......
Share of women employed in the nonagricultural sector (% of total nonagricultural employment)27.9..32.1....
Goal 4: Reduce child mortality
Target 4.A: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate
Immunization, measles (% of children ages 12-23 months)6742626358
Mortality rate, infant (per 1,000 live births)6761575452
Mortality rate, under-5 (per 1,000)9182777268
Goal 5: Improve maternal health
Target 5.A: Reduce by three quarters, between 1990 and 2015, the maternal mortality ratio
Maternal mortality ratio (modeled estimate, per 100,000 live births)340300290270250
Births attended by skilled health staff (% of total)..424153..
Target 5.B: Achieve, by 2015, universal access to reproductive health
Contraceptive prevalence (% of women ages 15-49)..26..32..
Adolescent fertility rate (births per 1,000 women ages 15-19)....806354
Pregnant women receiving prenatal care (%)..78..79..
Goal 6: Combat HIV/AIDS, malaria, and other diseases
Target 6.A: Have halted by 2015 and begun to reverse the spread of HIV/AIDS
Prevalence of HIV, female (% ages 15-24)......0.70.7
Prevalence of HIV, male (% ages 15-24)......0.60.6
Prevalence of HIV, total (% of population ages 15-49)..0.10.311.5
Target 6.C: Have halted by 2015 and begun to reverse the incidence of malaria and other major diseases
Incidence of tuberculosis (per 100,000 people)250250250250250
Tuberculosis cases detection rate (all forms)2468788285
Goal 7: Ensure environmental sustainability
Target 7.A: Integrate the principles of sustainable development into country policies and programmes and reverse the loss of environmental resources
Target 7.B: Reduce biodiversity loss, achieving, by 2010, a significant reduction in the rate of loss
Forest area (% of land area)69.668.166.56564.4
CO2 emissions (kg per PPP $ of GDP)00000
CO2 emissions (metric tons per capita)10011
Marine protected areas, (% of surface area)........0
Terrestrial protected areas (% of total surface area)........10
Target 7.C: Halve, by 2015, the proportion of people without sustainable access to safe drinking water and basic sanitation
Improved sanitation facilities (% of population with access)4747464745
Improved water source (% of population with access)4141394140
Goal 8: Develop a global partnership for development
Target 8: Various
Net ODA received per capita (current US$)10079514446
Debt service (PPG and IMF only, % of exports, excluding workers’ remittances)181086..
Internet users (per 100 people)000.81.71.8
Mobile cellular subscriptions (per 100 people)00019
Telephone lines (per 100 people)11111
Other
Fertility rate, total (births per woman)55544
GNI per capita, Atlas method (current US$)83010406206801180
GNI, Atlas method (current US$) (billions)3.44.93.34.27.9
Gross capital formation (% of GDP)24.421.921.919.819.9
Life expectancy at birth, total (years)5556586061
Literacy rate, adult total (% of people ages 15 and above)....57..60
Population, total (millions)4.14.75.46.16.4
Trade (% of GDP)89.6104.7115.4137.7115.1
Source: World Development Indicators database, 2010.
Source: World Development Indicators database, 2010.
Appendix 1 Papua New Guinea—Authorities’ Response to Recent Fund Policy Advice1
Fund RecommendationsPolicy Actions
Monetary and Exchange Rate Policy
Monetary policy needs to be focused on emerging inflation pressures. The central bank should be tightening monetary policy now with a view to achieving real lending rates of around 6 percent.The central bank kept the policy rate stable throughout the year at 7 percent.
Fiscal Policy
Delaying some infrastructure spending would ease overall demand pressures and help ensure that good value is achieved from this spending.Spending outside the budget fell sharply, compared to 2009. It is expected to be under the MTFS threshold of 4 percent of GDP.
It would be prudent to lower the assumption of normal mineral revenue to 3 percent of GDP between now and 2014, when LNG production should commence.Modification of the MTFS did not include the revision of the normal mineral revenue threshold.
Closer coordination of monetary and fiscal policy is desirable. Public trust accounts should be moved to the BPNG and procedures to automatically deposit above normal mineral revenue with the central bank should be introduced.Fiscal and monetary authorities meet regularly on a monthly basis. The authorities decided to open all new trust accounts at the BPNG.
The SWF needs to be integrated into the macro framework and thereby supported by other fiscal institutions, such as the MTFS and the Fiscal Responsibility Act.The authorities plan to review the current MTFS in 2011. They have indicated that the new MTFS will incorporate new guiding principles governing the revenue from SWF.
Financial Sector Policy
Banks should be encouraged to maintain strict lending standards as credit demand increases in line with opportunities associated with the LNG projects. Furthermore, all financial institutions need to guard against overexposure to the property sector that could become significantly overvalued during the LNG construction phase.NPLs have decreased, while provisioning remains high. Lending rates have increased little. All commercial banks remain well capitalized and profitable. Backward looking financial soundness indicators are all well above the prudential norms set by the BPNG.
Structural Reforms
The best way forward is a financing fund that directs all public spending through the budget, thereby enhancing macroeconomic stabilization and helping to ensure high quality spending aligned with development objectives. To minimize the potential for currency appreciation that would undermine the welfare of rural populations that depends on agriculture exports, the fund’s resources should be invested offshore.The Government has decided to establish an SWF consisting of a consolidated pool of three offshore funds: a stabilization, savings, and infrastructure fund. All expenditures are to go through the budget process.
Source: IMF staff.
Source: IMF staff.
Appendix 2 Papua New Guinea—Land Reform1

Ninety-seven percent of total land in PNG is held under customary tenure, while only 3 percent is under formal tenure, mostly owned by the State. Poor administration and an inadequate legal framework have prohibited productive use of both customary land and alienated land.2 The government’s development strategies recognize the need to implement appropriately designed land reforms to ensure that land is available for development. Past land reform initiatives in PNG have, however, largely failed. There is strong public resistance due to concerns that land reform will result in breakdown of traditional social safety mechanisms provided by communal ownership of land. Customary land supports more than 85 percent of the national population.

The National Land Development Program (NLDP) was launched in 2007 and the PNG parliament unanimously passed two laws in 2009 aimed at mobilizing land for development. The guiding principles underlying this legislation were that the customary ownership of the land was never to be lost but remain with the traditional landowners, and that any system of titling was as good as a state title. The first principle was demanded by PNG customary landowners and the latter by financial institutions.

Despite some progress, the implementation of the NLDP has generally been slow and its successful implementation remains a significant challenge. The Office of Urbanization is implementing pilot project areas in different parts of the country to accommodate urban expansion of cities and towns on land currently held under customary tenure using the new laws. To maximize chances of success the government must remain committed to a nationally-owned reform process that is transparent and inclusive and engage in broad participatory consultations that allow for full understanding of stakeholder interests and incentives.

Appendix 3 Papua New Guinea—Debt Sustainability Analysis1

Papua New Guinea (PNG) is assessed using the low-income country debt sustainability analysis (LIC DSA).2 While PNG remains at a moderate risk of debt distress, public debt sustainability has improved compared to the 2010 DSA assessment because of a stronger growth outlook. Under the baseline scenario, all external debt sustainability indicators remain well below their applicable thresholds. Stress tests indicate that the threshold for the present value of external public debt to GDP is breached only if prices of commodity exports in 2011–2013 are substantially below WEO forecasts and the government borrows to finance domestic consumption. Overall public debt should continue its downward path under the baseline. However, contingent liabilities related to the LNG project, arrears to public pension funds, and other domestic liabilities would delay this long-term adjustment. Substantial deterioration in the primary balance would harm PNG’s debt performance.

I. Background

PNG’s public and publicly guaranteed (PPG) debt levels have fallen dramatically over the past decade. Total public debt declined from 70 to 26 percent of GDP from 2001 to end-2010 (Appendix Table 1). External public debt fell from 50 to 11 percent of GDP during this period (Appendix Table 3a). Multilateral lenders such as the World Bank and the AsDB account for around 75 percent of PPG external debt, while Japan and Australia are the largest of the bilateral creditors. Private sector external debt at end-2010 is estimated at 13 percent of GDP.

Appendix Table 1Papua New Guinea: Public Sector Debt Sustainability Framework, Baseline Scenario, 2008–2031(In percent of GDP, unless otherwise indicated)
ActualEstimateProjections
200820092010Average5/Standard

Deviation
5/2011201220132014201520162011-16

Average
202120312017-31

Average
Public sector debt 1/31.732.126.521.918.318.319.814.513.810.98.1
o/w foreign-currency denominated13.212.910.79.79.49.79.77.26.96.45.6
Change in public sector debt−2.30.3−5.6−4.6−3.60.01.5−5.3−0.7−0.3−0.3
Identified debt-creating flows−10.58.9−4.0−5.0−2.7−0.61.9−1.40.1−2.3−0.6
Primary deficit−6.97.5−1.2−3.45.2−2.3−1.6−0.62.42.90.50.2−2.2−0.5−0.9
Revenue and grants32.327.532.533.431.429.525.217.616.918.516.5
of which: grants5.14.05.55.0444.13.92.72.41.81.1
Primary (noninterest) expenditure25.435.031.331.129.828.927.720.517.416.316.0
Automatic debt dynamics−3.61.4−2.8−2.7−1.10.0−0.5−4.3−0.40.0−0.1
Contribution from interest rate/growth differential−1.70.7−2.0−2.7−1.10.0−0.5−4.3−0.40.0−0.1
of which: contribution from average real interest rate0.42.30.1−0.50.00.30.2−1.00.30.30.2
of which: contribution from real GDP growth−2.1−1.6−2.1−2.2−1.1−0.4−0.7−3.3−0.7−0.3−0.2
Contribution from real exchange rate depreciation−1.90.7−0.80.00.00.00.00.00.0
Other identified debt-creating flows0.00.00.00.00.00.00.00.00.00.00.0
Privatization receipts (negative)0.00.00.00.00.00.00.00.00.00.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Debt relief (HIPC and other)0.00.00.00.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
Residual, including asset changes8.2−8.5−1.60.4−0.90.6−0.4−3.9−0.92.00.3
Other Sustainability Indicators
PV of public sector debt26.922.118.318.019.314013.210.17.3
o/w foreign-currency denominated11.19.89.39.49.26.76.45.74.8
o/w external11.19.89.39.49.26.76.45.74.8
PV of contingent liabilities (not included in public sector debt)
Gross financing need 2/1.317.78.14.33.22.25.36.54.50.61.3
PV of public sector debt-to-revenue and grants ratio (in percent)82.866.258.161.176.579.478.154.844.4
PV of public sector debt-to-revenue ratio (in percent)99.577.967.771.090.693.891.060.547.5
o/w external 3/41.234.734.436.943.044.843.933.930.9
Debt service-to-revenue and grants ratio (in percent) 4/15.314.8988.28.17.68.29410.05.85.3
Debt service-to-revenue ratio (in percent) 4/18.217.311.79.79.48.89.811.111.76.45.7
Primary deficit that stabilizes the debt-to-GDP ratio−4.67.2442.32.0−0.60.98.21.2−2.0−0.3
Key macroeconomic and fiscal assumptions
Real GDP growth (in percent)6.65.57.03.92.79.05.52.04.020.05.07.63.03.03.3
Average nominal interest rate on forex debt (in percent)2.72.62.53.10.42.72.82.82.92.92.92.82.72.52.6
Average real interest rate on domestic debt (in percent)0.912.80.33.95.9−4.1−0.23.01.5−12.33.6−1.45.35.34.5
Real exchange rate depreciation (in percent, + indicates depreciation)−11.45.3−6.8−5.010.20.0
Inflation rate (GDP deflator, in percent)7.7−2.57.06.04.212.59.65.56.924.67.511.14.04.04.8
Growth of real primary spending (deflated by GDP deflator, in percent)0.00.50.00.10.20.10.00.00.0−0.1−0.10.00.00.00.0
Grant element of new external borrowing (in percent)32.030.228.026.425.322.727.422.418.6
Sources: Country authorities; and staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Sources: Country authorities; and staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Appendix Table 2Papua New Guinea: Sensitivity Analysis for Key Indicators of Public Debt, 2011–2031
Projections
20112012201320142015201620212031
PV of Debt-to-GDP Ratio
Baseline221818191413107
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages2217138−3−8−32−66
A2. Primary balance is unchanged from 2011221816122−1−17−36
A3. Permanently lower GDP growth 1/2219192015151631
A4. All Other Liabilities (Pensions, SOEs and LNG Contingent Liabilities).2226262726262217
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2012-20132220222419192030
B2. Primary balance is at historical average minus one standard deviations in 2012-20132222242620191614
B3. Combination of B1-B2 using one half standard deviation shocks2220192116151518
B4. One-time 30 percent real depreciation in 20122223222318171413
B5. 10 percent of GDP increase in other debt-creating flows in 20122229293023232019
PV of Debt-to-Revenue Ratio 2/
Baseline6658617779785544
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages66534431−14−46−172−395
A2. Primary balance is unchanged from 20116656534813−8−93−218
A3. Permanently lower GDP growth 1/66596381878885186
A4. All Other Liabilities (Pensions, SOEs and LNG Contingent Liabilities).668288107147155119105
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2012-201366647395107111110179
B2. Primary balance is at historical average minus one standard deviations in 2012-20136670821021111118787
B3. Combination of B1-B2 using one half standard deviation shocks66626483909179108
B4. One-time 30 percent real depreciation in 201266727593100997577
B5. 10 percent of GDP increase in other debt-creating flows in 2012669197120133134109117
Debt Service-to-Revenue Ratio 2/
Baseline888891065
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages8875−6−9−49−96
A2. Primary balance is unchanged from 201188771−2−30−55
A3. Permanently lower GDP growth 1/888911111136
A4. All Other Liabilities (Pensions, SOEs and LNG Contingent Liabilities).88111618312117
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2012-20138881015161736
B2. Primary balance is at historical average minus one standard deviations in 2012-20138891320181316
B3. Combination of B1-B2 using one half standard deviation shocks888911121120
B4. One-time 30 percent real depreciation in 20128991013131014
B5. 10 percent of GDP increase in other debt-creating flows in 201288111927251923
Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Appendix Table 3aPapua New Guinea: External Debt Sustainability Framework, Baseline Scenario, 2008–2031 1/
ActualHistorical6/Standard6/Projections
AverageDeviation2011-20162017-2031
200820092010201120122013201420152016Average20212031Average
External debt (nominal) 1/25.626.623.922.823.825.626.521.021.224.328.4
o/w public and publicly guaranteed (PPG)13.212.910.79.79.49.79.77.26.96.45.6
Change in external debt−5.71.1−2.7−1.11.01.80.9−5.40.21.00.4
Identified net debt-creating flows−16.02.80.92.72.21.60.6−13.0−13.5−11.8−7.6
Non-interest current account deficit−11.56.622.3−2.910.419.913.87.14.3−8.2−12.7−12.1−8.7−11.7
Deficit in balance of goods and services−16.11.79.7−0.6−5.4−8.2−8.1−21.5−28.1−24.7−17.4
Exports77.356.863.675.173.768.061.758.360.949.539.3
Imports61.258.473.274.468.359.853.636.832.824.821.9
Net current transfers (negative = inflow)−2.0−1.4−2.9−4.62.3−2.5−1.9−1.5−1.2−0.8−0.6−0.20.2−0.1
o/w official−1.6−4.0−5.5−5.0−4.4−4.1−3.9−2.7−2.4−1.8−1.1
Other current account flows (negative = net inflow)6.76.315.623.121.116.813.714.115.912.88.5
Net FDI (negative = inflow)0.4−5.3−19.0−4.75.5−17.0−12.1−6.9−4.7−2.7−1.6−1.2−0.8−1.1
Endogenous debt dynamics 2/−4.91.5−2.5−0.20.61.41.0−2.10.81.51.9
Contribution from nominal interest rate1.61.71.61.51.71.92.01.61.72.12.7
Contribution from real GDP growth−1.6−1.4−1.6−1.8−1.2−0.5−1.0−3.7−1.0−0.7−0.8
Contribution from price and exchange rate changes−4.81.2−2.5
Residual (3-4) 3/10.3−1.8−3.6−3.8−1.20.10.37.513.712.88.0
o/w exceptional financing0.00.00.00.00.00.00.00.00.00.00.0
PV of external debt 4/24.423.023.825.326.020.520.723.527.6
In percent of exports38.330.732.337.242.135.234.047.470.3
PV of PPG external debt11.19.89.39.49.26.76.45.74.8
In percent of exports17.513.112.613.814.911.410.511.412.1
In percent of government revenues41.234.734.436.943.044.843.933.930.9
Debt service-to-exports ratio (in percent)5.17.25.54.34.25.36.04.94.86.59.5
PPG debt service-to-exports ratio (in percent)2.02.61.81.31.21.31.41.00.90.81.0
PPG debt service-to-revenue ratio (in percent)5.76.44.13.53.33.54.04.13.92.42.5
Total gross financing need (Billions of U.S. dollars)−0.30.71.01.11.01.01.0−0.9−1.4−1.20.8
Non-interest current account deficit that stabilizes debt ratio−5.85.625.021.012.85.33.4−2.8−12.9−13.1−9.1
Key macroeconomic assumptions
Real GDP growth (in percent)6.65.57.03 92.79.05.52.04.020.05.07.63.03.03.3
GDP deflator in US dollar terms (change in percent)18.3−4.410.46 71009.92.5−0.32.119.42.66.10.41.92.1
Effective interest rate (percent) 5/6.46.67.0581.77.78.28.18.28.88.98.39.510.29.7
Growth of exports of G&S (US dollar terms, in percent)20.6−26.032.211 522.141.56.1−6.0−3.735.412.514.30.42.42.4
Growth of imports of G&S (US dollar terms, in percent)4.9−3.748.014019.521.7−0.8−10.9−4.8−1.7−3.8−0.13.03.82.7
Grant element of new public sector borrowing (in percent)32.030.228.026.425.322.727.422.418.621.2
Government revenues (excluding grants, in percent of GDP)27.223.527.028.427.025.421.314.914.516.715.415.7
Aid flows (in Billions of US dollars) 7/0.40.40.60.60.60.60.60.60.50.60.6
o/w Grants0.40.30.50.60.50.50.50.50.50.50.5
o/w Concessional loans0.00.10.10.10.10.10.10.10.00.10.1
Grant-equivalent financing (in percent of GDP) 8/5.34.84.54.22.92.51.91.21.7
Grant-equivalent financing (in percent of external financing) 8/88.386.284.582.782.583.981.678.980.8
Mernojranidjurn items:
Nominal GDP (Billions of US dollars)8.08.19.511.412.312.513.319.120.628.145.6
Nominal dollar GDP growth26.20.818.119.88.11.76.243.37.714.53.45.05.5
PV of PPG external debt (in Billions of US dollars)1.11.11.11.11.21.21.31.62.2
(PVt-PVM)/GDPM (in percent)0.10.20.30.40.40.20.30.20.10.2
Gross workers’ remittances (Billions of US dollars)0.00.00.00.00.00.00.00.00.00.00.0
PV of PPG external debt (in percent of GDP + remittances)11.19.89.39.49.26.76.45.74.8
PV of PPG external debt (in percent of exports + remittances)17.513.112.613.814.911.410.511.412.1
Debt service of PPG external debt (in percent of exports + remittances)1.81.31.21.31.41.00.90.81.0
Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1 +g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1 +g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

II. Economic Outlook and Underlying DSA Assumptions

PNG weathered the global financial crisis well due to a large fiscal stimulus, strong domestic demand due to LNG project construction activities, and rebounding commodity prices. Real GDP growth was 7 percent in 2010 after a modest slowdown in 2009, and is projected to accelerate in 2011. PNG’s terms of trade and export earnings recovered dramatically from the lows of 2009, and both are projected to improve strongly in 2011 under the baseline scenario. Foreign reserves increased to around US$3.2 billion by March 2011, reflecting large and continuing financial inflows associated with the injection of equity and drawdown of loan funds for the financing of the LNG project by its partners. As indicated in the previous DSA,3 PNG is vulnerable to external demand and growth shocks. Due to rising commodity prices and strong growth, unfavorable public debt dynamics did not materialize in 2010.

Under the baseline scenario, commodity prices will remain high over the medium term while real GDP will move in line with the LNG sector. During the construction phase of the LNG project, elevated levels of domestic demand and the current account deficit will continue. With the start of LNG production in 2015, real GDP is projected to jump by 20 percent and the current account will move into a large and persistent surplus. Appendix Box 1 summarizes the medium-term macroeconomic framework underlying the DSA.

III. External Debt Sustainability Analysis

Over the projection period, all baseline PPG external debt and debt service indicators stay well below the policy-dependent debt burden thresholds (Appendix Table 3b and Appendix Figure 1). The PV of PPG external debt as a percentage of GDP is on a declining path and stays under 10 percent in the medium term, far below the 30 percent threshold. The PVs of PPG external debt-to-exports and debt-to-revenue ratios are also expected to stay below their applicable thresholds. Since additional financing needs for the LNG project and the current account deficit would be met with projected large FDI inflows, there would be no extra debt burden created. After 2015, the external debt burden is expected to fall even faster due to the projected large increase in exports and revenue from LNG production.

Appendix Table 3bPapua New Guinea: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2011–2031(In percent)
Projections
20112012201320142015201620212031
PV of debt-to GDP ratio
Baseline109997665
A. Alternative Scenarios
A1. Key variables at their historical averages in 2011-2031 1/100−8−16−14−101315
A2. New public sector loans on less favorable terms in 2011-2031 210910107778
A3. Authorities’ Price Assumptions for Gold, Copper and Oil in 2011-2013.92238372625185
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2012-201310999653−2
B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/101931302120143
B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-201310999663−2
B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/10172120141391
B5. Combination of B1-B4 using one-half standard deviation shocks102124231716112
B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/10121211874−3
PV of debt-to-exports ratio
Baseline1313141511101112
A. Alternative Scenarios
A1. Key variables at their historical averages in 2011-2031 1/130−12−25−24−162739
A2. New public sector loans on less favorable terms in 2011-2031 21313141613121519
A3. Authorities’ Price Assumptions for Gold, Copper and Oil in 2011-2013.1339786045413613
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2012-2013131213131085−5
B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/1331586146423711
B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-2013131213131085−5
B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/132331332522193
B5. Combination of B1-B4 using one-half standard deviation shocks132935372825214
B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/131213131085−5
PV of debt-to-revenue ratio
Baseline3534374345443431
A. Alternative Scenarios
A1. Key variables at their historical averages in 2011-2031 1/35−1−33−73−93−6780100
A2. New public sector loans on less favorable terms in 2011-2031 23534384649504349
A3. Authorities’ Price Assumptions for Gold, Copper and Oil in 2011-2013.338215017217617110834
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2012-201335343641413717−14
B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/35701211391421388522
B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-201335353742423818−14
B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/356483959793557
B5. Combination of B1-B4 using one-half standard deviation shocks3577961101121086410
B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/35464854534923−18
Debt service-to-exports ratio
Baseline11111111
A. Alternative Scenarios
A1. Key variables at their historical averages in 2011-2031 1/11100002
A2. New public sector loans on less favorable terms in 2011-2031 211111111
A3. Authorities’ Price Assumptions for Gold, Copper and Oil in 2011-2013.12332232
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2012-201311111110
B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/11232232
B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-201311111110
B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/11121121
B5. Combination of B1-B4 using one-half standard deviation shocks11122121
B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/11111110
Debt service-to-revenue ratio
Baseline43444423
A. Alternative Scenarios
A1. Key variables at their historical averages in 2011-2031 1/432101−16
A2. New public sector loans on less favorable terms in 2011-2031 243344434
A3. Authorities’ Price Assumptions for Gold, Copper and Oil in 2011-2013.43588895
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2012-201344444420
B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/43577774
B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-201344444420
B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/43466553
B5. Combination of B1-B4 using one-half standard deviation shocks44566663
B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/45556531
Memorandum item:
Grant element assumed on residual financing (i.e., financing required above baseline) 6/1919191919191919
Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Appendix Figure 1.Papua New Guinea: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2011-2031 1/

Sources: Country authorities; and staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to an authorities’ prices shock; in c. to a Exports shock; in d. to an authorities’ prices shock; in e. to a Exports shock and in figure f. to an authorities’ prices shock

Policy-Based PPG External Debt Burden Thresholds for PNG
Thresholds2010PNG’s ratios

2011-16
2017-31
PV of debt in percent of:
GDP3011.18.55.4
Exports10017.512.711.6
Revenues20041.239.634.5
Debt service in percent of:
Exports151.81.20.9
Revenues254.13.72.6

External debt sustainability is maintained under an array of possible stress tests, but would be threatened by poor fiscal policy in response to a large terms of trade shock (Appendix Table 3b). Consistent with WEO commodity price forecasts, the baseline scenario predicts PNG’s terms of trade to improve in 2011 before settling at a permanently high level. This, combined with the boost from LNG production, makes PNG resilient to a wide range of GDP growth and depreciation shocks. If we instead use the PNG authorities’ more conservative estimates for export prices over 2011–2013,4 and allow the government to borrow to finance the baseline levels of real consumption and imports (contrary to their stated fiscal strategy), then the PV of PPG external debt breaches the threshold of 30 percent of GDP. The price of gold is the most important price for external sustainability before LNG production kicks in.

Delays to the LNG project could generate adverse debt dynamics, even if PPG external debt indicators remain within the thresholds. While it is unrealistic for the LNG project to halt completely, delays to the project would slow down GDP growth and worsen PNG’s debt ratios. The historical scenario charts in Appendix Figure 1 can be interpreted as representing PNG’s debt dynamics in the absence of LNG construction and production, and without its associated liabilities, assuming that historical levels of real GDP growth are maintained.

IV. Public Debt Sustainability Analysis5

In the baseline scenario, PNG’s public debt ratio will continue its downward path over the medium and long term (Appendix Table 1 and Appendix Figure 2). This trend is aided by high commodity prices, rapid real GDP growth and the implementation of the authorities’ Medium Term Debt Strategy. The public debt-to-GDP ratio is forecast to decrease over the projection period as long as windfall revenues are saved during years of booming commodity prices. Provided these policies are in place, the PV of public sector debt will decline from 27 percent of GDP in 2010 to 13 percent of GDP in 2016 and to 7 percent of GDP by 2031.

Appendix Figure 2Papua New Guinea: Indicators of Public Debt Under Alternative Scenarios, 2011–2031 1/

Sources: Country authorities; and staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio in 2021.

2/ Revenues are defined inclusive of grants.

Economic growth and saving of commodity tax revenues are the key factors for the projected public debt path as shown in alternative scenarios and bound tests (Appendix Table 2). The public debt-to-GDP ratio would rise to 30 percent in 2031 if there is a negative shock to real GDP growth in 2012–13 with permanently lower revenues and unchanged expenditures until 2031.6 Keeping the primary fiscal surplus at 2.3 percent from 2011 through 2031 instead of moving into deficits over the medium term as in the baseline would result in the PV of the public debt-to-GDP ratio falling to zero by 2016. This scenario emphasizes the sensitivity of the public debt outlook to saving of windfall commodity revenues. Substantial deterioration of the primary balance in future budgets relative to the baseline would negatively affect debt sustainability.

Realization of contingent liabilities related to the LNG project, arrears to public pension funds, and other domestic liabilities would delay the downward trend in public debt ratios. The government’s unfunded superannuation liabilities, estimated to be 7 percent of GDP by end-2010, continue to grow, especially given the decision in the 2009 and 2010 budgets not to fully fund the central government’s 8.4 percent employer contributions. The government should develop a firm payment schedule for these unfunded liabilities. Contingent liabilities related to the LNG project are estimated to be about 7 percent of GDP in 2015.7 Although information is limited, attention should be given to the government’s possible need to backstop SOE borrowing.8 Should these factors materialize, unfavorable debt dynamics would not undermine public debt sustainability, but would substantially delay fiscal consolidation (Appendix Table 2 and Appendix Figure 2).9

V. Conclusion

PNG remains at moderate risk of debt distress, but PPG external debt sustainability has substantially improved as a result of high commodity prices and upcoming LNG production. The baseline scenario indicates that all external PPG debt burden indicators stay well below their indicative thresholds. External debt sustainability remains resilient to most stress tests, but would be threatened by a large negative terms of trade shock coupled with a poor fiscal response.

Public debt sustainability is sensitive to growth shocks and saving of windfall revenues over the longer term to pay down the debt. The government needs to carefully consider the risk of accumulating public liabilities until LNG taxation revenues are realized. Despite recent changes to the Medium Term Fiscal Strategy to allow 100 percent of windfall revenues to be used for public investment, it would be advisable for the authorities to use some portion of such gains to pay down high interest rate public debt. This would insulate the economy from adverse debt dynamics after possible negative growth shocks. One-off realizations of contingent liabilities would delay the paydown of government public debt, but would not generate unsustainable debt dynamics.

Appendix Box 1Macroeconomic Assumptions Underlying the DSA

  • Real GDP growth is projected to be 8 percent on average over the medium term, above the historical average of 4 percent, and slow gradually to 3–4 percent in the long run. In the medium term growth in the LNG and nonmineral sectors will offset the decline in copper and petroleum production.
  • Construction of the LNG project will be finished and production and exports are expected to start in 2015, with a maximum capacity of 6.6 million tons of LNG produced per annum. LNG production is estimated to raise the level of real GDP by about 20 percent in 2015. However, accounting for substantial income outflows, the LNG project is expected to increase annual GNI by about 8 percent.
  • Inflation is projected to rise to 9 percent in the near term due to increasing domestic demand and near-term capacity constraints, while stabilizing at around 4 percent in the long run.
  • The current account (including grants) is estimated to be in deficit in 2010 and the deficit is expected to remain sizeable until 2015, primarily reflecting the strong import growth during the construction phase of the LNG project. FDI inflows from foreign shareholders are projected to increase substantially and finance most of the imports.
  • The grant element of loans is expected to decline. As per capita income rises, the share of external financing provided on concessional terms is expected to decline over the projection period.1
  • The primary fiscal balance is projected to be in surplus of 2.3 percent of GDP in 2011 accounting for spending from the trust accounts. In the medium term primary deficits are anticipated, but these turn into surpluses over the long run as LNG tax revenues are realized.
1 Grant-equivalent financing (in percent of GDP) decreases over time. From 2016 onwards, the majority of new AsDB disbursements are through OCR facilities, which carry a higher interest rate than ADF loans.
Appendix 4 Papua New Guinea—FSAP: Main Lessons and Take-Aways

The joint IMF-World Bank FSAP mission, which visited Port Moresby in May 2010, took place against (i) a backdrop of wide-spread optimism for the operation of the Liquefied Natural Gas (LNG) projects after 2014 and (ii) a mild impact of the financial crisis on PNG largely due to the broad insulation of the financial sector from the global financial markets. The main findings and recommendations, which were updated during the 2011 Article IV consultations, are summarized below.

PNG’s financial sector

Total financial sector assets have grown to roughly 95 percent of GDP and are held by a wide range of institutions. Currently, there are four commercial banks, seven authorized superannuation funds, and a number of other nonbank financial sector institutions licensed and regulated by BPNG. General insurance companies regulated by the Insurance Commission and the stock exchange by the Securities Commission.

Banks and superannuation funds dominate the financial sector. Since the financial sector reforms in early 2000, banks have increased their assets fivefold to almost K17 billion by end-2010. The nationally owned Bank of South Pacific is the largest, followed by subsidiaries of two Australian banks and a Malaysian bank. In addition, there is a state-owned, non-deposit taking National Development Bank, which has a primary function of providing accessible credit to people in rural areas. Nonbanks are important, too, with about K7.5 billion in assets. Among them, the authorized superannuation funds (ASFs) are the largest, holding more than 70 percent of total nonbank financial assets. ASFs, in terms of assets size, are followed by the savings and loans societies, finance and microfinance companies, and insurance companies (including general, life, and broker).

Financial Sector InstitutionsTotal Assets
In million KinaIn percent
Commercial Banks16715.368.3
National Development Bank200.50.8
Authorized Superannuation Funds5450.822.3
Other Nonbank Institutions2097.17.9
Total24463.7100
Source: BPNG and IMF staff estimates as of September 2010.
Source: BPNG and IMF staff estimates as of September 2010.

Access to finance is one of the major hurdles to further financial sector deepening. Only about 10 percent of the population and 17 percent of adults currently have access to formal financial services. Although financial services providers make efforts to expand their services, the majority of people in rural communities are still financially excluded. The staff supports the authorities’ plan to conduct a financial literacy survey in partnership with the World Bank and UNDP during 2011. This survey could lead to specific projects aimed at extending financial services to complement the banking services provided by microfinance institutions to people in rural areas.

The authorities are committed to support financial inclusion. The PNG Development Strategic Plan 2010–2030 identifies the extension of microfinance banking services to all districts in PNG as a priority. In addition, the national payment system development program aims to encourage the introduction and use of innovative, convenient, and cost-effective new retail payment instruments, with a special focus on rural areas.

Overall financial sector soundness is satisfactory

Indicators point to a generally well-capitalized and highly profitable financial sector. Credit and market risks in the banking sector are relatively low and can easily be offset by prevailing high levels of capital, low levels of nonperforming loans, and high provisions. Nonetheless, high capital ratios are appropriate to accommodate lending to larger clients and growing credit risk that is expected in the medium term. Also, high concentration of the financial sector, the absence of secondary market for government securities, and the lack of repo and discount windows require banks to maintain higher liquidity.

Regulation and supervision of the banking sector has been strengthened, although several elements will still be required to move toward a more risk-based approach. The BPNG has been developing its supervisory techniques since the reforms of 2000, but it is essential that it completes the suite of prudential standards, enhance the available supervisory tools, and make better use of the tools it has. The crisis management framework is incomplete, and steps need to be taken to put this in place.

Authorized Superannuation Funds (ASFs) are the principal source of long-term investment. Papua New Guinea’s demographic profile and a system of compulsory savings in the formal sector, along with wage growth, will ensure a positive net cash flow and anchor the role of these funds as a key source of domestic savings. The ASFs and general insurers have been performing with increasing efficiency, while general insurers are well capitalized, profitable and exhibit sound risk management.

The reform agenda needs to continue

Payment and settlements systems need major reforms. The legal framework does not recognize payment services as an independent activity, while the lack of an inter-bank real-time payment system with collateralized liquidity management creates systemic risks. The clearing house operations are manual and paper based. Establishing an independent Payment Systems Department in the BPNG is crucial to support regulation and oversight.

Efforts to develop the local government securities markets need to be intensified. Although the overall operation of the primary market reflects best practice, banks have limited incentives to canvass investors. Smaller investors face hurdles, as the minimum amount to participate on a competitive basis is high and there is no opportunity for smaller investors to enter noncompetitive bids. Exposure of PNG to international investors through the LNG projects may provide new opportunities to attract nonresident investors.

Improving access to financial services remains a developmental challenge, and efforts need to be stepped up. Around 85 percent of the adult population is excluded from the formal sector, largely those in rural communities. The main barriers are operational challenges and infrastructure weaknesses, resulting in high intermediation costs.

Further developments on AML and CFT issues should be pursued. This should include enacting legislation on terrorist financing and the use of existing supervisory powers to encourage banks to undertake detailed customer due diligence.

The establishment of a sovereign wealth fund is under consideration, but modalities need to be carefully designed. In view of the large revenues anticipated from the LNG projects, a key concern for the government is the setting-up of the appropriate institutional and investment management arrangements.

Attachment Main FSAP Recommendations

Priority
Banking Sector
Credit Risk
Monitor current and emerging NPLs to assess the causes and macroeconomic impacts.High
Conduct a thorough analysis of counterparty exposure concentrations, with full account of interconnectedness.Medium
Conduct a thorough analysis of collateral and related exposures of lending to property valuations.Medium
Liquidity Risk
Develop monitoring systems and stress testing that allow for a revised definition of liquid assets (without government securities).High
Ensure that any steps to remove government deposits from banks are done with careful planning and consultation.High
Clarify and formalize bank liquidity-support arrangements for each bank with the BPNG, including through repurchase arrangements for government securities.High
Regulation and Supervision
Complete the supervisory regime by publishing a full set of prudential standards, starting with risk management, market, and liquidity risk but also including governance, credit, and operational risk in the context of a phased move to Basel II.High
Increase the range of administrative sanctions and make compliance with prudential standards compulsory, while developing a remedial action program.High
Enhance the capacity of the supervisory staff through training, so that the BPNG can move to full risk-based supervision.High
Conduct and document a full risk assessment as the basis for supervisory strategy.Medium
BPNG to explore scope for technical assistance to centralize data management systems.Medium
Systemically important institutions
Arrangements for liquidity improvement and contingency planning should be made to reduce the risk profile, while the number of shareholders should be increased in a measured way.Medium
Sovereign Wealth Funds
If authorities opt for a SWF to manage future LNG project-related proceeds, decide on the objective(s), funding and withdrawal rules, institutional arrangements, including organizational structure, roles and responsibilities, and investment strategy.High
Government Debt Markets
Assess the broader public-sector debt obligations such as borrowing and guarantees.High
Issue BPNG guidelines to market participants on sound procedures for repurchase transactions.High
Introduce a requirement that all repos should be collateralized and introduce the Master Repurchase Agreement.High
Transfer trust funds accounts to BPNG whilst carefully considering bank positions.Medium
Payment Systems
Implement the proposed National Payments System Development Plan.High
Establish a Payment Systems Department in the BPNG, with oversight of all payment and securities settlement systems.High
Insurance Sector
Enhance co-operation with local and foreign supervisory authorities, and improve supervisory transparency.High
Enhance the supervisory functions regarding offsite reporting and monitoring and onsite inspections.Medium
Develop guidance on governance, risk management, and internal controls.Medium
Financial Inclusion
Establish a functional coordination mechanism on financial inclusion through a national consultative process.Medium
AML
Give BPNG responsibility for enforcing financial institutions’ obligations.High
Complete and issue regulations on customer due diligence regime (especially with more focus on monitoring accounts).High
Crisis Management
Establish a discount-window lending program, including repurchase agreements.High
Strengthen its crisis preparedness by developing a contingency planning framework, including internal procedures on emergency liquidity assistance.High
1

Advice from the 2010 Article IV Consultation.

1

This appendix draws heavily from Chapter 3 of “The Political Economy of Economic Reform in the Pacific,” Yala (2010).

2

Papua New Guinea Development Strategic Plan 2010-2030.

1

Since Papua New Guinea is an IBRD/IDA blend country, this DSA is prepared by Fund staff in consultation with the World Bank and the Asian Development Bank (AsDB) under the IMF-WB DSA framework for Low-Income Countries. The fiscal year of Papua New Guinea is the calendar year.

2

Papua New Guinea is rated by the World Bank as a weak performer for its policies and institutions for the purposes of the IMF-WB low-income country DSA framework. Hence the applicable thresholds for this category for external public debt are: 30 percent for the present value (PV) of debt-to-GDP ratio; 100 percent for the PV of debt-to-exports ratio, 200 percent for the PV of debt-to-revenue ratio, 15 percent for the debt service-to-exports ratio, and 25 percent for the debt service-to-revenue ratio.

3

See Papua New Guinea: 2010 Article IV Consultation, IMF Staff Report 10/164.

4

The stress test uses authorities’ prices for gold, copper and oil only. This amounts to an average negative shock to export values of 22 percent relative to the baseline for each of the three years.

5

Public debt includes domestic central government, external public, and publicly guaranteed debt.

6

This is a temporary shock to GDP growth, so that the growth rates during 2012-13 are set to the historical average minus one standard deviation. Another permanent GDP growth shock, which could bring the PV of the debt-to-GDP ratio to 31 percent in 2031, is defined as the baseline GDP growth rate minus one standard deviation divided by the square root of the length of the projection period.

7

These liabilities arise from the issue of exchangeable bonds by the PNG government to finance its equity participation (in 2009) and its completion guarantee for debt financing (by 2015). Under the scheme, the creditor acquired exchangeable bonds, amounting to US$1.1 billion, with the option to exchange the bonds for equities in the Oil Search Company. Under the completion guarantee, if the project fails, the government may have to pay up to US$2 billion to the creditor.

8

From 2008 Article IV DSA estimates based on end-2007 financial statements of nine SOEs, contingent liabilities related to SOEs amount to about 2.5 percent of GDP. Off-balance sheet liabilities, which also may be significant, are not considered. Improving the financial data of SOEs, especially related to contingent liabilities, would help authorities get a better picture of public debt. Staff is supportive of government intentions to move toward a whole-of-government debt stock approach.

9

The alternative scenario (All Other Liabilities: Pension, SOEs, and LNG contingent liabilities) assumes that pension and SOEs liabilities are to be covered in the 2012 budget (total about 8 percent of 2012 GDP) and all LNG contingent liabilities will materialize in 2015 (about 7 percent of GDP).

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