Resilience and Growth in the Small States of the Pacific
Chapter

Appendix 6. Papua New Guinea

Author(s):
Hoe Khor, Roger Kronenberg, and Patrizia Tumbarello
Published Date:
August 2016
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Papua New Guinea is the largest of the Pacific island countries, with a population of about 7.5 million and a land area of 462,800 square kilometers (about the size of Thailand). It occupies the eastern half of the island of New Guinea and approximately 600 offshore islands. The country is just south of the equator, making its climate moderate tropical with high seasonal rainfall.

Papua New Guinea gained independence in 1975 from an Australian-administered United Nations trusteeship and is a member of the Commonwealth of Nations. The national government includes three independent branches: the executive, the legislative, and the judiciary. Executive power is vested in the National Executive Council or Cabinet, composed of the prime minister and about 30 ministers.

Sources of Growth and Economic Profile

Main sources of growth. The mineral sector has been the main driver of growth since independence. But this source of growth has been volatile in the past decade, reflecting the pace of new discoveries and fluctuations in international commodity prices. More recently, extractive-industry-related construction has become one of the main sources of growth, particularly since the start of the construction of a large-scale liquefied natural gas (LNG) project in 2010. LNG production started in 2014 and reached full capacity in 2015, with the oil and gas extraction sector contributing to three-quarters of growth in 2014–15. With LNG production expected to stabilize from 2016 onward, however, agriculture (including fishing and logging), construction, and wholesale and retail trade will again become the main contributors to growth.

Production, employment, exports, and imports. Agriculture remains the dominant sector for household income and employment, generating about a third of GDP during 2006–13. The mineral and energy sector was also a large contributor to national income, contributing 9 percent of GDP over the same period. But as the economy undergoes major structural change in the next few years, this sector’s contribution is expected to rise to about 19 percent of GDP by 2015. Minerals and petroleum currently dominate exports (72 percent of the total in 2013); the other main exports are cocoa, copra, coffee, palm oil, rubber, tea, and logs. The manufacturing sector accounts for only 6 percent of GDP and contributes little to exports. Papua New Guinea has been running a large current account deficit in recent years, but as LNG exports came onstream and LNG-project-related imports subsided, the deficit quickly declined and turned into a surplus in 2014.

External income. The country has very large outflows of investment income and remittances owing to foreign investments in the natural resource sector. Investment income and remittance outflows in net terms averaged 5.9 percent and 1.1 percent of GDP in 2006–13, respectively.

Development aid and technical assistance. Foreign grants averaged 14 percent of total government revenue in 2006–13. Australia is the biggest contributor to Papua New Guinea’s development assistance program, with other major sources of financial and technical assistance from the European Union, Japan, the Asian Development Bank, and the World Bank. Newer development partners, such as China and Malaysia, are becoming more prominent. The IMF has provided substantial technical assistance recently in price and national accounts statistics, sovereign wealth fund management, and tax reform for extractive industries.

Government finance. Government expenditure represents about a third of GDP, of which about 40 percent is development spending. The government’s fiscal framework is based on three medium-term economic strategies: the Medium-Term Fiscal Strategy, the Medium-Term Development Strategy, and the Medium-Term Debt Strategy. The Fiscal Responsibility Act further guides the fiscal framework, and limits public debt to below 30 percent of GDP. The current Medium-Term Fiscal Strategy focuses on development needs, with a commitment to allocate two-thirds of total budget resources to key areas such as health, education, infrastructure, and law and order by 2017. The government expects to have the sovereign wealth fund operational in 2016 to help manage resource revenues.

Financial sector. There are four commercial banks, seven authorized superannuation funds, and five life insurance companies and other nonbank financial sector institutions, all licensed and regulated by the Bank of Papua New Guinea, the central bank. The financial sector largely serves the formal sector and provides little reach to the very large informal, rural, and self-employed segments of the population. Total financial sector assets increased to K33 billion (about 100 percent of GDP) as of December 2012 from K9.5 billion at the end of 2005, with banking sector assets about 68 percent of total financial sector assets.

Business climate and investment. Much scope exists to improve private sector development through improved business conditions. Despite some improvements, the business environment remains challenging on many fronts. Papua New Guinea ranked 145th out of 189 countries in the World Bank’s 2016 Doing Business report. Critical areas include law and order, governance, labor skills, land rights, transportation costs, and electricity supply, among others.

Monetary policy. The main objective of monetary policy is to achieve and maintain price stability. The Bank of Papua New Guinea largely relies on indirect instruments (that is, open market operations and the Kina Facility Rate) to conduct monetary policy, but other tools are also used, notably the cash reserve requirement. Semiannual statements set out the central bank’s stance and conduct of monetary policy over the coming six months. Despite formal monetary policy instruments, however, the monetary policy transmission mechanism lacks effectiveness because of structurally high excess liquidity in the banking system.

Exchange rate and competitiveness. Papua New Guinea adopted a floating exchange rate system in 1994. Capital movements into and out of the country are largely unrestricted. However, in June 2014, the central bank introduced a trading band of 150 basis points around a de facto appreciated exchange rate target. Accordingly, the de facto arrangement was reclassified by the IMF from floating to a crawl-like arrangement, effective April 11, 2014. Since then, the exchange rate has depreciated gradually, but large foreign exchange shortages have continued. The external position is expected to improve in the medium term as new mineral and petroleum projects are developed.

Growth Challenges, Vulnerabilities, and Spillovers

Main growth challenges. Making the best use of natural resource revenues for inclusive growth while maintaining macroeconomic and debt sustainability is the main challenge. The government needs to ensure that resource revenue is channeled to the sovereign wealth fund and used effectively to foster inclusive growth in the face of weak capacity and governance challenges. Given the strong kina, improvements in the competitiveness of nonmineral tradable industries will require deeper structural reforms.

Main vulnerabilities. Risks to growth are tilted toward the downside, in particular over the longer term, reflecting uncertainty over commodity prices. Lower LNG and mineral prices are expected to continue to pressure government revenue, export earnings, and the kina. Depressed commodity prices may also reduce future inflows of foreign direct investment.

Regional and global economic spillovers. A weak global economy has dampened external demand and commodity prices. But reductions in quantitative easing in advanced economies are not expected to have a large impact, because the domestic financial market is not well integrated into the global market, with little capital inflow observed beyond foreign direct investment related to mineral projects. If risk factors were to materialize, however, funding costs for any future mining projects and the debt burden of the private sector could rise, which could reverberate on the economy.

Appendix Table 6.1Papua New Guinea: Selected Economic Indicators, 2010–15
Nominal GDP (2014): US$16.8 billion1GDP per capita (2014): US$2,2321
Main export products: gold, copper, oil, palm oil, logs, coffeePopulation (2014): 7.5 million
Remoteness (GDP-weighted distance): 8,600 km
Sources: Papua New Guinea authorities; and IMF, “Papua New Guinea: 2015 Article IV Consultation–Staff Report” (Country Report No. 15/318).Note: SWF = sovereign wealth fund.

Based on period average exchange rate.

Expenditure classification was changed in 2013.

Current balance excludes grants and development expenditure (capital expenditure).

Public external debt-service-ratio (in percent of exports).

Index, 2005 = 100.

Share of loans denominated in foreign currency.

World Bank, Doing Business reports.

United Nations Development Program.

1991–20002001–092010–152015
AverageAverageAverage20102011201220132014Estimate
GDP, GDP growth, employment, and prices
Real GDP (percent change)4.83.78.27.710.78.15.58.59.0
Mineral20.2−2.330.1−2.0−11.8−7.47.2134.260.2
Nonmineral17.44.66.48.712.89.25.40.71.5
Real GDP per capita (percent change)1.61.34.83.46.23.83.05.96.3
Consumer prices (percent change, average)9.66.75.15.14.44.55.05.36.0
Shares in real GDP (percent)
Agriculture29.136.828.732.531.428.628.026.725.0
Construction4.311.419.716.719.021.823.119.617.8
Mineral14.712.19.78.56.85.85.912.718.7
Sources: Papua New Guinea authorities; and IMF, “Papua New Guinea: 2015 Article IV Consultation–Staff Report” (Country Report No. 15/318).Note: SWF = sovereign wealth fund.

Based on period average exchange rate.

Expenditure classification was changed in 2013.

Current balance excludes grants and development expenditure (capital expenditure).

Public external debt-service-ratio (in percent of exports).

Index, 2005 = 100.

Share of loans denominated in foreign currency.

World Bank, Doing Business reports.

United Nations Development Program.

Contributions to real GDP growth (percent)
Agriculture3.10.70.91.12.3−0.50.91.00.6
Construction0.51.52.02.64.34.62.6−1.9−0.2
Mineral1.7−0.32.4−0.2−1.0−0.50.47.97.7
Share in real GDP (in percent)
Private consumption
Private investment
Public consumption
Public investment
Exports minus imports
Contributions to real GDP growth (percent)
Private consumption
Private investment
Public consumption
Public investment
Exports minus imports
Public finances
Central government finance (percent of GDP)
Revenue and grants28.831.828.531.330.429.228.227.324.7
Total domestic revenue23.726.225.326.027.026.325.625.221.6
Grants5.15.63.25.33.42.92.52.13.1
Expenditure and net lending231.631.432.028.228.732.436.134.532.3
Current (excluding grants)24.419.921.215.817.519.326.426.322.1
Of which: wages and salaries8.58.47.57.07.57.67.18.17.7
Development (capital)7.211.510.812.411.213.09.88.110.2
Current balance3−0.76.44.110.39.56.9−0.8−1.2−0.5
Overall balance−2.80.4−3.53.11.7−3.2−8.0−7.2−7.6
Financing2.7−0.43.8−3.9−2.78.47.85.87.6
Assets (SWF, trust fund)0.80.20.00.00.00.00.00.00.0
Debt2.0−0.43.8−3.9−2.78.47.85.87.6
Of which: external0.0−0.91.2−0.30.10.51.00.94.7
Of which: concessional−1.1−1.40.5−0.40.00.51.00.91.2
Other−0.20.0−0.30.81.0−5.20.11.40.0
Public–debt–to–GDP ratio (percent)61.449.230.725.623.026.734.035.639.4
Sources: Papua New Guinea authorities; and IMF, “Papua New Guinea: 2015 Article IV Consultation–Staff Report” (Country Report No. 15/318).Note: SWF = sovereign wealth fund.

Based on period average exchange rate.

Expenditure classification was changed in 2013.

Current balance excludes grants and development expenditure (capital expenditure).

Public external debt-service-ratio (in percent of exports).

Index, 2005 = 100.

Share of loans denominated in foreign currency.

World Bank, Doing Business reports.

United Nations Development Program.

Balance of payments (percent of GDP, unless otherwise indicated)
Current account balance5.42.1−21.7−21.5−23.6−53.6−31.8−4.24.6
Excluding official transfers0.5−2.8−24.3−24.4−26.8−56.3−34.4−6.42.5
Overall balance−0.14.30.24.89.6−2.1−8.6−1.1−1.2
External debt service (in percent of exports of goods and services)47.55.61.41.51.31.51.51.50.9
Foreign direct investment4.03.97.25.78.012.25.95.16.1
External debt58.247.3118.769.589.9144.6157.9129.2121.2
Excluding Bank of Papua New Guinea53.145.7117.367.688.6143.3156.5128.0120.1
Main sources of external income (total)−8.5−8.8−0.6−5.4−3.7−5.4−4.37.77.3
Investment income (net)−7.4−8.70.7−4.5−2.5−3.4−2.78.78.4
Remittances (net)−1.1−0.1−1.3−0.9−1.2−2.0−1.6−1.0−1.1
Contributions to external income growth (percent)
External income growth−5.720.6−44.3−11.0−8.071.2−19.6−295.5−2.5
Investment income (net)−4.017.4−48.1−9.6−22.140.8−12.4−284.0−1.3
Remittances (net)−1.73.23.8−1.414.030.4−7.2−11.6−1.2
Exchange rate (kina to U.S. dollar period average)1.53.22.42.72.42.12.22.52.6
Real effective exchange rate (period average)590.187.7117.4100.0108.7128.1126.9123.5
(percent change)2.33.8−3.78.717.9−0.9−2.7
Money, credit, and financial sector
Broad money (percent change)11.417.09.810.217.310.96.73.49.9
Credit to private sector (percent of GDP)16.617.825.926.424.626.328.724.624.5
(percent change)7.516.811.218.17.912.117.53.58.0
Bank assets (percent of GDP)44.749.069.470.974.979.165.461.4
Short-term treasury bill interest rate (six–month)8.45.45.24.35.85.05.16.7
Nonperforming loan ratio4.81.71.72.02.01.21.61.5
Foreign banks market share (percent of total loans)66.46.15.64.86.97.3
Business climate indicators
Business environment rankings7
Doing business (overall)123106115119114141145
Construction permits124119115119131130127
Getting electricity49242526279498
Enforcing contracts170165167170181169169
Getting credit13912214314688165167
Sources: Papua New Guinea authorities; and IMF, “Papua New Guinea: 2015 Article IV Consultation–Staff Report” (Country Report No. 15/318).Note: SWF = sovereign wealth fund.

Based on period average exchange rate.

Expenditure classification was changed in 2013.

Current balance excludes grants and development expenditure (capital expenditure).

Public external debt-service-ratio (in percent of exports).

Index, 2005 = 100.

Share of loans denominated in foreign currency.

World Bank, Doing Business reports.

United Nations Development Program.

Human development index80.50.50.50.50.50.5
Memorandum:
Nominal GDP (millions of kina)6,46615,96635,09026,42130,52232,07034,59541,66845,262
Nominal GDP (millions of U.S. dollars)14,4225,20514,5889,71612,87315,39115,41316,80917,323
Sources: Papua New Guinea authorities; and IMF, “Papua New Guinea: 2015 Article IV Consultation–Staff Report” (Country Report No. 15/318).Note: SWF = sovereign wealth fund.

Based on period average exchange rate.

Expenditure classification was changed in 2013.

Current balance excludes grants and development expenditure (capital expenditure).

Public external debt-service-ratio (in percent of exports).

Index, 2005 = 100.

Share of loans denominated in foreign currency.

World Bank, Doing Business reports.

United Nations Development Program.

Sources: Papua New Guinea authorities; and IMF, “Papua New Guinea: 2015 Article IV Consultation–Staff Report” (Country Report No. 15/318).Note: SWF = sovereign wealth fund.

Based on period average exchange rate.

Expenditure classification was changed in 2013.

Current balance excludes grants and development expenditure (capital expenditure).

Public external debt-service-ratio (in percent of exports).

Index, 2005 = 100.

Share of loans denominated in foreign currency.

World Bank, Doing Business reports.

United Nations Development Program.

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