Papua New Guinea
Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
03 Apr 2009
eISBN:
9781451831771
Language:
English
Keywords:
ISCR; CR; exchange rate; asset; bank asset quality; banking sector assets; commodity; banking sector liquidity; fund staff estimate; asset class; investment portfolio allocation; fund assets; Stock markets; Commercial banks; Stocks; Nonperforming loans; assets size
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This Selected Issues paper explores the medium-term determinants of the current account balance in Papua New Guinea. It provides an assessment of the exchange rate, and presents some background on recent exchange rate developments. It uses two dynamic panel regression models to estimate the current account and exchange rate determinants across 55 countries. The paper applies the estimation results to Papua New Guinea’s data and presents the exchange rate assessment for the kina under a baseline scenario and a terms-of-trade-shock scenario.

Abstract

This Selected Issues paper explores the medium-term determinants of the current account balance in Papua New Guinea. It provides an assessment of the exchange rate, and presents some background on recent exchange rate developments. It uses two dynamic panel regression models to estimate the current account and exchange rate determinants across 55 countries. The paper applies the estimation results to Papua New Guinea’s data and presents the exchange rate assessment for the kina under a baseline scenario and a terms-of-trade-shock scenario.

I. The Global Financial Turmoil: The Impact on Papua New Guinea’s Financial Sector1

A. Introduction

1. Despite rapid growth in the last few years, Papua New Guinea’s financial system is likely to remain relatively immune from the turmoil in global financial markets. Since 2000, a favorable external environment and the introduction of financial sector reforms provided a strong foundation for financial sector expansion. This chapter examines the potential vulnerabilities in Papua New Guinea’s expanded financial sector given the current state of global capital markets. In particular, it focuses on liquidity and asset quality, the areas that have proven to be most vulnerable in other financial systems, and concludes that Papua New Guinea’s financial system is relatively well positioned to ride out the current storm.

B. Overview of the Financial Sector

2. Legislative reform has led to a significantly larger and sounder financial system. Financial sector reforms, in conjunction with the economic recovery driven by high commodity export prices, helped spur the development of the financial sector. The introduction of several new Acts2 gave the Bank of Papua New Guinea (BNPG) an independent role as the monetary authority, financial regulatory, and supervisory authority. Subsequently, the BPNG introduced prudential rules consistent with international best practices, covering banks, superannuation funds, and other financial institutions. These changes elevated the overall performance of the financial sector. Since 2000, total financial sector assets have almost quadrupled to kina 19 billion, with banking sector assets comprising more than 60 percent of the total. Bank asset quality has also improved dramatically. The ratio of nonperforming loans to total loans declined from 16.9 percent in 2000 to 1.3 percent in September 2008. Return on assets rose from 1.2 percent in 2000 to 1.6 percent in September 2008. As of September 2008, the return on equity was 61.4 percent.

3. Total financial sector assets have grown to roughly 90 percent of GDP and are held by a wide range of institutions. Currently, there are 4 commercial banks, 10 superannuation funds, and a number of other nonbank financial sector institutions licensed and regulated by BPNG. Also, there are general insurance companies regulated by the Insurance Commission and a stock exchange, regulated by the Securities Commission.

A01ufig01

Financial Sector Assets

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

A01ufig02

Financial Sector Assets: December 2007

(In percent of total assets)

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; Kina Securities Ltd.; and Fund staff calculations.

4. Banks and superannuation funds dominate the financial sector. Since the reforms, banking sector assets more than tripled, reaching kina 12 billions The nationally owned Bank of South Pacific (BSP) is the largest, followed by subsidiaries of two Australian banks, Australia and New Zealand Banking Group Limited (ANZ) and Westpac Banking Corporation (Westpac), and a Malaysian bank, Maybank. In addition, there is the state-owned, non-deposit taking National Development Bank, which has the primary function of providing accessible credit to people in rural areas (assets of about ½ percentage point of total banking assets). The nonbank sector is the second largest with roughly kina 6 billion in assets. The authorized superannuation funds (ASFs) are the largest, holding about 65 percent of total nonbank financial assets. Among the ten licensed ASFs, Nasfund and Nambawan stand out with kina 1.2 billion and kina 2.3 billion in assets respectively (together holding approximately 87 percent of total superannuation fund assets). ASFs, in terms of assets size, are followed by the savings and loans societies, insurance companies (including general, life, and broker), and finance and microfinance companies.

A01ufig03

Banking Sector Assets, November 2008

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

A01ufig04

Superfunds Total Assets

(In millions of kina)

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; and Fund staff calculations.

C. Vulnerability of the Financial System to the Global Turmoil

5. Two key areas of vulnerability have been exposed in some countries’ financial sectors, liquidity and asset quality. As the financial crises evolved and credit conditions tightened in global financial markets countries with financial sectors heavily dependant on wholesale funding, such as Iceland, have come under considerable stress. Further, many countries have been forced to introduce public guarantees to ensure their banks have continued access to international wholesale funding. In addition, a prolonged period of low interest rates and easy credit led to rapid growth in low quality lending in many countries, such as the United States, and the recent rapid rise in credit defaults has forced many governments to directly inject funding to stabilize their financial institutions. The sharp deterioration in equities markets has also undermined the balance sheets of many nonbank institutions around the world.

Liquidity Vulnerabilities

6. Banks are funded primarily by deposits and have been unaffected by tight global capital markets. Papua New Guinea’s banking system is isolated from the international capital markets with deposits accounting for more than 80 percent of liabilities. BSP holds over 50 percent of total deposits with the bulk of the remainder held by the two Australian subsidiaries. About 95 percent of total BSP deposits are denominated in kina, with most of the rest denominated in either U.S. dollars or Australian dollars. Both of the Australian subsidiaries also rely primarily on domestic funding, with local currency deposits of more than 80 percent of total deposits.3 In addition, banking sector liquidity in Papua New Guinea is very high. As of November 2008, roughly 60 percent of total assets were liquid (55 percent for BSP, and 60 percent for ANZ and Westpac).

A01ufig05

Bank Liabilities, November 2008

(In millions kina)

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; Bloomberg; and Fund staff calculations.

7. Foreign currency deposits are a small and relatively stable share of total deposits. The largest share of foreign currency deposits is held by ANZ (56 percent) with Westpac and BSP roughly sharing the balance. In contrast to Australia, the government has not guaranteed deposits nor are the deposits of the two Australian subsidiaries guaranteed by the Australian government. But this does not appear to have triggered significant transfer of foreign currency deposits toward the parent banks in Australia.

A01ufig06

Share of Foreign Currency Deposits in Total Deposits, 2007-08

(In percent)

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; and Fund staff calculations.

Asset Quality Vulnerabilities

8. Lending comprises a relatively small share of banks assets and nonperforming loans have been declining. Even though lending increased to 20 percent of GDP from about 15 percent over the last eight years, its represents only 35 percent of total bank assets. The ratio of nonperforming loans to total loans has also decreased considerably, falling to its current level of 1.3 percent from 16.9 percent in 2000. In addition, the ratio of provisions to nonperforming loans has increased dramatically from 16 to 150 percent. However, nonperforming loans are a lagging indicator and loan quality could decline looking ahead as the deterioration in the external environment impacts borrowers’ debt-servicing capabilities. Of the 60 percent of total assets that are liquid, about 70 percent are government securities and 10 percent are deposits with the BPNG.

A01ufig07

Bank Assets, November 2008

(In millions of kina)

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

A01ufig08

Banking Sector Indicators

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; and Fund staff calculations.

9. There are almost no direct exposures to troubled international financial institutions. Further, the funding structure of the Australian subsidiaries rules out the possibility of any exposure via the Australian parent banks, both of which also have AA ratings (See Table 1).

Table 1.

Commercial Banks’ Credit Ratings

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Source: Standard and Poor’s, http://www.standardandpoors.com

10. Although the equity market has declined along with global equity markets, the impact has been limited. Stock market capitalization jumped from about 50 percent of GDP in 2002 to almost 200 percent of GDP in the first half of 2008. Since the peek in late-June 2008, the Kina Securities Index (KSI) has dropped by more than 40 percent. This decline along with declines in foreign equity markets will have an impact on the balance sheets of the superannuation funds. For the two biggest funds, investment in equities is the largest exposure in their investment portfolio and accounted for the bulk of their returns in 2007. Mining, oil, and gas industries dominate among the domestic and internationally listed equities. As of end-September 2008, the investment portfolios of both funds show a decline in the equity share, in line with the drop in KSI and foreign equity markets. However, these funds expect returns in 2008 to remain positive, albeit significantly lower than returns in 2007.4

A01ufig09

KSI: Kina Securities Index

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; and Fund staff estimates.

Nambawan Super: Investment Guidelines

(In percent)

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Source: Nambawan Super Superannuation Fund.

Nambawan Super: Portfolio Value

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Sources: BPNG; Nambawan Super; and Fund staff estimates.

Nasfund: Investment Guidelines

(In percent)

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Source: Nasfund Superannuation Fund.

Nasfund: Portfolio Value

article image
Sources: BPNG; Nasfund; and Fund staff estimates.
A01ufig10

Nambawan: Investment Portfolio Allocation, September 2008

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; and Fund staff estimates.
A01ufig11

Nasfund: Investment Portfolio Allocation, September 2008

Citation: IMF Staff Country Reports 2009, 113; 10.5089/9781451831771.002.A001

Sources: Bank of Papua New Guinea; and Fund staff estimates.

D. Conclusions

11. Papua New Guinea’s financial system has weathered the global turmoil well and appears positioned to continue to do so. The reforms introduced and implemented in the past have brought positive results and elevated financial sector performance. The primarily domestic-deposit-based funding arrangement, the level of liquidity, and financial soundness indicators suggest a stable banking sector. The largely domestic-deposit-base liabilities significantly limit the risks of liquidity pressures arising from tight international credit markets and the large holdings of liquid assets imply the banks could withstand sizable reductions in domestic liquidity. Nonperforming loans have also fallen to historical lows, however, the rapidly deteriorating external environment is expected to reduce borrower’s debt-servicing abilities and loan quality will likely deteriorate. Fortunately, provisioning against default is substantial. The superannuation funds exposure to equities markets will notably reduce their returns in 2008 relative to previous years, however, returns appear poised to remain positive in 2008.

References

  • Australia and New Zealand Banking Group—ANZ, 2008, Annual Report. Available via the Internet: http://www.anz.com

  • Bank of Papua New Guinea, 2008, Financial Soundness Indicators, September 2008.

  • Bank of Papua New Guinea, 2008, Statement of Assets and Liabilities, November 2008.

  • Bank of South Pacific, 2007, Annual Report 2007. Available via the Internet: http://www.bsp.com.pg/

  • Bank of South Pacific, 2008, Financial Statements Half Year Results 2008, (Papua New Guinea). Available via the Internet: http://www.bsp.com.pg/

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  • Hussain, Qaizar, 2008, Financial Sector Developments in Papua New Guinea—Selected Issues, IMF Staff Country Report No. 08/93 (Washington: International Monetary Fund).

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  • Independent Consumer and Competition Commission, 2007, “Review of the General Insurance Industry in Papua New Guinea,” Issues Paper (Port Moresby, Papua New Guinea).

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  • International Monetary Fund, 2008, Report on the Monetary and Financial Statistics Mission, (Washington: International Monetary Fund).

  • Kina Communiqué, 2008, November 07, 2008, (Papua New Guinea). Available via the Internet: http://www.kina.com.pg/default.asp

  • Nambawan Super Superannuation Fund, 2007, Annual Report 2007 (Papua New Guinea). Available via the Internet: http://www.nambawansuper.com.pg/index.htm

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  • National Superannuation Fund, 2007, Annual Accounts 2007 (Papua New Guinea). Available via the Internet: http://www.nasfund.com.pg/

1

Prepared by Erdembileg Ochirkhuu (Asia and Pacific Department).

2

These included the Central Banking Act, the Banks and Financial Institutions Act, and the Superannuation and Life Insurance Act.

3

These subsidiaries are small relative to their parent banks as they comprise less than 1 percent of their respective banking groups’ total activity. Unlike their Papua New Guinea subsidiaries, the parent banks are heavily dependant on international wholesale funding which represent 58 percent of GDP (IMF Country Report No. 08/311).

4

Nasfund reported after tax net surplus of kina 74 million in 2008, compare to kina 321 million in 2007. Nambawan has not yet reported 2008 results.

References

  • Bems, Rudolfs, and Ireneu de Carvalho Filho, 2008, Savings and Precautionary Motive for Exporters of Exhaustible Resources, Power point Presentation, (Washington: International Monetary Fund).

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  • Bems, Rudolfs, and Ireneu de Carvalho Filho, Box 6.1 Current Account Determinants for Oil-Exporting Countries, “Financial Stress, Downturns, and Recoveries, October 2008,” World Economic Outlook, (Washington: International Monetary Fund).

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  • Edison, Hali, and Francis Vitek, 2009, “Australia and New Zealand Exchange Rates: A Quantitative Assessment,” IMF Working Paper No. 09/7 (Washington: International Monetary Fund).

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  • Isard, Peter, Hamid Faruqee, Russell Kincaid, and Martin Fetherston, 2001, “Methodology for Current Account and Exchange Rate Assessments,” IMF Occasional Paper No. 209 (Washington: International Monetary Fund).

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  • Isard, Peter, and Hamid Faruqee, 1998, “Exchange Rate Assessment. Extensions of the Macroeconomic Balance Approach,” IMF Occasional Paper No. 167 (Washington: International Monetary Fund).

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  • Kauzi, Gae, and Thomas Sampson, 2009, “Shock Exposure-Commodity Prices and Kina,” forthcoming as Bank of Papua New Guinea Working Paper.

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  • Lee, Jaewoo, Gian Maria Milesi-Ferretti, Jonathan Ostry, Alessandro Prati, and Luca Ricci, 2008, “Exchange Rate Assessments. CGER Methodologies,” IMF Occasional Paper No. 261 (Washington: International Monetary Fund).

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  • Ricci, Luca, Gian Maria Milesi-Ferretti, and Jaewoo Lee, 2008, “Real Exchange Rate Fundamentals: A Cross Country Perspective,” IMF Working Paper No. 08/13 (Washington: International Monetary Fund).

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  • Thomas, Alun, Jun Il Kim, and Aqib Aslam, 2008, “Equilibrium Non-Oil Current Account Assessments for Oil Producing Countries,” IMF Working Paper No. 08/198 (Washington: International Monetary Fund).

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Appendix. Data set and Model Specifications

Country coverage

Algeria, Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Croatia, Czech Republic, Denmark, Egypt, Finland, France, Germany, Greece, Hong Kong SAR, Hungary, India, Indonesia, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Malaysia, Mexico, Morocco, Netherlands, New Zealand, Norway, Pakistan, Papua New Guinea, Peru, Philippines, Poland, Portugal, Russia, Saudi Arabia, Singapore, Slovak Republic, South Africa, Spain, Sweden, Switzerland, Taiwan POC, Thailand, Tunisia, Turkey, United States, United Kingdom, Venezuela.

Sub-group of oil-exporting countries includes: Algeria, Egypt, Indonesia, Malaysia, Papua New Guinea, Russia, Saudi Arabia, and Venezuela.

Data Sources

IMF World Economic Outlook Database: Current account balance, fiscal balance, real GDP at purchasing power parity, oil trade balance, real per capital GDP growth; and population growth.

World Bank World Development Indicators Database: Population over 65 years, and economically active population, i.e., population between 15 and 64 years old.

Macroeconomic Balance Approach8

The basic building blocks of the macro-balance approach are:

  • first, to estimate an equilibrium relationship between the current account balance and a set of macroeconomic fundamentals;

  • second, to use the coefficients and the medium-term values of the fundamentals (i.e., the WEO projections for 2013) to compute an estimated equilibrium current account balance (i.e., norm);

  • and third, to calculate the real exchange rate adjustment needed to close the gap between the estimated current account norm and the underlying current account balance projected over the medium term—a horizon over which domestic and partner-country output gaps are closed and the lagged effects of past exchange rate changes are fully realized—at prevailing exchange rates. The degree of exchange rate misalignment is calculated by dividing the difference between the underlying current account and the estimated current account norm, by country-specific elasticities of the current account with respect to the real exchange rate.9

The MB estimated equation derived from a panel regression model is:

CAi,t = β0,t + βTxi,t + εi,t,

where CAi, t is the current account as a share of GDP; β0,i represent the country fixed effects; xi, t denotes the vector of explanatory variables; and εi, t is the error term.

The interpretations of the variables as determinants of the current account are as follows:

  • Fiscal Balance: A higher government budget balance raises national savings and therefore increases the current account balance.10

  • Demographic variables: a higher old-dependency ratio (i.e., a higher share of inactive old dependent population) and a higher population growth rate (i.e., a higher share of inactive young dependent population) reduce national savings and decrease the current account balance.

  • Oil balance: Higher oil prices increase the current account balance in oil exporting countries and decrease the current account balance in oil-importing countries.

  • Economic growth: Economies that are in the early stage of development have a greater need for investment, thus their current account balance tends to be in deficit. As they develop, their current account balance should improve. Among countries at similar stages of development, the stronger economic growth is relative to trading partners, the lower the current account is likely to be. The deviation of the real per capita GDP growth rate from its trading-partner average is the variable used to capture relative economic growth. The current account balance is expected to decline with relative growth.

Equilibrium real exchange rate approach

The estimated equation takes the following form:

lnQ¯i,t=β0,i+β⁢xi,t+ϵi,t,

where β0,i denotes a country specific fixed effects; lnQ¯i,t is the logarithm of the real effective exchange rate; xi, t denotes the vector of explanatory variables; and εi,t is the error term.

The explanatory variables or medium-term fundamentals include the following:

  • The terms of trade (expressed in logarithms). Higher terms of trade should appreciate the real effective exchange rate through real income or wealth effects.

  • Real output per worker. This variable is a measure of productivity. Although this measure does not differentiate between productivity in the tradabale and nontradable sectors, it is used as a proxy to capture Balassa-Samuelson effects given the strong correlation between the GDP per worker and relative productivity in tradables and nontradables production. An increase in productivity should appreciate the real effective exchange rate.

  • Government consumption relative to GDP and relative to trading partners. This variable is also used as a proxy to capture Balassa-Samuelson effects. Higher government consumption is likely to appreciate the real exchange rate to the extent that such consumption falls more on nontradables than tradables, thereby raising the relative price of the former.

  • Net foreign assets (NFA) to GDP. Standard intertemporal macroeconomic models predict that debtor countries will need a more depreciated real exchange rate to generate the trade surpluses necessary to service their liabilities.

Table 1.

Papua New Guinea: GDP by Sector at Current Market Prices, 2003–07

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Sources: Data provided by the National Statistical Office through 2004; Treasury Department estimates for 2005 through 2007.

Sum of industries less imputed bank service charge, plus import duties less subsidies.

Table 2.

Papua New Guinea: GDP by Sector at 1998 Constant Prices, 2003–07

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Sources: Data provided by the National Statistical Office through 2004; Treasury Department estimates for 2005 through 2007.

Sum of industries less imputed bank service charge, plus import duties less subsidies.

Table 3.

Papua New Guinea: Production of Major Commodities, 2004–08

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Sources: Data provided by the Papua New Guinea authorities.
Table 4.

Papua New Guinea: Employment by Sector, 2004–08

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Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Not included in overall index; excludes subcontractors; includes both mining and petroleum.

Table 5.

Papua New Guinea: Consumer Price Index by Expenditure Group, 2004–08

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Sources: National Statistical Office; and Bank of Papua New Guinea, Quarterly Economic Bulletin.
Table 6.

Papua New Guinea: Central Government Budget 2004–07

(In percent of GDP)

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Sources: Data provided by the Papua New Guinea authorities; and Fund staff estimates.
Table 7.

Papua New Guinea: Central Government Revenue and Grants 2004–07

(In millions of kina)

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Sources: Data provided by the Papua New Guinea authorities; and Fund staff estimates.
Table 8.

Papua New Guinea: Central Government Domestic Debt, 2004–08

(In millions of kina; end of period)

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Sources: Data provided by the Bank of Papua New Guinea; and Department of Treasury.

Discount value.

Face value.

Table 9.

Papua New Guinea: Monetary Survey, 2004–08

(In millions of kina; end of period)

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

Year-on-year percentage change.