Papua New Guinea showed solid economic growth, supported by greater political stability, fiscal framework, and a healthy banking sector. Executive Directors encouraged the authorities to consider tighter macroeconomic policies in the face of rising inflation pressures and also stressed the need of a tight fiscal policy. They welcomed the Sovereign Wealth Funds (SWF), and considered it important to integrate the use of resources in the SWF into the budget and macroeconomic framework, supported by strong fiscal institutions. Directors observed that Liquefied Natural Gas (LNG) and other resource projects provide an opportunity to raise long-term growth and living standards.
PNG has experienced an unprecedented period of growth and stability, lasting more than 10 years and withstanding the global financial crisis.
Our PNG authorities are now in the process of establishing a path towards economic and social development and prosperity, as set out in the Papua New Guinea Vision 2050 (Vision 2050). The vision aims to mobilize service delivery, wealth creation and human capital development across seven key pillars of society and the economy. In particular, the authorities are undertaking an ambitious reform program to harness PNG’s significant resources wealth to improve the living standards of the entire population, including future generations. A detailed strategy for the first stage of the Vision 2050 is set out in the Development Strategic Plan 2010-2030 (DSP), which establishes an interim objective of achieving middle-income status by 2030.
However, while PNG’s resources wealth provides significant opportunities, it also imposes significant macroeconomic challenges. These include the challenge of managing overheating pressures, and of capturing and productively investing profits from the resources industry for the benefit of the broader community. The authorities are keenly aware of the ‘boom and bust’ cycles experienced in other resource-rich developing nations, and previously in PNG, and are committed to avoiding this disastrous outcome. The establishment of an offshore sovereign wealth fund (SWF) to manage wealth from PNG’s natural resource projects is an important component to the authorities’ strategy to overcome the ‘boom and bust’ cycle.
The balanced budget forecast for 2011 is a significant achievement in the context of the upcoming 2012 elections and rising public expectations of the Government’s spending capacity. It withdraws the large fiscal impulse of the previous year and avoids the temptation to borrow against future LNG revenues. The authorities also take note of Staff’s recommendation that the budget be tightly managed to avoid exacerbating overheating pressures. In this regard, they note that, on balance, it may be preferable to take a pragmatic approach to the savings target in the Budget in order to reduce the subsequent pressures for unplanned or unbudgeted spending.
Our authorities remain committed to a sustainable medium-term fiscal strategy (MTFS). In relation to the evolution of the MTFS rule - most recently to allow windfall revenues to be used for development investment instead of debt reduction while debt is below 30 per cent of GDP - they emphasize the need for fiscal rules to be both conceptually sound and politically realistic. The objective must be to build credibility by reinforcing political commitment to a binding but achievable framework, rather than risk eroding commitment to a framework which is too inflexible. Moreover, they note that, for countries such as PNG with relatively low levels of Government debt and large development needs, further debt reduction may not always be the most productive use of windfall revenues.
Trust fund and other off-budget accounts are being better integrated into the budget and public financial management frameworks. As part of the 2012 Budget process, the Government will require agencies to report on public monies held in trust accounts, including by reconciling actual spending, projecting future spending, providing details on how the funds will be spent, and identifying the legal authority for the operation of the trust account.
Our authorities agree that the quality of development spending is crucial if resources wealth is to be translated into genuine improvements in living standards across the economy. To this end, the Medium-Term Development Plan 2011-2015 (MTDP), which establishes the framework for development spending in accordance with the DSP and Vision 2050, has been designed to address the main shortcomings of its predecessor, the Medium Term Development Strategy. In particular, the MTDP is policy-based, focuses on seven key priority areas, seeks to create a greater sense of ownership among local communities, and involves improved planning processes including harmonization between recurrent and development spending and between provisional and national programs. The authorities are also investing in stronger public financial management and monitoring and reporting systems.
Our authorities agree that inflation is a key risk given the economy’s capacity constraints and the additional demand associated with the construction of the LNG project. They are closely monitoring inflation developments, including through monthly meetings between the Bank of PNG, Treasury and the Treasurer which track the performance of the budget and its implications for inflation.
The authorities have taken a number of steps to withdraw liquidity from the economy, including requiring new Government trust accounts to be opened with the Bank of PNG instead of commercial banks, and allowing contractors involved in the construction of the LNG project to hold offshore accounts and pay for imported materials used for the project directly from these accounts. Further increases in the cash reserve requirement are also being considered by the Bank of PNG.
The Bank of PNG also stands ready to tighten monetary policy as necessary to contain inflation within single-digits, while being mindful that prematurely tightening monetary policy could unnecessarily retard growth. The Bank expects inflation to fall short of this threshold in 2011, at 8.5 percent.
The authorities are taking steps to improve the quality of inflation data, including by using the 2010 household income and expenditure survey to update the CPI basket.
Exchange rate policy
Our authorities continue to support a floating Kina. The Bank of PNG’s intervention in the exchange market is guided by its price stability objectives, and is primarily designed to provide liquidity, especially to smaller institutions, given that there are few participants in the market. Two-way movement of the Kina is accommodated and the Bank has been a net seller of foreign reserves.
An appreciating Kina will bring challenges as well as benefits. While acknowledging that further appreciation of the Kina as LNG revenues begin to flow may help to reduce imported inflation and overheating pressures, the authorities are also conscious of its distribution implications. Whereas inflation impacts particularly on the urban poor, Kina appreciation is particularly damaging to rural citizens relying on export cash crops, such as coffee, cocoa and copra. With 85 per cent of the population living in rural areas with limited alternative sources of income, the impact of Kina appreciation is likely to be widespread. Moreover, Kina appreciation will exacerbate the challenges of developing the non-minerals sector in order to diversify the economy.
Sovereign wealth fund
The Government will establish an offshore sovereign wealth fund (SWF) to manage the revenue inflows from the LNG and mineral projects, and their impact on the economy. The SWF will comprise three components - a savings fund, a stabilization fund, and an infrastructure fund. The objectives of the SWF are to: promote savings to finance future spending and smooth Government spending over the long term, insulate the budget and the economy from destabilizing movements in commodity prices and output, and provide capital for the delivery of strategic nation-building infrastructure. The SWF will be funded from the dividend and tax revenue from mineral projects, in addition to the LNG project. Drawdown arrangements are under discussion, and will be integrated into the budget framework.
The SWF will operate in accordance with international standards and be subject to a high degree of legislative protection. The SWF will comply with the Generally Accepted Principles and Practices (Santiago Principles) established by the International Working Group of Sovereign Wealth Funds. The PNG authorities will also consider participation in the Extractive Industries Transparency Initiative once the SWF has been established. To avoid future political interference with the operation of the Fund, the legislation establishing the SWF will require a two-thirds majority vote by Parliament to be amended.
Cross-departmental bodies have been established to reach a consensus on the design and operation of the SWF. A Secretaries Committee chaired by the Secretary of the Treasury and including the Governor of the Bank of PNG is overseeing the establishment of the SWF. It is being supported by an inter-departmental working group.
Our authorities are committed to having the legislation establishing the SWF in place before the 2012 elections. Given the uncertainty about the political landscape following the elections, the authorities wish to build upon the current high level of consensus and seek passage of the laws establishing the SWF by early 2012.
Our PNG authorities would like to thank Fund staff for the timely technical assistance that is being provided to facilitate the establishment of the SWF.
Our PNG authorities are pursuing wide-ranging structural reforms to mobilize investment under the guidance of the Vision 2050, DSP and MTDP.
Land development is a particular priority, as less than 5 per cent of PNG’s land mass is currently available in the formal market, largely reflecting PNG’s unique and diverse arrangements for customary ownership of land. The authorities are piloting new mechanisms for facilitating land leasing by groups of traditional landowners, under arrangements that protect the rights of both landowners and investors. The MTDP also provides for strengthening land administration, including through computerized land titling and land use records, streamlining dispute resolution and reducing the backlog of unresolved disputes, and introducing a Land Use Planning Scheme.
Another key priority is improving law, order and justice, as crime has become a significant deterrent to investment and tourism in recent decades. The immediate emphasis is on rebuilding the sector’s capacity through the employment of additional police and court officers, improved training, establishment of new police stations and village courts, and more reliable payment of judicial officers. Additionally, the authorities will seek to address the backlog of court cases through additional judicial positions and early resolution of new cases at the community level.
The Government will also pursue policies to diversify the economy, by supporting improved productivity and market access for sectors such as agriculture, livestock, forestry, fishing, manufacturing and tourism. A range of initiatives have been identified to develop small- and medium-sized enterprises and foster local entrepreneurs, such as microfinancing, training courses, better access to markets and reducing the regulatory barriers to establishing a business.
Investment in human capital and transport, utilities and communications infrastructure will support economic development across the economy. Providing access to markets and social services remains challenging in PNG, which has some of the most rugged terrain and isolated communities in the world. The Government has identified ten ‘economic corridors’ where physical and social infrastructure development will be targeted, in order to maximize economies of scale and focus on areas where the gains are likely to be the greatest.
PNG’s financial system remains well-capitalised and profitable. The banks have limited off-shore borrowing requirements, low loan-to-deposit ratios, high levels of liquidity, and low non-performing loans.
Banks are well-provisioned against future risks. Banks maintain a healthy degree of caution as to the risks associated with the mining projects and their impacts on asset prices. They have tightened their lending standards and reduced their exposure to property markets.
The PNG authorities welcome the findings of the Financial System Stability Assessment (FSSA) and take note of its recommendations. They will continue to strengthen regulation and supervisory techniques and bolster the crisis management framework. The authorities have also commenced a National Payments project to strengthen clearance and settlement infrastructure, which will combine financial stability objectives with the goal of improving financial inclusiveness. Other financial inclusion initiatives include mobile banking and payments services, financial education and microfinance.