Papua New Guinea: Staff Report for the 2015 Article IV Consultation
Author:
International Monetary Fund. Asia and Pacific Dept
Search for other papers by International Monetary Fund. Asia and Pacific Dept in
Current site
Google Scholar Close
Publication Date:
18 Nov 2015
eISBN:
9781513584683
Language:
English
Keywords:
ISCR; CR; deficit; debt; resource; staffs projection; PNG LNG project; IMF staff estimate; return on equity; debt service; commodity export receipt; Commodity prices; Global
Download PDF (728.4 KB)

Despite strong growth relating to a large liquefied natural gas (LNG) project, Papua New Guinea (PNG) faces strong headwinds from severe revenue shortfalls due to lower global commodity prices and temporary suspension of a large mining operation. Given the large drop in government revenues, decisive consolidation will be needed to keep the government debt-to-GDP ratio on a downward trajectory over the medium term. To this end, expenditure growth should slow and budget resources should focus on high-impact spending, while safeguarding social outlays.

Abstract

Despite strong growth relating to a large liquefied natural gas (LNG) project, Papua New Guinea (PNG) faces strong headwinds from severe revenue shortfalls due to lower global commodity prices and temporary suspension of a large mining operation. Given the large drop in government revenues, decisive consolidation will be needed to keep the government debt-to-GDP ratio on a downward trajectory over the medium term. To this end, expenditure growth should slow and budget resources should focus on high-impact spending, while safeguarding social outlays.

Context

1. PNG has abundant resources including agriculture, cultural diversity, fisheries, forestry, minerals, and petroleum/LNG. Despite a series of mineral and petroleum/LNG discoveries since independence in 1975 that have provided the main growth drivers, PNG remains one of the lowest income countries in the region. Moreover, growth has been volatile over the past decade, reflecting the pace of new discoveries and fluctuations in international commodity prices. While the commencement of LNG production boosted overall GDP growth in 2014–15, slow growth outside of the mineral and petroleum/LNG sectors calls for a renewed policy focus on economic transformation through developing PNG’s many renewable resources and non-resource industries while continuing to tap its non-renewable resources in an environmentally sustainable manner that benefits the entire population.

2. Lack of access to finance is a key constraint on inclusive growth, in tandem with poor infrastructure and chronic law and order problems. PNG is among the least-banked countries in the region, despite the fact that systemic liquidity is ample, and banks and other financial intermediaries are seeking alternatives to public sector financing given their large exposures to government debt. While there has been good progress with mobile banking, very little bank credit is allocated to rural businesses and households. Factors contributing to limited financial access include the country’s level of income and economic development, relatively-skewed income distribution, lack of competition in the banking sector, weak contract enforcement, customary land ownership that impedes the use of land as collateral, large rural population with limited access to urban centers and banking services, and the large informal sector.

3. Falling commodity prices and the temporary suspension of a large mining operation pose challenges for macroeconomic management in the near term. Revenue prospects have worsened significantly relative to the 2015 budget. A comprehensive policy response to these and related shocks is urgently needed that allows for a measured but ambitious medium-term fiscal consolidation path to safeguard fiscal sustainability, improved cash and treasury management practices, measures to reduce excess liquidity, and greater exchange rate flexibility. Although PNG’s medium-term external position looks favorable given the large projected LNG earnings and prospective new mineral and LNG projects, BPNG should allow the kina to move more quickly to restore equilibrium in the FX market and maintain an adequate level of international reserves.

4. Political setting. The political situation is stable, with the coalition government representing almost all members of parliament. Governance reforms present an ongoing challenge. The next general election is scheduled to be held in 2017.

Recent Developments, Outlook and RISKS

A. Recent Developments

5. Growth is robust and inflation remains contained. Real GDP is expected to expand strongly by about 9 percent in 2015, reflecting mostly the coming on stream of LNG production (Box 1) and notwithstanding temporary closure of a large copper and gold mine (OK Tedi). Non-resource GDP is likely to grow by 1½ percent this year and by about 3½ percent in 2016 with agriculture and construction dampened by unfavorable weather conditions and lower government spending, respectively. CPI inflation is projected to stabilize at around 6 percent in 2015, as the effects of lower oil and commodity prices are offset by the kina depreciation.

6. The external current account balance is expected to turn into a surplus while international reserves remain below the staff’s assessment of reserve adequacy. The current account is expected to turn from deficit to surplus in 2015 as the LNG plant has its first full year of operation, while the overall balance of payments is expected to be near zero including since most commodity export receipts are kept offshore. Gross international reserves are projected to remain at around $2 billion in 2015 (equivalent to 3 months of total goods and nonfactor services imports) and to strengthen modestly over the medium term.

7. Fiscal consolidation has become more difficult and the public debt to GDP ratio is rising, albeit from a low level. The Mid-Year Economic and Fiscal Outlook (MYEFO) released in early August projected a K 2.5 billion revenue shortfall in 2015 (equivalent to 5.5 percent of GDP) compared to the K 1.3 billion shortfall expected in the budget. Non-resource revenues are also expected to be lower mainly due to the second round effects of lower commodity prices on the broader economy. Staff estimates that medium-term fiscal targets (i.e., a balanced budget by 2017 and debt-to-GDP ratio of below 30 percent by 2016 as envisaged in the Medium-Term Fiscal Strategy (MTFS)) are no longer feasible. Public debt has increased from 23 to 36 percent of GDP during 2011–14, as a result of a large expansion of the fiscal deficit, from 3.2 percent in 2012 to 7.2 percent of GDP in 2014. The non-resource primary balance (NRPB) also widened over this period.

uA01fig02

The path to consolidation is more difficult…

Fiscal balance (in percent of GDP)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; and IMF staff estimates.
uA01fig03

…and public debt has risen

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

8. There are no signs of a generalized credit boom. Overall credit growth has continued at a moderate pace, broadly in line with nominal GDP growth since 2010. Commercial banks have solid capital buffers and the ratio of NPLs to total loans remains low. Nevertheless, PNG’s ratio of domestic private credit to GDP was well below the average for countries at a simliar level of development in the region and elsewhere (e.g., Pacific Island small states with 63 percent). Other indicators also point to low levels of financial development and access to finance (see Selected Issues Paper on financial inclusion).

uA01fig04

Credit growth is in line with nominal GDP

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; and IMF staff estimates.

B. Outlook and Risks

9. Medium-term growth is expected to converge to about 3 percent, supported by agriculture and preparations for the hosting of APEC 2018. The government plans to spend K 3 billion over 2015-18 on the preparations for APEC 2018 (e.g., upgrading the airport). Thus, 2018 will see a winding down of construction activity, with overall growth projected to slow down to 1½ percent in 2018 and stabilize at 3 percent over the longer term.1 Inflation is expected to stabilize at around 5 percent, which is in line with its ten-year historical average, as imported price inflation remains stable and domestic agricultural supply continues to expand.

10. Risks to the outlook are increasingly skewed to the downside. Fiscal consolidation necessitated by weaker-than-anticipated revenue performance will dampen non-resource growth over the short run, and a weak global economy could further dampen external demand and commodity prices. Over the longer term, LNG developments in Australia and shale gas developments around the world could continue to put downward pressure on LNG prices and government revenue. Global financial market instability could also affect prospects for external commercial financing or foreign direct investment. Upside risks include the potential for a second LNG project, further mineral resource development, and scope for increasing trade with Asia. The mission stressed that the prospect of new mineral and LNG projects should not divert attention from the need to tighten fiscal and monetary policy now and allow for greater exchange rate flexibility.

11. Authorities’ views. The authorities broadly concurred with the outlook. They noted that the longer-lasting drought caused by El Niño could prolong a temporary mine closure and worsen a poor harvest of crops. They placed somewhat greater emphasis than the staff on an upside to growth from a number of prospective extractive sector projects, including a second LNG project and several major gold-copper projects, over the longer term.

Policy Discussions

12. Discussions centered on the policies needed to maintain macroeconomic stability in the near term and raise growth in the medium term. The staff’s view is that this will require a measured but ambitious medium-term fiscal consolidation path, measures to reduce excess liquidity and tighten monetary policy, and greater exchange rate flexibility. In the medium term, structural reforms are necessary to improve financial deepening and resilience and boost inclusive growth.

A. Maintaining Macroeconomic Stability

Fiscal Policy

13. The mission strongly encouraged the authorities to adopt a more ambitious package of fiscal measures. The baseline shows that the authorities’ plan to cut expenditures by K 1.3 billion in 2015 would still yield an increase in the debt-to-GDP ratio (from 36 to 45 percent) over the medium term despite lower fiscal deficits from 2016-20 (see the text chart below). Staff encouraged the authorities to limit debt to 35 percent of GDP by 2020, as specified in the staff’s alternative adjustment scenario, which would require a more ambitious set of measures totaling K 2.0 billion in 2015 and lower deficits relative to the baseline by 1 percent of GDP in 2016, and by about 2 percent of GDP from 2017 through 2019. The under-execution of expenditure suggests there is room for cuts and reprioritization. This more ambitious set of measures aims to balance the need for stronger fiscal consolidation to ensure debt sustainability with the need to avoid an overly contractionary fiscal stance and protect vulnerable groups. Given the inherent volatility of resource GDP and revenue,2 the mission encouraged the authorities to consider using the NRPB as an underlying fiscal target. Use of the NRPB as a policy target can help insulate fiscal policy from resource revenue volatility and help capture the underlying fiscal policy stance, while using the overall balance as a fiscal target tends to promote pro-cyclical spending.3

14. A multi-pronged approach, including strengthening revenue performance and curbing low-impact expenditures, is needed to address the immediate fiscal pressures.

  • Revenue measures. Staff would encourage the authorities to adopt measures to strengthen revenue collection, including by suspending the Infrastructure Tax Credit until the Internal Revenue Commission (IRC) makes recommendations based on an audit of the scheme, and other measures recommended by the Tax Review Committee.4 Revenue measures would, however, likely yield significant additional revenue only starting in 2016.

  • Expenditure cuts. The bulk of the fiscal adjustment will have to come from reductions and reprioritizations of expenditure. The staff’s adjustment scenario requires a net expenditure reduction of about K 2.0 billion in 2015 (about 30 percent from goods and services and 70 percent from low-impact capital expenditures), and continued spending restraint in subsequent years, while focusing on improving the quality of spending (see the Selected Issues Paper on structural reforms for discussion of government spending inefficiencies). Care should be taken to ensure that consolidation does not affect high priority social spending, including in health, education, law and justice, and agriculture.

uA01fig05

Decisive consolidation is needed…

Fiscal balance (in percent of GDP)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; and IMF staff estimates and projections.
uA01fig06

…to keep the debt ratio on a downward path

Public debt (in percent of GDP)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

15. A sound framework for budgetary financing needs to be put in place. Identifying sufficient financing in 2015 is expected to be challenging, as planned asset sales are likely to be delayed due to complications associated with asset pricing, financing options, and negotiations with the large group of landowners. Given that the banks and superannuation funds have mostly reached their internal limits on sovereign exposure, there is limited appetite for holding additional government securities, which has led to a sharp rise in T-bill yields. Announcement of a suitably ambitious fiscal adjustment plan at an early date would be important to bolster market confidence, particularly given rising financing needs and a planned debut US$1 billion sovereign Eurobond placement in the coming months. In this context, it will also be important to put in place a Medium-Term Debt Management Strategy (MTDS) to increase the efficiency of financing and minimize the costs and risks associated with new external funding options. The central bank should refrain from providing direct financing to the government. An updated Debt Sustainability Analysis (DSA) indicates that PNG’s risk of external debt distress remains low. However, there has been a significant increase in overall public debt, which amounts to about 56 percent of GDP once arrears to a superannuation fund and other liabilities are taken into account.5

uA01fig07

Yield curve has steepened sharply

(In percent)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

16. Stronger PFM is needed to improve the quality of spending and development outcomes. Implementing further reforms identified in the recent Public Expenditure and Financial Accountability (PEFA) assessment, including improving cash management and the Integrated Financial Management System (IFMS) rollout, will be important to support the authorities’ fiscal consolidation, building upon the recent publication of the PEFA document and the final roadmap. SOE reform is also needed to minimize fiscal risk and enhance transparency and governance. For example, the return on equity (ROE) averaged 10.5 percent between 2003 and 2007, but fell to 3.4 percent in 2007–12, outperformed by regional peers. Sustained political commitment is needed to improve the efficiency of SOEs by placing them on a sound commercial footing and ensuring adequate and timely disclosure and transparency.

17. It is important to ensure that the proposed Sovereign Wealth Fund (SWF) is adequately resourced and effectively managed. The final stage of the legislation has been approved by the Cabinet. Ensuring that all resource revenues flow through the budget will help to improve transparency and better target national priorities for resource revenue use. The Kumul Trust, which will consolidate the PNG government’s interests in petroleum, mining, and other state-owned enterprises, under three holding companies, should be designed to ensure that transparency and efficiency of public investment are enhanced, with governance structures that can support the achievement of stated corporate goals. Continued commitment to implementing the Extractive Industry Transparency Initiative (EITI) will also be important.

18. Authorities’ views. The authorities concurred with the need for ambitious fiscal consolidation while avoiding cuts in key priority areas such as infrastructure, health and education, and law and order. They acknowledged the importance of agreeing and communicating the budget adjustment measures ahead of the Eurobond issuance to reassure potential investors. For 2015, they will consider postponement of some lower-priority projects. The authorities reiterated commitment to adhering to the Santiago Principles in the operation of the SWF, while noting that little resource revenue would be saved in the near term owing to PNG’s huge development needs. They will also consider IMF technical assistance to support development of a MTDS that will help to provide a sound framework for future financing.

Monetary Policy and Exchange Rate

19. The kina exchange rate should be allowed to move more quickly to a market clearing level. FX queues have reportedly increased despite the slow but steady depreciation of the kina vis-à-vis the U.S. dollar since the trading band was introduced in June 2014, amid reports that BPNG has intervened in the FX market. The restricted range of USD/kina movement resulted in a change in the de facto exchange rate regime classification, from floating to a crawl-like arrangement, effective April 2014. The mission stressed that the slow pace of depreciation would prolong the market imbalance, giving rise to the potential for costly disruptions to business activities. Given that the currencies of other commodity exporters had depreciated more against the U.S. dollar than the kina, the mission stressed that the kina should be allowed to depreciate more quickly to a level that would clear the FX market. This would also help restore the external competitiveness of non-resource exports, and is consistent with limited balance sheet currency mismatches. Should inflationary pressures arise from exchange rate pass-through, BPNG should tighten monetary policy. The mission also supported BPNG’s intention to maintain an adequate level of international reserves. Staff agreed that the FX trading band could be maintained in the near term to help avoid a sharp widening of bid/ask spreads. Over time, however, a plan should be developed to improve the efficiency and transparency of the FX market, drawing upon follow-up IMF TA, and underpinned by sound fiscal and monetary policies. It should be noted in this context that the medium-term, real effective exchange rate (REER) assessment produced mixed results (Box 3), while PNG’s external position is expected to strengthen as LNG exports increase over the medium term. PNG maintains an exchange restriction subject to IMF approval under Article VIII, Section 2(a) of the IMF’s Articles of Agreement arising from the requirement to obtain a tax clearance certificate evidencing the payment of all taxes prior to making payments or transfers for certain current international transactions.

uA01fig08

The kina has depreciated more slowly than other regional currencies

(2014 July=100)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; and IMF staff estimates.

20. The mission advised the authorities to mop up excess liquidity to increase the effectiveness of monetary policy transmission, tighten the monetary stance, and dampen downward pressures on the kina. It also advised the government to support BPNG’s efforts to deploy effective monetary policy tools including by maintaining a tighter fiscal stance and avoiding recourse to central bank financing. In the near term, given the challenging fiscal environment, BPNG was advised to focus on withdrawing excess liquidity, including by increasing the cash reserve requirement (CRR), encouraging the transfer of government balances from commercial bank accounts to BPNG, and stepping up the use of open market operations. Staff also encouraged BPNG to establish an interbank interest rate corridor as recommended by recent IMF technical assistance. As noted below, commercial banks are highly liquid, have sound capital positions, and are among the most profitable in the world. In this context, banks are in a strong position to adapt to reduced liquidity and a more rapid depreciation of the kina exchange rate in line with market forces without significant adverse balance sheet effects. Accordingly, staff does not anticipate that significant real sector effects would result from monetary tightening, particularly given the massive expansion in LNG production this year. Staff also advised BPNG to refrain from providing any direct financing to the government to safeguard its independence and operational effectiveness, and help maintain macroeconomic stability.

21. Authorities’ views. The authorities emphasized that the USD/kina rate was market determined and that the market, not BPNG, was keeping the rate at its current level. Import payments were not, in their view, being unduly delayed as reflected in the absence of importer bankruptcies. They stressed the need to avoid undue exchange rate volatility and high bid/ask spreads. They also emphasized past experience has shown that a faster pace of depreciation may not necessarily have the desired results of stimulating FX supply and clearing the market, and would be inflationary as PNG is heavily reliant on imports. The authorities acknowledged that excess liquidity inhibits the monetary transmission mechanism while noting that, thus far, inflationary pressures had remained contained despite persistent excess liquidity. They agreed that suitably-tight monetary and fiscal policies were a precondition for the proper functioning of any FX market. BPNG nevertheless reiterated its request for follow-up IMF TA regarding its participation in the FX market, and will work on clarifying its focus. It stands ready to absorb excess liquidity and tighten monetary policy should inflationary pressures intensify. BPNG also reiterated its intention to avoid any direct financing of the government budget deficit. It saw no need to reform the Central Banking Act or to strengthen its balance sheet, given that negative capital was largely attributable to valuation losses on international reserves driven by the rapid appreciation of the kina in 2011–12. BPNG’s balance sheet has improved following the depreciation of the kina and a partial recapitalization of BPNG by the government using non-tradable securities.

Financial Sector

22. The mission stressed that BPNG should remain vigilant to emerging sector-specific risks. PNG’s financial system appears robust given strong indicators of bank capital adequacy, asset quality, liquidity, and profitability. Looking forward, BPNG, banks, and superannuation funds should carefully consider the potential impact of lower government spending and the temporary suspension of a large mining operation for assets exposed to affected sectors, including real estate, transport and logistics.

23. Going forward, macroprudential policies should play an important role by limiting any buildup of systemic vulnerabilities. BPNG should continue to move forward to enhance the function of a macroprudential policy division, which is in the process of being established, and set up a comprehensive database including sectoral loan data and household and corporate debt measures.

24. The authorities are encouraged to continue strengthening the AML/CFT regime. Key legislation aimed at improving compliance with international standards for AML/CFT has been passed, which could facilitate removal from the Financial Action Task Force’s (FATF’s) gray list. They should continue to implement AML/CFT tools effectively to address risks of politically exposed persons and ensure robust domestic and international cooperation on AML/CFT matters.

25. Authorities’ views. The authorities pointed out that commercial banks’ balance sheets and future earnings prospects are strong. They saw banks’ exposure to the construction sector through lending as a potential systemic risk, but thus far, NPLs have remained low and have not increased. They reiterated their commitment to further strengthening monitoring of potential systemic risks and implementing the legislation relating to AML/CFT.

B. Promoting Financial Sector Development and Resilience

26. Structural improvements in the financial sector will be important to enhance resilience to shocks and access to finance. As enumerated above, PNG suffers from a number of structural barriers to improving financial access and development that have impeded growth and hampered new investment.

27. To promote financial development, greater efforts are required to, inter alia, address the lack of competition, facilitate development of the capital market, and improve the functioning of the FX market. Lack of competition for financial services impedes access to finance and economic diversification. For instance, small farmers and agribusiness entrepreneurs are facing credit constraints to scale up their business and invest in new processing capacity that is critical to achieving yield and quality improvements. Underdeveloped capital markets limit the sources of financing for government, enterprises, and individuals, while a shallow and inefficient FX market distorts the expectations and commercial behavior of market participants, and constrains the role of the exchange rate as a shock absorber.

  • Lack of competition. Three large banks (two Australian banks and one domestic bank) play a dominant role in providing credit to the economy. Wide interest rate spreads in PNG are associated with the oligopolistic nature of the banking system, while also reflecting the costs and risks of doing business.6 Similarly, a lack of competition can lead to relatively high levels of profitability,7 which can limit incentives for banks to innovate and seek out new customers in order to expand their customer base. In this context, the priority is to facilitate financial deepening by reducing entry barriers, including for microfinance institutions, and encouraging the development and adoption of new technologies such as mobile banking and microfinance products.

  • Underdeveloped capital markets. Commercial banks’ assets are largely concentrated in government securities reflecting few investment alternatives, while at the same time, excess liquidity suggests that government borrowing has not crowded out private sector borrowing. Banks and superannuation funds are reaching their internal limits for exposure to the government, forcing the authorities to diversify its financing sources, including via a prospective Eurobond offering of US$1 billion. Looking forward, authorities should promote development of the domestic capital market over the medium term, including by taking measures required to develop a secondary market for government securities.

  • Shallow FX market. The interbank FX market is currently one-sided given the overvalued exchange rate and there is a structural shortage of FX. Mineral tax receipts account for about two-thirds of FX inflows, while FX transactions are highly regulated by the BPNG. The authorities should focus on measures that would help to eliminate FX market distortions (see Selected Issues Paper on the FX market).

uA01fig09

Interest rate spreads in PNG are relatively high

(In percent)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; and IMF staff estimates.
uA01fig10

Banks’ assets are concentrated in govt securities

(In percent, as of end-2014)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; and IMF staff estimates.

28. Authorities’ views. The authorities broadly concurred with the need to promote financial development, improve the capital market, and reform the FX regime over the medium term. BPNG has put in place legislation for micro-insurance products and mobile banking services, and is taking steps to enhance financial literacy through education and safeguard consumer protection. Meanwhile, they have authorized five microfinance institutions.

C. Boosting Inclusive Growth

29. The government’s structural reform agenda appropriately emphasizes agriculture and an enabling environment for business. In agriculture, the government should continue to move forward with the Asian Development Bank (ADB) and the World Bank to enhance productivity (i.e., the Productive Partnerships in Agriculture Project for smallholder coffee and cocoa producers), fill the infrastructure gap, and facilitate access to finance (see Selected Issues Paper on structural reforms). The government also needs to concentrate on reforms to lower the cost of doing business and increase competition. Continued investment in health and education will be important in this respect, as will improvements in infrastructure and law and order.

  • Infrastructure. In agriculture, lack of access to market is identified as a major obstacle to increasing the supply of perishable products. Lack of access to affordable electricity is also a critical constraint on development The electrification rate in PNG is among the lowest in the world.

  • Health and education. Social indicators point to the challenges of basic needs, despite recent efforts to improve access to health and education (including vocational training). Provision of services and necessary facilities such as health clinics should be expanded and improved, especially in rural areas.

  • Law and order. Chronic law and order problems need to be addressed to enhance ease of doing business, promote more business startups, and unleash the potential in tourism. According to the 2014 World Bank Enterprise Survey, 81 percent of businesses reported that their decisions for further investment or expansion of their operations were adversely affected by the poor security situation in the country. Indeed, 67 percent of firms identified crime as a problem; this is more than four times the regional average for firms in East Asia and the Pacific (16 percent) and higher than all of the regional averages.

30. Continued efforts to increase access to finance will also be important to support private sector development and growth. As noted above, PNG remains among the most under-banked economies in the region, despite recent efforts to promote financial sector development and financial inclusion. The high level of collateralization required to obtain loans, and the large share of customary land that cannot be used as collateral are the main obstacles to obtaining bank credit, including for SMEs. It will thus be important to address these constraints to allow better financial access for SMEs and support growth.

31. Authorities’ views. The authorities agreed that agriculture is a key area for inclusive growth given that a majority of the population relies on the sector, including those in the informal sector. They noted that increased competition in public utilities and telecommunications is also important. The authorities agreed that development of essential financial infrastructure is a priority, as set out in the 2014–15 National Financial Inclusion and Literacy Strategy. They are roughly halfway towards the goal of reaching 1 million previously un-banked citizens, 32 percent of which are women. Going forward, BPNG will begin considering a follow-up strategy for the coming year, benefiting from recent work and support from the World Bank, ADB, and Pacific Financial Inclusion Programme (PFIP).

Other Issues

32. The authorities are firmly committed to improving macroeconomic statistics. They recognized the importance of sound macroeconomic statistics for informed policy decisions and IMF surveillance. More decisive reform is needed to address institutional weaknesses in the National Statistics Office (NSO) and enhance the coordination with other stakeholders. The authorities are moving forward with the publication of new GDP estimates for 2007–13, planned for late this year.

Staff Appraisal

33. PNG is facing strong headwinds from lower commodity prices. While growth is expected to increase to 9 percent this year reflecting the full year effect of LNG production which started last year, fiscal and external performance this year have been adversely affected by the sharp drop in LNG and other major export commodity prices. Prudent macroeconomic policies are therefore essential to maintaining debt sustainability and safeguarding the external position.

34. Decisive fiscal consolidation will be needed to keep the government debt to GDP ratio on a downward trajectory over the medium term. Given the large drop in government revenues due to commodity prices and recent disruptions in the mining sector, the authorities are strongly encouraged to adopt a more ambitious package of fiscal measures to narrow the fiscal deficit this year and over the medium term. They are also encouraged to adopt medium-term fiscal anchors appropriate to the context of a commodity producer in order to help guide policy development and assessment.

35. Better expenditure prioritization and improvement in PFM will be crucial for improving development outcomes. High priority should be given to implementing high-impact projects and improving the delivery of frontline health and education services. While recent progress on strengthening PFM is welcomed, including having published the PEFA document and finalized a roadmap, the authorities are encouraged to implement its recommendations, including to strengthen cash and treasury management practices.

36. The SWF should be put into operation as soon as practicable. It is important to ensure that all public resource revenues are channeled through the budget. This would improve transparency and better target national priorities for resource revenue use and is consistent with the SWF’s role in macroeconomic stabilization and wealth sharing.

37. A further depreciation is needed to safeguard external buffers and eliminate imbalances in the FX market. To these ends, BPNG should allow the exchange rate to be more market-determined and move quickly to a market-clearing rate. This should be supported by suitably-tight fiscal and monetary policies. To facilitate this adjustment and improve monetary policy effectiveness, BPNG should mop up excess liquidity in the banking system. Staff does not recommend Fund approval of the tax clearance certificate regime as it is not temporary and has not been imposed for balance of payments reasons.

38. Moving decisively to implement structural reforms will help boost medium-term growth prospects. Continued efforts are needed to improve infrastructure, and law and order, invest in health and education, attract more FDI, accelerate SOE reforms, and reduce business costs. A revival of agriculture and a strengthening of the SME sector supported by innovations in financial inclusion will also be vital for improving the livelihood of the majority of the population.

39. While staff welcomes the recent progress, more decisive action is needed to improve macroeconomic statistics. The authorities’ commitment to reforming the National Statistical Office is a strong step in this direction, with IMF TA continuing to assist reform efforts and improve capacity. Staff looks forward to the publication of new GDP estimates later this year.

40. It is proposed that the next Article IV consultation with PNG will be held on the standard 12-month cycle.

Papua New Guinea—Update on the LNG and Mineral Projects

Successful commencement of LNG production has boosted the overall growth performance but brought weaker-than-expected revenue due to falling commodity prices. There is significant upside in terms of exploration from the second LNG project and other mining projects planned over the medium term.

PNG LNG Project

Production is expected to reach full capacity of 6.9 million tons per year in 2015. The project started in 2010, led by ExxonMobile, with a total cost of US$19 billion. The first LNG shipment from the PNG LNG project took place in May 2014, ahead of schedule. The main buyers are Japan, mainland China, and Taiwan POC, with the contract price linked to the oil price (Japan Crude Cocktail). The expected operational life of the project is 30 years.

A sizable portion of earnings will be diverted to loan repayments and partially offset by accelerated depreciation allowances. The construction costs are financed by a mix of 30 percent equity and 70 percent debt. While export earnings are more than adequate to cover the loan repayments, significant tax revenues from the LNG project are not expected before 2021–22, largely due to accelerated depreciation allowances.

uA01fig11

Project Timeline

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Company websites and IMF staff compilation.

Papua LNG (Elk-Antelope) Project

Industry analysis suggests Elk-Antelope will be the most competitive newly-built LNG project in the world, with production estimated at 8 million tons per year. The joint venture consists of French oil major Total SA as operator (40.1 percent), InterOil (36.5 percent) and Oil Search (about 23 percent). Under the proposed project schedule, early works would begin in the third quarter of 2016, with a final investment decision and construction starting in 2017. The total cost is estimated at around US$15 billion, which would have a significant impact on the economy.

Other Major Mining Projects

PNG has several mine projects that are scheduled to begin production over the medium term. Among them are Wafi-Golpu (gold and copper), Frieda River (a global top 10 undeveloped open pit copper mine), Solwara 1 (deep sea mining of gold and copper), Yandera (copper), Mt. Kare (gold), Imwauna (gold), and new deposits/mine within the vicinity of PNG’s oldest operating mine, OK Tedi (gold and copper).

Papua New Guinea—Alternative Commodity Price Scenario

An alternative commodity price scenario suggests that the external current account balance is highly sensitive to the commodity price projections, whereas the fiscal position would be affected to a lesser extent, largely reflecting the base effects of the previous downward revision in resource revenues from K 2.4 billion to K 0.6 billion for 2015.

Alternative Scenario (a further 20 percent decline in commodity prices)

  • Assumptions. All mineral prices (LNG, crude oil, gold and other metals) would fall further by 20 percent over 2015–20, with no change in the volume. For 2015, the price decline is assumed to take effect during the second half of the year.

  • External balance. The current account would decline by around 7 percent of GDP relative to the baseline, and would be expected to remain in deficit over 2016–20. The size of the impact on the current account is roughly the same as the earlier LNG price drop of about 50 percent. The impact on the overall balance of payments would be almost entirely offset by the impact on the financial account since most commodity export receipts are kept offshore. As a result, the international reserves would remain broadly unchanged compared to the baseline.

  • Fiscal position. Revenue and the overall balance would decline by about 0.5 percent of GDP on average, relative to the baseline, owing to lower mineral tax revenues and LNG dividends. Compared to the impact of the previous commodity price adjustment, the impact would be much smaller because the level of resource revenue had already fallen from K 2.4 billion (in the 2015 budget) to K 0.6 billion (under the baseline) for 2015, reflecting lower commodity prices and the temporary suspension of a major mining operation.

uA01fig12

Current Account Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

uA01fig13

Overall Fiscal Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Papua New Guinea—External Sector Assessment

Staff’s overall assessment is that the medium-term external position is broadly in line with fundamentals and desirable policies. The medium-term real effective exchange rate assessment produced mixed results.

The kina has been weakening since 2013, as commodity prices fell and capital inflows associated with the LNG project passed their peak. The kina has depreciated by 16 percent against the U.S. dollar from June 2014, when the exchange rate band was introduced, to early October 2015, but excess demand for foreign exchange persists.

Exchange Rate Assessment: Baseline Results

(In percent)

article image

Staff projection over 2020.

CA norm stabilizing NFA at -30.8 percent of GDP, assuming a nominal GDP growth rate of 6.9 percent.

Beidas-Strom and Cashin, IMF WP/11/195, Table 2.A, specification IV. Based on a semi-elasticity of the CA/GDP with respect to the REER of -0.31.

Overvaluation is assessed relative to August 2015.

CGER-like estimates produced mixed results. The PPP approach suggests a 25 percent overvaluation, while the other three approaches indicate a range of 4–19 percent of undervaluation. These results suggest that the medium term current account is not out of line with fundamentals and desirable policies. As suggested in the 2012 Board paper, “Macroeconomic Policy Frameworks for Resource-Rich Developing Countries,” the augmented MB approach incorporates oil-related variables such as the oil trade balance and oil wealth including LNG, and the ERER approach is conducted based on the long-run relationship between the REER and real oil price.

The reserve metric approach suggests that PNG’s current reserve holdings are below the level deemed adequate (estimated to be close to 5 months of imports).1 On the other hand, the optimal reserve approach indicates that the current holdings are well above the optimal level (about 2.5 months of imports for the fixed regime).2 This latter result depends critically on the long-term opportunity cost of holding reserves, which is currently estimated to be 8.7 percent. Given that poor data quality may hamper the credibility of the estimated opportunity cost, more weight should be placed on the results of the reserve metric approach.

uA01fig14

Augmented MB Approach

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

uA01fig15

EREER Approach

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

1These metrics are based on the specifications in Nkunde Mwase’s IMF Working Paper (WP/12/205). The metric is 4.2 months of imports for the floating exchange rate regime and 4.9 months of imports for the fixed exchange rate regime. 2See IMF Working Paper “Optimal Precautionary Reserves for Low-Income Countries: A Cost-Benefit Analysis” (WP/11/249).
Figure 1.
Figure 1.

Papua New Guinea: Real Sector

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; Google; World Bank Doing Business 2015; and IMF staff estimates and projections.
Figure 2.
Figure 2.

Papua New Guinea: External Sector

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; UNCTAD; and IMF staff estimates and projections.
Figure 3.
Figure 3.

Papua New Guinea: Fiscal Sector

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; IMF World Economic Outlook; and IMF staff estimates and projections.
Figure 4.
Figure 4.

Papua New Guinea: Monetary Sector

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Country authorities; IMF International Financial Statistics; and IMF staff estimates and projections.
Figure 5.
Figure 5.

Papua New Guinea: Financial Access Indicators

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A001

Sources: Pacific Financial Inclusion Programme; Alliance for Financial Inclusion; and IMF Financial Access Survey.
Table 1.

Papua New Guinea: Selected Economic and Financial Indicators, 2011–16

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

Based on period average exchange rate.

Resource sector includes production of mineral, petroleum, and gas and directly related activities such as mining and quarrying, indirectly related activities such as transportation and construction.

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

Table 2.

Papua New Guinea: Summary Operations of the Central Government, 2011–16

article image
Sources: Department of Treasury; and IMF staff estimates and projections.

As the authorities integrated the recurrent and development budgets from 2014 there is a discontinuity in the classification.

Nonresource net lending(+)/borrowing(−).

Discrepancies between the overall balance and financing arise because transactions of trust accounts are not fully accounted for due to data weaknesses.

Contingent liabilities include future unfunded superannuation liabilities, and IPBC borrowings.

Table 3.

Papua New Guinea: Balance of Payments, 2011–20

(In millions of U.S. dollars)

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

Includes staff’s estimates related to the PNG LNG project.

Temporary suspension of a mining operation is expected to dampen resource exports in 2015 and 2016.

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

Table 4.

Papua New Guinea: Monetary Developments, 2011–16

article image
Sources: Bank of Papua New Guinea; and IMF staff estimates and projections.
Table 5.

Papua New Guinea: Medium-Term Scenario, 2011–20

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

Real GDP growth projections are based on the chained Laspeyres measure.

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

Includes staff’s estimates related to the PNG LNG project.

Public external debt service includes changes in check float.

July 2015 IMF WEO projections.

Table 6.

Papua New Guinea: Financial Soundness Indicators, 2010–14 1/

(In percent)

article image
Sources: Bank of Papua New Guinea; and IMF staff calculations.

Fourth quarter data for each year.

Capital base includes Tier 1 and 2 capital.

Return on equity is calculated with Tier 1 capita l.

Table 7.

Papua New Guinea: Status of Millennium Development Goals

article image
Source: World Bank, World Development Indicators database, 2014.