Papua New Guinea: Staff Report for the 2015 Article IV Consultation—Debt Sustainability Analysis
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International Monetary Fund. Asia and Pacific Dept
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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.

Background

1. PNG’s public and external debt burdens have fallen significantly over the past decade. Public debt declined from 62 percent of GDP at end-2004 to about 22 percent of GDP in 2011, but rose to around 42½ percent in 2014.3 Public and publicly guaranteed (PPG) external debt also declined sharply, from a peak of over 50 percent of GDP in 2001 to around 16 percent in 2014. Around 70 percent of current public external debt is owed to the Asian Development Bank and the World Bank. Domestic debt consists of treasury bills (45 percent) and inscribed stocks (55 percent) with an average maturity of 5 years. The main creditors are resident banks and superannuation funds. The government is planning to issue a sovereign bond of around US$1 billion in 2015.4

Underlying Assumptions

2. Over the medium term, PNG’s growth prospects and current account developments will be heavily influenced by its extractive sector and the LNG price outlook. Box 1 summarizes the medium-term macroeconomic framework underlying this DSA update. Economic activity is projected to continue to grow in 2015, reflecting the fact that liquefied natural gas (LNG) production reaches full capacity. The current account deficit narrowed in 2014 due to the winding down of the construction of the LNG project. With LNG exports coming on stream this year, the deficit is expected to turn into a surplus in 2015, while the temporary suspension of a major mining operation will dampen mineral exports.

External DSA

3. The baseline scenario indicates that all PPG external debt ratios stay well below the indicative thresholds, while there is a short-lived breach in the extenal debt service-to-revenue ratio due to the inclusion of a loan which has been moved to a public enterprise. The present value of the external debt stock is expected to rise in the near term because of an Australian $1.2 billion loan (6.8 percent of GDP) that government took in early 2014, but fall over the medium term as this loan is repaid and with the expectation that new external borrowing will be moderate (Figure 1).5 The public external debt service ratios follow a similar profile, with higher debt service initially rising as a result of this loan but subsequently falling to very low levels, reflecting PNG’s relatively small external debt stock as well as the fact that most of its public external debt is highly concessional. There is a breach of the external debt service-to-revenue ratio in 2016. However, the breach is short-lived and is mainly due to the inclusion of the UBS loan which has been moved off the government balance sheet to the NPCP. Without this loan, the indicator would remain below the indicative threshold and the risk to debt sustainability therefore appears to be manageable. High levels of private external debt could potentially create balance of payments pressures by competing with the public sector for foreign exchange. Nevertheless, such risks are mitigated by the fact that a large part of the loans are adequately backed by expected cash flows from the LNG project.

Figure 1.
Figure 1.

Papua New Guinea: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2015–2035

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. In figure b. it corresponds to a Exports shock; in c. to a Exports shock; in d. to a Exports shock; in e. to a Exports shock and in figure f. to a Exports shock.

4. PNG is vulnerable to certain extreme shocks despite the currently low external debt burden, but these shocks have a low probability of materializing. There is a protracted breach of the PV of the debt-to-GDP ratio under the historical scenario and a near breach under the export shock scenario. Also, there is a near breach of the external debt service-to-revenue ratio under the export shock scenario, when the sovereign bond is rolled over. However, these scenarios could be thought of as circumstances where the LNG project has completely failed or suffered a major delay. In the historical scenario, for instance, when the current account deficit is fixed at the ten-year average of 2005–14, the simulation effectively keeps imports at levels elevated by the LNG project and rules out the expected large increases in LNG exports going forward. Given that LNG production has already commenced and is set to reach a full capacity this year, such an outcome is very unlikely, while there is potential risk of a further commodity price decline and rollover risk stemming from the planned sovereign bond.

Public DSA

5. The public debt dynamics for PNG remains stable, but there are risks to this outlook.6 The public debt burden is expected to decline continuously over the projection period under the baseline (Figure 2). However, failures to consolidate the fiscal position would significantly increase debt burden. There are also risks arising from unfunded superannuation and public enterprise liabilities. The former are estimated to be about 6½ percent of GDP at end-2014 and the latter about 7½ of GDP, but data on the latter are incomplete and not up to date. Once these liabilities are taken into account, there would be a noticeable increase in the public debt burden over the medium term, as shown in the customized scenario (“All other liabilities”) for the public DSA.7

Figure 2.
Figure 2.

Papua New Guinea: Indicators of Public Debt Under Alternative Scenarios, 2015–2035

Citation: IMF Staff Country Reports 2015, 318; 10.5089/9781513584683.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025.2/ Revenues are defined inclusive of grants.

Authorities’ Views

6. The authorities agreed with the DSA findings, noting that the current risk of debt distress is low, but fiscal consolidation is crucial for debt sustainability. The authorities acknowledged that a continuation of the current fiscal stance is not sustainable and that expenditure restraint is needed to keep the debt on a downward path. They also recognized the importance of more comprehensive data on debt and other liabilities, in particular, off-budget and public enterprise debt, in assessing PNG’s overall debt burdens. They will consider an IMF technical assistance mission on the Medium-Term Debt Management Strategy (MTDS) to provide a sound framework for future budgetary financing.

Conclusion

7. Papua New Guinea’s PPG external debt remains at low risk of debt stress. However, the overall risk of public debt distress has remained heightened, given the rising stock of public domestic debt in recent years. Contingent and non-contingent liabilities significantly increase the public debt burden, and a failure to consolidate the fiscal position would result in unsustainable debt dynamics. The government needs to bring the public debt on a downward trajectory over the medium term, while focusing on improving spending quality to make the most out of a restrained resource envelope in meeting the country’s development needs. The terms and conditions of all loans including the UBS loan should also be published to ensure fiscal transparency and debt sustainability. Going forward, a planned debut sovereign bond issuance should be used to improve the debt profile and terms and cover existing commitments rather than finance new projects.

Macroeconomic Assumptions Underlying the DSA Update

Macroeconomic assumptions for this DSA are generally more conservative than those for the previous DSA. In particular, projections of GDP growth and external current account are somewhat lower than those for the 2014 DSA, as are projections of the primary fiscal balance. This largely reflects a less favorable outlook for the resource sector owing to lower commodity prices and a temporary mine closure. LNG prices are assumed to decline by about 30 percent in 2015 and by around 5 percent in 2016, reflecting the recent plunge in oil prices.

  • Real GDP growth is projected at around 4 percent on average over the medium term8, and to slow to 3 percent in the long run.

  • Inflation is expected to be about 3½ percent over the medium term and will stabilize at 5 percent in the long run.

  • The current account (including grants) will turn into a surplus in 2015 as LNG production comes on stream and imports related to the LNG project subside, and is projected to be 5 percent of GDP on average during 2015–20.

  • The grant element of loans is expected to average around 35 percent. A sovereign bond reduces the grant element of loans when it is issued and rolled over with a 10-year interval.

  • The primary fiscal balance is estimated to be in deficit of 5 percent of GDP in 2015. During the current medium-term fiscal strategy period (2013–17), a continuous primary deficit of 4 percent of GDP on average is expected. After 2024, the primary fiscal balance is projected to turn into a surplus, with an average of 0.4 percent of GDP during 2024–34.

Table 1a.

Papua New Guinea: External Debt Sustainability Framework, Baseline Scenario, 2012–2035

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

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

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

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

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

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

Defined as grants, concessional loans, and debt relief.

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

Table 1b.

Papua New Guinea: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2015–2035

(In percent)

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Sources: Country authorities; and staff estimates and projections.

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

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

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

Includes official and private transfers and FDI.

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

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

Table 2a.

Papua New Guinea: Public Sector Debt Sustainability Framework, Baseline Scenario, 2012–2035

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Public debt includes domestic central government debt, external public debt, and the guarantee for the UBS loan.

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

Revenues excluding grants.

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

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

Table 2b.

Papua New Guinea: Sensitivity Analysis for Key Indicators of Public Debt 2015–2035

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Sources: Country authorities; and staff estimates and projections.

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

Revenues are defined inclusive of grants.

1

This DSA was prepared jointly with the World Bank, in accordance with the Debt Sustainability Framework for low-income countries approved by the Executive Boards of the IMF and the IDA.

2

Papua New Guinea is rated as a medium performer for its policies and institutions for the purposes of the IMF-World Bank low-income country DSA framework.

3

For 2014, this DSA assessment includes the UBS loan in public debt. If the UBS loan is excluded, public debt is 35½ percent of GDP and PPG external debt is around 9 percent of GDP in 2014.

4

The terms and conditions have not been disclosed. For the analytical purposes, this DSA assumes 10-year maturity with a 10 percent interest rate and that a sovereign bond will be rolled over when it matures.

5

The government contracted this loan from UBS in March 2014 to finance the purchase of a 10 percent stake in the Oil Search Limited, an oil and gas company. It has been moved off the government balance sheet to the National Petroleum Company PNG (NPCP). The terms and conditions of this loan have not been disclosed. For the purpose of this DSA, staff has assumed a two-year loan maturity with 8 percent annual interest and included it as part of publicly guaranteed external debt.

6

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

7

This scenario assumes that the full amount of superannuation arrears is added to the debt stock, and 100 percent of SOEs debt is realized to become actual liabilities and added to the debt stock. The SOEs debt stock is assumed to grow in line with nominal GDP.

8

The government plans to spend K 3 billion over 2015–18 on the preparations for APEC 2018. 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.

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Papua New Guinea: 2015 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Papua New Guinea
Author:
International Monetary Fund. Asia and Pacific Dept
  • Figure 1.

    Papua New Guinea: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2015–2035

  • Figure 2.

    Papua New Guinea: Indicators of Public Debt Under Alternative Scenarios, 2015–2035