Outlook and Risks

PNG will grow strongly in 2015, but the economy has been impacted by lower commodity prices and slowing growth in non-resource sectors. PNG will record its 14^th consecutive year of economic growth in 2015, its longest period of sustained growth. The economy is expected to grow strongly at 9 percent this year, though this represents a significant downward revision as a result of the impact of lower international commodity prices and the El Niño weather pattern affecting the mining, agriculture, forestry and fisheries sectors. Despite weaker commodity prices and the temporary closure of the Ok Tedi copper and gold mine, the resource sector is growing strongly, largely as a result of the commencement of the PNG LNG project. However, the non-resource sectors are growing more slowly. Lower activity in the construction and manufacturing is expected to largely offset growth in non-resource other sectors.

The medium term outlook is for growth to return to its long term average. However, the authorities recognize there are a range of risks to this baseline. Further falls in commodity prices or a worsening of the drought would impact the outlook further. A worsening of the drought could prolong the closure of the Ok Tedi mine beyond the first quarter of 2016. An extended drought would also further affect agricultural output, which would particularly impact on large numbers of subsistence farmers. On the upside, the authorities note that there continue to be prospects for further resource projects in the medium-term (including for a second major LNG project), given the highly competitive characteristics of PNG’s natural resource endowment and its record in delivering world-class resource projects.

Fiscal Policy and Public Debt Management

The authorities have responded to considerably lower resource revenues in 2015 with a package of responsible fiscal measures. With lower international commodity prices and the weather-related temporary shutdown of the Ok Tedi mine, resource revenues will be significantly lower than budgeted in 2015. The authorities have responded prudently to these developments by identifying expenditure savings of 1.4 billion kina, while avoiding cuts in priority areas of education, health, infrastructure, and law and order so as to continue supporting inclusive and sustainable development. At the same time, the authorities have also announced revenue measures to raise an additional 1.1 billion kina from tax collections and dividends from state entities. Together, these adjustments will contain the 2015 budget deficit to 4.5 percent of GDP, which is close to the originally budgeted deficit of 4.4 percent of GDP and broadly in line with staff advice.

While the level of public debt remains manageable, the authorities agree with staff on the need to restrain its growth, particularly as financing conditions tighten. While PNG’s public debt continues to be at a moderate level by international standards, the authorities recognize that the recent growth should be curtailed and that steps are required to move debt to a pathway that is consistent with a credible medium term strategy. PNG continues to finance the deficit mainly from domestic sources. Although the domestic market has sufficient liquidity to finance the deficit and also meet private sector borrowing needs, some institutional investors are approaching their limits for government securities. The authorities have therefore commenced a process to issue an international sovereign bond, and intend to use a significant proportion of the proceeds to buy back securities and reposition the debt portfolio. The government recognizes the importance of announcing the detail of its fiscal strategy ahead of the bond issuance. In the coming weeks, the authorities will provide further detail of the immediate fiscal adjustments by way of a supplementary 2015 budget. These fiscal adjustments will assist in reducing financing pressures and interest costs generally. The authorities have recently published the 2016 Budget Strategy, which lays out the medium-term plans for fiscal consolidation, while ensuring the pace of this consolidation is sensitive to the impact on growth and employment. This strategy aims to prioritize and improve the quality of expenditure while broadening the tax base, with the immediate aim of stabilizing public debt at 35 percent of GDP. Looking ahead, the authorities aim to return to a balanced budget and bring debt to GDP back to 30 percent by 2020. The authorities are considering the role the non-resource primary balance could play in anchoring fiscal policy and look forward to further discussions with staff on this approach. The authorities have also expressed interest in IMF technical assistance to review and update the existing medium-term debt strategy to provide a sound framework for debt management and future debt financing.

The comprehensive tax review will provide options to modernize PNG’s revenue system with the aim of improving the efficiency and competitiveness of the PNG economy. The authorities commissioned the tax review in late-2013 as an important part of the medium term fiscal strategy. As the tax review comes to its conclusion, it will present options on securing a broader, more efficient and more stable revenue base, including on how best to leverage revenues from the resources sector, that will sustainably support PNG’s development objectives. The authorities appreciate the IMF technical assistance received throughout the review process and look forward to further support when considering the implementation of these significant tax reforms.

The authorities are strengthening public financial management (PFM) to improve the quality of cash management and effectiveness of spending. The recent Public Expenditure and Financial Accountability (PEFA) assessment made several significant recommendations to improve cash management, including the overnight reconciliation of cash from a wide variety of sources into a single public account and the greater use of electronic funds transfer. The PFM roadmap that resulted from the PEFA assessment highlights improved cash management among the key reforms to be implemented. The authorities are also committed to improving the quality of expenditure and improving the rate of project execution. PNG’s ‘Vision 2050’ document highlights the focus on a new service delivery model to ensure that spending yields tangible development outcomes. The authorities continue to embed a multi-year budgeting framework, along with sector-led budgeting that gives priority to projects and activities with demonstrated outputs, outcomes and impacts.

The authorities are establishing a new Sovereign Wealth Fund (SWF) to better manage the revenues from PNG’s considerable endowment of non-renewable resources.

Drawing on past IMF advice, the authorities have developed legislation for the SWF, which was passed by Parliament in July 2015. As noted in the staff report, the authorities remain committed to operating the SWF consistent with the Santiago Principles, so as to properly manage the macroeconomic impacts of volatile resource revenues and to ensure this endowment is safeguarded to meet PNG’s development objectives. A stabilization fund will help protect the economy from the volatility associated with commodity cycles, while providing a reliable source of revenues to the budget for social and development spending. A savings fund will invest the real value of extracted mineral and petroleum resources overseas to help with macroeconomic management and seek the best returns for future generations. All investments will be managed by an independent and qualified board.

Monetary Policy and Exchange Rate

Inflation is contained and monetary policy remains neutral for the time being. Headline inflation is projected to be around 6 percent for 2015. Inflationary pressures are expected to remain in check due to the lower growth outlook for the domestic economy, lower foreign inflation from PNG’s major trading partners, and a low pass-through of kina depreciation to domestic prices. The BPNG continues to maintain a neutral monetary policy stance, though it stands ready to absorb excess liquidity and tighten monetary policy should inflationary pressures emerge.

Consistent with market forces, the kina has depreciated by over 16 percent relative to the US dollar in the last year. As a result of lower international prices for PNG’s key export commodities, the supply of foreign currency has been lower than demand, which has contributed to the depreciation of the kina. The authorities consider that the exchange rate continues to be market determined, though structural issues in the market have been responsible for the persistent excess demand for foreign currency. Consistent with its mandate, the BPNG has been intervening to meet some of the excess demand in the foreign exchange market and to avoid any undue delay in meeting import orders. While staff has suggested that a faster depreciation would be desirable, the authorities note that structural issues associated with PNG’s commodity-export oriented economy mean that this may not necessarily stimulate the necessary supply to smoothly clear the market. In addition, past experience has shown that this can exert inflationary pressures, as PNG is heavily reliant on imports. At the same time, the authorities also emphasize the need to avoid excessive volatility in the exchange rate. Nevertheless, the authorities are exploring options to improve the operation of the foreign exchange market, and have requested further technical assistance.

The authorities are committed to ensuring that international reserves are adequate and do not fall below current levels. By the end of 2015, the level of international reserves is projected to be close to USD 2 billion, which staff estimates would provide import coverage for 3.1 months.¹ The decline in reserves over recent years mainly reflects lower foreign direct investment since the completion of the LNG project construction, while foreign exchange outflows have increased due to a rise in import demand. Looking ahead, the proceeds from the planned sovereign bond issuance and the anticipated sale of the PNG government’s equity in the LNG project to local governments and landowners would be expected to increase holdings of international reserves.

Financial Sector and Structural Reforms

PNG’s financial sector is sound, with ongoing efforts to promote financial development and increase access to finance. The financial sector is robust, with commercial banks maintaining strong balance sheets and the number of non-performing loans remaining low. The authorities recognize the need to promote further financial sector development to facilitate better access to finance and support greater diversity in the economy. PNG has made considerable progress in broadening access to financial services through the use of mobile banking, though the authorities recognize that access to branches and ATMs remains difficult for significant parts of the population, including the high proportion of citizens that live in rural areas. The BPNG has been promoting an ambitious strategy to enhance financial inclusion and literacy, which within two years has brought over half a million people into the banking system for the first time, with nearly a third of these being women. The authorities have also made progress implementing AML/CFT legislation, which is expected to facilitate removal from the Financial Action Task Force’s gray list.

The authorities are committed to inclusive growth policies and investments in non-resource sectors that will support sustainable and broader-based growth in the medium to long-term. In particular, the authorities are committed to supporting the development of a more vibrant agricultural sector, given that a majority of the population relies on this sector. Public investments in roads and increased access to finance will help to create opportunities for a more dynamic and productive agricultural sector. Likewise, the authorities are investing in the considerable potential of other sustainable sectors including forestry, fisheries, and tourism. The Competition Review and the Financial Sector Services Review are currently underway and will help identify areas for future reform. These reforms together with ongoing transparency and governance reforms, enhanced secured lending arrangements and efforts to reduce unnecessary regulatory burdens will also help improve the business environment, including for SMEs. PNG’s participation in the Extractive Industries Transparency Initiative will also contribute to an improved investment climate. Governance reforms will promote greater efficiency and improved management of state-owned enterprises.