Papua New Guinea: 2018 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
Publication Date:
03 Dec 2018
eISBN:
9781484388150
Language:
English
Keywords:
ISCR; CR; debt; resource; PNG NSO staff; project debt repayment; balance of payments; BPNG FX allocation; return on equity; long-term debt; resource project investment cycle; Exchange rate adjustments; Fiscal consolidation; net FX inflow
Download PDF (1.3 MB)

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Papua New Guinea

Abstract

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Papua New Guinea

Recent Developments, Outlook, and Risks

A. Economic Activity, Inflation, and Balance of Payments

1. In recent years the Papua New Guinea (PNG) economy has grown sluggishly, reflecting a combination of domestic and external factors. Low commodity prices, together with the end of large resource project investments, dampened growth in the main resource sectors. Additionally, a severe drought in 2015–16 pulled down growth in the mining and agricultural sectors. Policy developments have also contributed to slow growth in the non-resource sector. Fiscal consolidation, while essential to restoring fiscal sustainability, has unavoidably dampened aggregate demand. A shortage of foreign exchange (FX), sustained by an overvalued exchange rate, also led to severe import compression, inhibiting investment and production in the non-resource sector. Thus, aggregate growth averaged around 2 percent in 2016–17. With the fading impact of the 2015–16 drought on food and betelnut prices, inflation eased from 6.7 percent in 2016 to 4.7 percent in 2017.

2. Growth in 2018 has been adversely affected by a large (magnitude 7.5) earthquake, disrupting production and exports by the gas, oil, and mining industries. Although production in these industries has recovered well, output in the resource sector as a whole is still projected to be below 2017 levels. Activity in the rest of the economy has been supported by expenditure related to PNG’s hosting of APEC, good agricultural harvests, and some improvement in the supply of FX to the non-resource sector. Consequently, overall GDP growth is projected to be close to zero percent in 2018.1

3. Inflation has continued to ease. CPI inflation continued to decline in the first half of 2018, against a background of weak domestic growth, low inflation in major trading partners, limited exchange rate depreciation, and favorable agricultural supply conditions. Inflation is projected to rise slightly, to 4.8 percent at end-2018, reflecting higher international energy prices and some depreciation of the Kina.

4. In 2019 a stronger macroeconomic performance is expected. In the resources sector, full recovery of production and exports from the earthquake is projected. In the non-resource sector, output, consumption and investment will benefit from further improvements in FX supply, reflecting higher commodity prices and intervention to reduce the FX orders backlog. Aggregate GDP growth is projected at 3.8 percent, while inflation is projected remain around 5 percent as the Kina is assumed to depreciate gradually through the year. Over the medium term, aggregate growth is projected to trend upwards towards the estimated sustainable rate of about 4 percent. If major new resource projects are initiated, growth could be substantially higher.

5. Despite a large current account surplus, PNG continues to face a shortage of FX. PNG’s current account surplus for 2018 is estimated at around 23 percent of GDP, as higher commodity prices offset the impact of the temporary cut in export volumes, while FX shortages continue to delay and compress imports. The current account surpluses have been almost entirely offset by capital and financial account outflows, mainly related to project debt repayments. PNG’s international reserves have remained fairly stable, at around $1.7 billion, equivalent to 5 months of imports. Going forward, some improvement in FX inflows is projected, associated with higher commodity prices, a sovereign bond issue, and ADB and World Bank loans. This is expected to lead to an increase in imports as the FX backlog is shortened, and an increase in international reserves that diminishes gradually over the projection horizon.

B. Fiscal Policies and Financing

6. The budget deficit is projected at 2.9 percent of GDP this year. Tax collection so far this year is up substantially from last year and well above budget projections. This reflects efforts by both the Internal Revenue Commission (IRC) and Customs Service to strengthen tax compliance, as well as the impact of higher commodity prices on resource revenues. These gains, however, have been substantially offset by expenditure slippages, particularly on personnel emoluments. Consequently, fiscal consolidation has stalled, and the public debt/GDP ratio is projected at 36.8 percent of GDP this year, exceeding the government’s debt ceiling target.2

7. Significant progress has been made in strengthening public financial management. An Integrated Financial Management Information System (IFMIS) was introduced with technical support by the European Union and its coverage is being extended from the central government to provincial governments, with the roll out due to be completed by end-2018. The government has also passed a National Procurement Act. These measures should facilitate improved accountability, monitoring, and control of fiscal operations and procurement processes.

8. The Government has recently issued a debut sovereign bond. The bond issue is for $500 million with a 10-year maturity and a yield of 8.375 percent. While issuance of a sovereign bond will raise PNG’s external debt/GDP ratio, the government’s intention to use the funds to improve the government’s domestic debt profile, as well as to help resolve the FX and exchange rate conundrum, will be positive and important outcomes.

C. Monetary and Foreign Exchange Policies

9. PNG is seeking to restore exchange rate flexibility. While a flexible exchange rate is not a panacea, it has a valuable role to play in cushioning the economy from the impact of strong swings in commodity prices and resource project investment cycles. Although the kina depreciated significantly over 2012–2015, as commodity prices declined, there was much less depreciation in real terms, and from 2016 until recently, the Kina moved very little against the US dollar. The Bank of Papua New Guinea (BPNG) has been reluctant to have the Kina depreciate, out of concern for the inflationary impact of depreciation and limited supply and demand responses to depreciation. However, stability in the Kina, supported by FX rationing, has led to sharp compression of imports and the buildup of a large backlog of FX orders at the overvalued exchange rate, and weak tax compliance in some export-oriented industries has also reduced FX inflows. The challenge now is for PNG to achieve an orderly adjustment in the exchange rate and restoration of exchange rate flexibility, and to strengthen policy implementation using interest rates.

10. The BPNG also needs to strengthen its capacity to implement monetary policy using interest rates. Interest rate transmission is currently weak and needs to be improved to provide BPNG with effective policy instruments to manage in a flexible exchange rate framework. The FX shortage has also contributed to a buildup of excess liquidity, as bank deposits have been bolstered by funds intended for dividend payments abroad, while credit growth has been weak, reflecting the slow growth of the economy. In such circumstances, the BPNG’s ability to affect monetary conditions has remained very limited.

11. Against this background, the BPNG is adopting broad-ranging reforms to monetary and foreign exchange policies. The measures are intended to: (i) improve monetary policy communication; (ii) strengthen the monetary operations framework; (iii) restore functioning of the FX market and exchange rate flexibility; (iv) lengthen the maturity structure of public debt; and (v) strengthen the BPNG’s formulation of monetary policy.3

12. Steps taken towards implementing this reform agenda include:

  • An IMF technical assistance (TA) mission recently visited PNG to provide advice on implementing the reforms and additional TA is likely to be provided;

  • The Pacific Financial Technical Assistance Center (PFTAC) has assisted BPNG staff with strengthening capacity in forecasting and policy analysis, including analysis of the impact of exchange rate adjustment;

  • BPNG has notified banks that it will no longer provide direction on the allocation of FX to customers;

  • Since July, BPNG has undertaken several interventions to increase FX supply, averaging about $50 million per month, and has also overseen a gradual downward adjustment in the exchange rate against the US dollar of around 0.3 percent per month. Discussions with banks suggest that intervention plus some improvement in export earnings has begun to shorten the backlog of FX orders and delays in filling orders, particularly for trade in goods and service;

13. A baseline projection, based on current policies is summarized in Table 1.4 In the baseline, further fiscal consolidation is projected, in line with announced policies. Ongoing efforts to strengthen revenue mobilization and expenditure control are projected to bring down the budget deficit to 2.2 percent of GDP in 2019, and to 0.8 percent of GDP by 2023. However, while the pace of fiscal consolidation does gradually bring the public debt/GDP ratio down over the medium term, it is still projected to be above the medium-term target range of 30–35 percent in 2021. The projection incorporates issuance of a sovereign bond and ADB and World Bank loans. These inflows will boost international reserves initially and then be used to reduce the FX orders backlog, while the current gradual pace of exchange rate adjustment is assumed to continue.

Text Table 1.

Medium-term projection based on unchanged policies

article image

D. Risks

14. The main risks in the outlook include:

Upside:

  • Liquefied Natural gas (LNG) and mining projects, which could begin in 2020, would boost investment inflows and growth, easing the fiscal crunch and the shortage of FX, but timing and values are too uncertain to include in the baseline projection.5

  • Non-resource sector growth could be boosted by a stronger than expected response of activity and investment to easing of FX rationing and gradual exchange rate adjustment.

Downside:

  • If the easing of FX shortages and adjustment in the exchange rate are delayed, growth would be adversely affected.

  • Weakening of global growth could lead to a reversal of recent increases in commodity prices. This would adversely affect government revenues, increasing pressure for fiscal consolidation. This plus an adverse impact on business confidence would cut growth prospects.

E. Macroeconomic Outlook with Recommended Policy Adjustments

15. Stronger economic policies, involving more ambitious fiscal consolidation coupled with exchange rate adjustment would yield favorable results (Table 2). In the adjustment scenario, public debt to GDP ratio is reduced to within the 30–35 percent medium-term target range by 2019, and monetary policy eliminates overvaluation of the Kina and the FX orders backlog over the same period. In this scenario, the growth and inflation trajectories would be broadly preserved, while the potential for debt distress as well as significant disruption in the FX market would be much lower than in the unchanged policies scenario. The following sections elaborate on policies under such an adjustment scenario.

Text Table 2.

Medium-term projection based on Adjustment Scenario

article image

Authorities’ Views

16. With regard to the economic outlook, the authorities believe that the post-earthquake recovery in production is somewhat stronger than estimated by Fund staff, involving growth of around 1 percent for the year. The authorities also noted that they are using their own estimates for GDP growth since 2014, as they have questions about the NSO figures (Box 1). The higher nominal GDP figures used by Treasury contribute to a much lower estimate for the debt/GDP ratio in 2018 and a quicker decline in the ratio to within the target range of 30–35 percent, as indicated in the Mid-Year Economic and Fiscal Outlook (MYEFO).

Policies for Macroeconomic Stability and Development

17. The main macroeconomic challenges for the government are to finish putting in place policies that will help promote economic stability, and to strengthen its long-term development framework. Important measures have been adopted to promote macroeconomic stability, but further fiscal consolidation is needed. Additionally, monetary and exchange rate policies should be geared towards restoring exchange rate flexibility. From a longer-term perspective, the development policy framework emphasizes the need to promote the non-resource sector in order to achieve sustainable development goals. In this context the revenue strategy will play a critical role, as will a framework for managing future resource project revenues, and the strengthening of governance arrangements.

A. Fiscal Policy

18. The adoption of a zero non-resource primary balance as a medium-term fiscal target should help to provide fiscal stability and sustainability, as well as promote intergenerational sharing of benefits from natural resources. To further underpin fiscal adjustment, an annual expenditure rule would help reconcile the debt and revenue targets and focus attention on the level of revenues need to support development spending.

19. Additional fiscal consolidation measures are needed in 2019–22. To establish a sustainable and credible fiscal adjustment path, further steps should be taken to strengthen revenue and expenditure management as well as to achieve fiscal consolidation consistent with bringing the debt/GDP ratio down to the long-term target of 30 percent over the medium term. This will require cutting net spending by around K 1 billion (1.4 percent of GDP). As sustained revenue increases under the Medium Term Revenue Strategy (MTRS) may take time to be realized, the primary focus should be on spending restraint. Clearly, though, sustained increases in revenues would ease the task of adjustment. The degree to which the debt/GDP ratio exceeds the target is somewhat uncertain, suggesting that a gradual approach to fiscal consolidation is appropriate.6

20. To achieve further fiscal consolidation, staff recommend the following measures:

  • Financial management controls over the Personnel Emoluments should be improved without delay, with a view to reducing personnel costs by about K 0.5 billion (10 percent or 0.7 percent of GDP):

    • Complete identifying public employees using head counts, national identification cards and appointment letters. Use IFMIS data to identify staff collecting more than one pay cheque;

    • Remove from the payroll names of persons not actually working;

    • Ensure budget allocations are based on accurate data;

    • Ensure that the Organizational Staffing and Personnel Emolument Audit Committee (OSPEAC) meets regularly and takes action;

    • Reduce the expenditure ceiling on personnel emoluments costs from 40 to 35 percent of non-resource, non-grant revenue, to make the ceiling binding.

  • District and Provincial Service Improvement Program (DSIP and PSIP) grants. These grants have been largely protected while goods and service expenditures have been cut substantially. It is recommended that these grants be scaled back by K 0.5 billion (50 percent, or 0.7 percent of GDP), at least until the debt target has been achieved. Moreover, to strengthen transparency and accountability, cuts should fall most heavily on programs providing the least accountability.7

  • Expenditure arrears and payments delays. Eliminating payments delays and arrears should be a priority in budget implementation. Uncertainty regarding timing of government payments is cited by the business sector as one of the most important factors dampening non-resource sector business activity. A clear policy of paying on time and eliminating arrears would significantly boost business confidence.

  • Revenue expansion. The government’s strong commitment to strengthen domestic revenue mobilization through implementation of the MTRS is welcome. Recommendations to strengthen the revenue effort include:

  • Ensuring that all members of the government negotiating teams for major new gas and mining projects are provided with the analysis and tools developed by recent IMF and World Bank TA teams focusing on extractive industries fiscal regimes. A well-informed team with a clearly agreed strategy and understanding of trade-offs is essential to getting the best deal for PNG;

  • The MTRS is a very large and complex undertaking, and will require strong and focused management. Active governance by the MTRS Steering Committee (SC) is essential. Priorities should include:

    • The SC should hold regular governance meetings and require regular reports from Treasury and IRC management to monitor progress against MTRS deliverables; and dedicated resources should be allocated for the SC secretariat;

    • The large taxpayer office should be used to pilot modern tax administration procedures which can then be rolled out to other taxpayers;

    • IRC should quickly build a compliance risk management function to identify and address tax non-compliance, especially in high risk industries like logging, fisheries, and gold mining. Appropriate resources should then be allocated to strengthen enforcement, ensuring that all taxpayers pay the tax properly owing. Tax audit specialists should be contracted in to IRC to address more complex risks in the natural resources sector.

21. Fund staff support the use of the sovereign bond and other government borrowing to lengthen the maturity profile of domestic public debt and resolve the FX orders backlog. The implementation of the government’s debt management operations will need to be very closely coordinated with the interventions to reduce the FX orders backlog in order to minimize uncertainty and volatility in liquidity conditions.

Authorities’ Views

22. The authorities agreed that additional fiscal consolidation is needed, although there is some uncertainty about the magnitude, and that a combination of revenue and expenditure measures is appropriate. Revenue efforts will focus on increasing compliance as well as strengthening non-tax revenue. On expenditure, it was noted that both payroll and grants are sensitive areas. On payroll, audits at the provincial level will be used to bring spending under better control, and at the national level savings are being achieved through some restructuring of departments. For PSIPs and DSIPs, the focus is on increasing transparency, as well as improving procurement practices, which may lead to savings.

B. Monetary and Foreign Exchange Policies

23. To address PNG’s monetary and FX challenges, a carefully designed and implemented strategy is needed. Key objectives are to (i) restore exchange rate flexibility and a functioning FX market; (ii) strengthen BPNG capacity to use interest rates to manage monetary conditions; and (iii) reduce the government’s dependence on short-term domestic debt. Elements of the strategy need to include:

  • Clearing the backlog of FX orders prior to floating the exchange rate. This is needed to avoid a large, disruptive movement in the exchange rate. While the backlog may have been reduced this year, commercial bank estimates suggest that the overall figure is around US$1 billion. A well-communicated commitment to clear the backlog though regular FX interventions by BPNG over the next year or so could have a very favorable impact on business sentiment, with beneficial effects on investment. Easing of import compression should also favorably affect production, as the supply of intermediate imports increases, as well as putting some downward pressure on inflation. The magnitude of these effects is difficult to gauge, but could be substantial.

  • Gradual elimination of exchange rate overvaluation should precede floating. A rapid adjustment of the exchange rate would significantly boost inflation, while real adjustment of imports and exports would likely take some time. Consequently, Fund staff agree with the authorities that a gradual approach toward eliminating the overvaluation is appropriate, but a somewhat faster pace of adjustment is recommended than that seen so far in 2018. The EBA analysis (Box 2) suggests that PNG’s external position is moderately weaker than implied by fundamentals and desirable polices, and the Kina is overvalued by 10.7 percent. Private sector estimates suggest somewhat greater overvaluation. Overvaluation effectively acts as a subsidy for imports and dividends being paid abroad, while taxing exports. These effects run counter to the direction of the government’s development strategy. Eliminating overvaluation will require a depreciation of 12–15 percent in nominal terms. Once the FX orders backlog has been largely eliminated, and exchange rate overvaluation reduced, conditions will be largely set for re-establishment of an interbank FX market without a sharp further adjustment of the exchange rate. BPNG should aim to complete this transition within two years.

  • Other measures to boost the net supply of FX to the market. Exchange rate adjustment will work to boost export revenues and dampen imports without resort to rationing, but other policies can help. The focus needs to be on achieving sustainable rather than temporary increases in inflows. Measures to increase tax compliance by export earners, in particular, will not only increase government revenues but also increase FX inflows on a sustained basis.

  • Strengthened liquidity management. Clearing the backlog of FX orders will withdraw substantial liquidity from the system. At the same time, using proceeds from government foreign borrowing to retire short-term debt will inject liquidity. Managing these operations in a way that achieves liquidity objectives will require strengthening liquidity forecasting, as well as ensuring excellent communications with market participants. It will also require strengthening the monetary policy operational framework so that BPNG is able to adjust liquidity conditions appropriately. Steps to strengthen the liquidity management framework should be pursued in the near term.

Authorities’ Views

24. The authorities agreed with Fund staff on the general thrust of monetary and exchange rate policy reforms, especially the need to carefully manage the liquidity effects of the use of FX to clear the FX orders backlog and reduce short-term public debt. They agreed that good communication with stakeholders is essential. Planning of the reform implementation strategy is under way and TA will be requested as needed.

C. Financial Stability

25. The PNG financial system appears to be generally sound, but some developments will need careful monitoring. PNG banks are well-capitalized (average 29 percent tier 1 capital asset ratio), have low NPLs (average 1.3 percent), and a high return on equity (average 27.4 percent), so are generally in a good position to absorb shocks. Nonetheless, there are three areas of risk that will need careful monitoring by the BPNG:

  • Kina Bank’s proposed acquisition of ANZ retail and non-corporate commercial business may well be a healthy move not only for the banks themselves, but for the efficient functioning of the system as a whole.8 Initially, however, Kina Bank will be absorbing a large number of customers that it does not know well, and its management team will face a large increase in the scale of its work. Both factors could challenge risk management, and will need to be monitored closely by BPNG;

  • BPNG’s reforms to monetary and FX operations, together with Treasury’s intention to change the maturity structure of government debt, are bound to raise challenges for the commercial banks in managing liquidity, FX, and credit risks, as well as lead to changes in the functioning of markets. Clearly BPNG Financial Markets Department will need to work with the banks to ensure that changes are introduced in as smooth a fashion as possible, but BPNG Supervision Department will also need to be involved to ensure that risks are properly managed.

  • The impact of reductions in systemic excess liquidity and exchange rate adjustment on financial stability could adversely affect some firms’ balance sheets. Discussions with banks suggest that gradual exchange rate adjustment is unlikely to generate significant stresses among banks’ customers, but this will bear careful monitoring.

26. Difficulties in the operation of the interbank market will need to be addressed. There is some evidence that the interbank market is not effectively redistributing liquidity between banks. Although interbank bilateral exposure limits may play a role, that the terms of access to central bank liquidity facilities may be inhibiting a market solution. A market-based solution should be sought, in which central bank liquidity provision is limited.

Authorities’ Views

27. The authorities agreed that careful monitoring of Kina bank’s expanded business will be needed for some time, and that the impact of changes in monetary and FX operations will also need to be monitored. The BPNG is currently considering options for dealing with maldistribution of liquidity between banks.

Policies for Inclusive Development

28. Achieving the government’s development objectives will require better management of natural resource wealth, development of the non-resource sector, and addressing challenges in governance and corruption. Significant efforts are already underway, including under the new government’s Alotau II Accord, the Vision 2050 development strategy, and the 2018 National Budget, underscoring the government’s commitment to infrastructure investment, law and order, and education and health services. To further this agenda will require efforts in the following areas:

  • Better management of natural resource wealth. The government recognizes the importance of harnessing PNG’s considerable natural resource wealth, and has begun negotiating commercial agreements for major new LNG projects. Improvements in the terms of LNG agreements, in line with international best practice, will yield significant revenues. It will be important to develop a framework to manage and use these revenues, including a sovereign wealth fund, to safeguard resources for future development and growth, fiscal buffers to protect against macroeconomic shocks and natural disasters, and more transparent expenditure to ensure resources are used as efficiently as possible.

  • Development of the non-resource sector. To achieve inclusive growth and poverty reduction, development policies need to focus on the non-resource sector. The strategy needs to provide incentives for private sector investment, supported by government provision of essential public goods, including infrastructure, education, healthcare, clean water and electricity and telecommunications. Financing these will require sustained increases in government revenue, as well as careful prioritization of projects, and hence putting together a consistent and efficient medium-term fiscal framework will be essential. Fund staff also strongly endorse the BPNG’s efforts to promote financial inclusion, especially as it will tend to promote greater gender equity.

  • Addressing challenges in governance and corruption is essential to attain development objectives. PNG has extensive governance and corruption weaknesses undermining the effectiveness and efficiency of government. Addressing these weaknesses effectively would substantially increase PNG’s attractiveness as a destination for investment, raise the sustainable rate of growth, and promote economic inclusion. For these reasons, Fund staff strongly support the elimination of corruption and strengthening of governance as part of PNG’s development strategy, and its effective implementation through actionable measures.

29. Recent measures that will serve to strengthen governance and reduce corruption are welcome, including:

  • Establishment of the Independent Commission Against Corruption (ICAC). This is a welcome development, but much will depend on its precise mandate and powers. Fund staff recommend that ICAC’s enabling legislation be passed and gazetted in the near term, and that ICAC be given a high degree of autonomy, particularly with regard to the selection of cases that it investigates, and its powers of prosecution.

  • Roll-out of the IFMIS budget monitoring system. IFMIS is not only extremely helpful for management of government spending, but can also be used to promote a transparency and discipline in the use of public funds. Specifically, Fund staff recommend that IFMIS data be used to monitor implementation of DSIP and PSIP spending and compare such spending against guidelines for use of such funds. Publication of such information can help improve discipline in the use of the funds and increase public confidence that they are used well.

  • National Procurement Act. The new Act, involving greater centralization of procurement, offers the potential for substantially increasing the transparency and integrity of the procurement process, with significant benefits in terms of efficiency. The National Procurement Commission should be established quickly, given considerable autonomy, provide clear guidelines for procurement at all levels of government, and monitor and report publicly on compliance.

  • Government payroll controls. Since 2017, the Treasurer has been emphasizing the need to bring the public sector payroll under control, as this has been a consistent source of significant budget over-runs. In Fund staff’s view, this is one of the costliest areas of weakness in public sector governance and needs to be addressed urgently. OSPEAC should be much more proactive in leading efforts to strengthen improvements in payroll monitoring and control, as well as eliminating over-payment to absent workers as well as people collecting multiple pay cheques, and so on.

  • AML/CTF compliance. Since PNG was grey-listed in 2014 by the Financial Action Task Force (FATF) for failure to strengthen its AML/CTF supervision, there have been major improvements in governance arrangements. In 2015, PNG passed 5 major pieces of legislation to strengthen the AML/CFT regime, in line with FATF recommendations. In 2016 the BPNG took over AML/CTF supervision from the police Financial Intelligence Unit (FIU), establishing the Financial Analysis and Supervision Unit (FASU), and has expanded its staff from about 5 in the FIU to a planned 30–35. These actions led to PNG’s removal from the grey-list in 2016. With ADB assistance, FASU conducted a National Risk Assessment (NRA) in 2017, awaiting clearance by the National Executive Council. This will guide FASU’s AML/CFT strategy. Fund staff recommend immediate clearance of the NRA and strategy documents. In addition, Fund staff recommend that Memorandums of Understanding (MOUs) be pursued between FASU and its counterparts with important trade and financial partners in the region, including China, Malaysia, and Indonesia. FASU should also be a regular participant in meetings of the Bank South Pacific supervisory college.

Authorities’ Views

30. The authorities broadly agreed with the staff on the importance of governance reforms. They noted that ICAC is still a work in progress, and that the NRA will be made public shortly. This will allow the FASU to publicize its work program. It was noted that logging and fishing are particularly challenging areas for AML.

Statistics and Other Issues

31. Urgent action is needed to strengthen governance, management, and performance at the National Statistical Office (NSO). Timely production, compilation, and dissemination of macroeconomic statistics is essential to effective fiscal and monetary policy formulation. The management of NSO should be strengthened without delay. To this end, it is suggested that the NSO Reform Committee, including BPNG, Treasury, IRC, and Customs, be reactivated under the chairmanship of BPNG or Treasury. The Committee should:

  • Overhaul the NSO management team and review NSO’s budget;

  • Establish a set of key economic statistics to be produced and published, including appropriate release timetables, for which NSO should be accountable;

  • Ensure that changes in methodology, significant data revisions, and major new initiatives (e.g. the proposed 2019 HIES survey) are thoroughly reviewed by the Committee;

  • Establish appropriate MOUs with government departments to make available administrative data (e.g. GST data) to NSO to use in improving the quality and lowering the cost of producing key macroeconomic series.

32. Recent TA recommendations to improve balance of payments data should be implemented. A recent IMF TA mission was able to obtain valuable information on the disposition of earnings from extractive industries, especially the LNG sector. Fund staff recommend incorporation of this information into the balance of payments compilation, as this makes a large difference to the picture of balance of payments developments, and their interpretation for policymakers.

33. Fund staff welcome the elimination of BPNG guidance to authorized FX dealers on the use of FX, and encourage elimination of remaining FX restrictions inconsistent with Article VIII of the IMF’s Articles of Agreement:

  • The requirement for a tax clearance certificate prior to making payments or transfers for current international transactions should be eliminated;

  • Limits placed on spreads between the exchange rate on BPNG FX allocations and dealer rates with clients should be eliminated or modified to avoid inconsistency with Article VIII limits. This can be achieved by re-formulating the bands in terms of percentage points rather than basis points, with the bands explicitly limited to less than 2 percentage points.

Authorities’ Views

34. The Authorities agreed on the need to improve governance and rebuild capacity in NSO, and agreed with the approach suggested by staff.

Staff Appraisal

35. In recent years the Papua New Guinea (PNG) economy has grown sluggishly, reflecting a combination of domestic and external factors, and in 2018 was adversely affected by a large earthquake. In 2015–16, low commodity export prices as well as a severe drought dampened growth, but policy developments have also contributed to slow growth. Fiscal consolidation in response to weak revenues, while essential to restoring fiscal sustainability, has dampened aggregate demand, while an overvalued exchange rate has contributed to a shortage of FX and severe import compression, inhibiting activity in the non-resource sector. The earthquake in early 2018 disrupted oil, gas, and minerals exports for a period and, although production and exports have recovered, growth for the year is estimated at close to zero, while inflation has declined to 4 ½ percent.

36. Strengthened macroeconomic policies would help reduce risks while underpinning longer-term economic growth. In 2019, with full recovery from earthquake effects, growth is projected to pick up to 3.8 percent. Although new resource projects are beginning to be negotiated, significant investment and growth spillovers are unlikely until at least 2021. Until then, growth will continue to be held back by the need for fiscal consolidation to bring the public debt/GDP ratio down towards the long-term target ceiling of 30 percent. Monetary and exchange rate policies are moving in the direction of greater exchange rate flexibility, but at the present pace of adjustment, the Kina will remain significantly overvalued and FX shortages persist for a lengthy period. More ambitious fiscal adjustment, and additional flexibility and development of the monetary and exchange rate framework, coupled with structural policies for inclusive growth and better harnessing of PNG’s natural resource wealth would have significant payoffs.

37. The government should build on its recent important measures to strengthen the fiscal framework. In addition to reconfirming a long-term debt/GDP target of 30 percent, with a temporary ceiling of 35 percent, the government adopted a zero non-resource primary balance as a medium-term fiscal target. Staff also recommend adoption of an expenditure rule (determined jointly with the revenue target) to reconcile the fiscal targets and guide budget policy. The government’s strong commitment to strengthen domestic revenue mobilization through implementation of the Medium-Term Revenue Strategy is also welcome. The recent issue of a debut sovereign bond will raise PNG’s external debt/GDP ratio, but the government’s intention to use the funds to improve the domestic public debt profile, as well as to help resolve the FX and exchange rate conundrum, will be positive and important outcomes.

38. In the near term, additional fiscal consolidation is needed. Substantial progress in narrowing the fiscal deficit was made in 2017, but consolidation has stalled in 2018, and the public debt/GDP ratio is well above the long-term target. Although there is some uncertainty about the size of the gap to close (reflecting some uncertainty about the level of nominal GDP), staff recommends a faster pace of consolidation than is projected on current policies. This should be pursued through a combination of revenue increases and reductions in spending, particularly on the government wage bill and grants.

39. The pace of exchange rate adjustment should be stepped up somewhat, and the backlog of FX orders be cleared. Staff welcome the greater exchange rate flexibility seen in recent months, as well as the increase in supply of FX to market participants. But a faster pace of adjustment is recommended, and the FX proceeds of the bond issue and other inflows of FX can be used to eliminate the backlog of FX orders so that an interbank FX market can be re-established within two years. These steps should be complemented by other measures to boost the supply of FX to the market. Liquidity management will also need to be strengthened to manage the liquidity effects of the public debt management and FX operations will be needed, and the impact of such measures on financial stability carefully monitored.

40. 41. Achieving the government’s development objectives will require better management of natural resource wealth, development of the non-resource sector, and addressing challenges in governance and corruption. In this context, staff recommend that PNG seek better terms in negotiations for new resource projects and also develop a framework for management and use of resource revenues. Additionally, an assessment of the long-term cost of non-resource sector development should be taken into account in determining domestic revenue mobilization targets. Fund staff strongly support the elimination of corruption and strengthening of governance as part of PNG’s development strategy.

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

Papua New Guinea: National Accounts

In March 2018, the NSO released National Accounts data for 2014 and 2015. The data incorporate an improved methodology for calculating national accounts deflators, which seeks to take better account of differences between input and output prices. The single extrapolation method introduced improves on the previous single deflation method (where input and output prices were assumed to move identically), but falls short of the preferred double deflation method.1 However, double deflation is more data demanding and so is often not feasible.

The NSO data show much lower nominal GDP growth in 2015 than estimated by Treasury. Treasury estimates nominal GDP growth in 2015 of 9.8 percent vs just 0.7 percent for NSO. The discrepancy reflects higher Treasury estimates for both real growth and the deflator in 2015. Treasury estimated real GDP growth of 10.5 percent and a decrease in the deflator of 0.7 percent vs. NSO’s estimate of 5.3 percent growth and a decline of 4.4 percent in the deflator. These differences appear to reflect different information on activity and prices in sectors such as oil, gas, and construction. The change in deflator methodology may have had some effect, but is not the primary explanation for the difference between the Treasury and NSO figures.

The NSO figures are likely to be revised. Treasury has initiated meetings of key stakeholders, including NSO, BPNG, and IRC, to discuss differences between the NSO and Treasury estimates and to agree on appropriate revisions to the 2014–2015 data.

1 See: Alexander and others “Measure up: A Better Way to Calculate GDP” SDN/17/02.

Papua New Guinea: External Assessment

PNG’s external position is moderately weaker than implied by fundamentals and desirable policies, given its weak gross foreign reserve position and overvalued real effective exchange rate.

The extended External Balance Assessment (EBA) methodology, EBA-lite tool, provides mixed results.1,2 The EBA-lite current account balance (CAB) analysis implies a current account norm of –3.8 percent of GDP, compared to an estimated outcome of 23.9 percent of GDP, suggesting that the REER is undervalued by around 65 percent. The current account surplus in 2017, was supported by large LNG exports and continued import compression caused principally by restricted access to FX. However, this surplus has been largely offset by capital and financial account outflows associated with the LNG project – mainly servicing of the project debt.

The EBA-lite REER index model, on the other hand, suggests an overvaluation of 10.7 percent. This is consistent with relatively high inflation following the drought in 2015/16 and small exchange rate adjustments thus far to the terms of trade movements. In 2017, the real effective exchange rate (REER) appreciated marginally by 0.3 percent while the nominal effective exchange rate (NEER) depreciated by around 3 percent when compared to 2016 outcomes.

The EBA-lite REER index model result is used instead because the EBA-lite current account balance does not incorporate the effects of restricted FX.

Despite improvement in the current account, the reserves-to-import ratio is below the level implied by the reserve adequacy metric approach.3 Reserves were around 5 months of imports at end-2017, lying below what the metric approach suggests as reserves levels for a resource rich country and above a 3-month import cover rule. While LNG exports have increased, the net FX inflow from these exports has been limited, as these are mostly held offshore and as mentioned earlier mostly for project debt servicing.

EBA-lite Results

article image
uA01fig01

Reserve Adequacy

(In Months of Imports)

Citation: IMF Staff Country Reports 2018, 352; 10.5089/9781484388150.002.A001

Source: IMF staff estimates and projections.1 The EBA-lite tool does not incorporate the structural break caused by the LNG project in the economy.2 Elasticities of exports (-0.43) and imports (0.98) are estimated in Nakatani, Ryota (2017) “External Adjustment in a Resource-Rich Economy: The Case of Papua New Guinea” IMF Working Paper No.17/267.3 Central government data are used owing to data limitations. The assessment is based on staff judgement because there is a wide range of adequate levels of reserves, depending on methods used.
Figure 1.
Figure 1.

Papua New Guinea: Real Sector

Citation: IMF Staff Country Reports 2018, 352; 10.5089/9781484388150.002.A001

Figure 2.
Figure 2.

Papua New Guinea: Balance of Payments

Citation: IMF Staff Country Reports 2018, 352; 10.5089/9781484388150.002.A001

Figure 3.
Figure 3.

Papua New Guinea: Fiscal Sector

Citation: IMF Staff Country Reports 2018, 352; 10.5089/9781484388150.002.A001

Figure 4.
Figure 4.

Papua New Guinea: Monetary Sector

Citation: IMF Staff Country Reports 2018, 352; 10.5089/9781484388150.002.A001

Table 1.

Papua New Guinea: Selected Economic and Financial Indicators, 2014–19

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, but excludes 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 2a.

Papua New Guinea: Summary Operations of the Central Government, 2014–19

(In millions of Kina)

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

The 2015 other revenue includes infrastructure tax credit, recoveries from former years (mainly fees and charges) and asset sale.

Withdrawals from the Stabilization Fund (mining and petroleum taxes; mining, petroleum and gas dividends.)

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

Grants include spending on wages and salaries, goods and services, and capital expenditure.

Discrepancies between the overall balance and financing arise because of data coverage gaps in revenue and expenditure for extrabudgetary units, and payment arrears and cash withdrawals from trust accounts which are not fully accounted for due to data weaknesses.

Contingent liabilities include future unfunded superannuation liabilities with Nambawan Super and SOE borrowing.

Table 2b.

Papua New Guinea: Summary Operations of the Central Government, 2014–19

(In percent of GDP)

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

The 2015 other revenue includes infrastructure tax credit, recoveries from former years (mainly fees and charges) and asset sale.

Withdrawals from the Stabilization Fund (mining and petroleum taxes; mining, petroleum and gas dividends.)

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

Grants include spending on wages and salaries, goods and services, and capital expenditure.

Discrepancies between the overall balance and financing arise because of data coverage gaps in revenue and expenditure for extrabudgetary units, and payment arrears and cash withdrawals from trust accounts which are not fully accounted for due to data weaknesses.

Contingent liabilities include future unfunded superannuation liabilities with Nambawan Super and SOE borrowing.

Table 3.

Papua New Guinea: Balance of Payments, 2014–23

(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.

Includes money transfer via offshore accounts.

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

Table 4.

Papua New Guinea: Monetary Developments, 2014–19

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

Papua New Guinea: Medium-Term Scenario, 2014–23

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.

IMF World Economic Outlook. Liquefied Natural Gas (LNG) price index is Indonesian LNG in Japan.