Statement by Nigel Ray, Executive Director for Papua New Guinea, Grant Johnston, Alternate Executive Director, and Sali David, Advisor to Executive Director November 26, 2018

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

Papua New Guinea is the largest Pacific island country and one of the most culturally diverse nations in the world, with over 800 different ethnic languages. Around 85 percent of the population lives in rural and remote areas, where government services are difficult to access. Almost all land is in customary ownership. Much of it, however, comprises swamps, steep mountains, dense forests, rivers and rugged terrain, and PNG suffers frequently from natural disasters. The physical and climatic conditions create logistical and infrastructure challenges and many development indicators remain low. The country is richly endowed with natural resources, and the oil, gas and mining industries make up a significant part of the economy. While this exposes PNG to commodity-driven cycles, the country has a sound financial system and a stable political environment, and the Government is committed to sound macroeconomic management.

Developments and outlook

The 2018 Supplementary Budget and the 2019 Budget were presented to Parliament in mid-November. These show the budget deficit and debt-to-GDP ratios on declining paths, in compliance with the Fiscal Responsibility Act and the Medium Term Fiscal Strategy. Revenue in 2018 has been higher than expected but so has expenditure, with spending increases primarily due to higher employment in the Government’s priority areas of education, health and law and order. The expected Budget outturn in 2018 has improved, despite a large earthquake that cost many lives and disrupted operations at oil and gas fields and at a gold mine. The PNG authorities expect 0.3 percent growth in 2018, compared to staff’s zero percent, due to a faster-than-anticipated recovery from the earthquake, improved commodity prices and APEC-related activities. They agree the economy will pick up substantially next year, boosted by a recovery in the oil and gas sector and by activity associated with large mining and petroleum projects.

PNG issued its first sovereign bond in October, raising US$500 million for a 10-year maturity that was heavily over-subscribed. In addition, budget support loans were secured from the ADB and World Bank, with the first tranches of US$100 million and US$150 million, respectively, occurring in 2018. Other external financing efforts in 2018 include the final, US$190 million, disbursement of a Credit Suisse commercial loan.

Fiscal policy

The authorities are committed to prudent financial management. Although fiscal consolidation has been challenging, the authorities have made good progress on tax collection and public financial management. Resident TA from the Fund has helped implement a five-year Medium-Term Revenue Strategy aimed at mobilizing domestic revenue. A large taxpayer office was opened in September to improve service and compliance.

On the expenditure side, the authorities note staff’s suggestions for spending cuts but recognise that these are in difficult and sensitive areas. As part of the 2019 Budget, the Government is establishing tighter controls in the payroll system to ensure salaries are linked to budget warrants, as is the case for goods and services. It is also instituting tighter controls on the in-take of teachers, health workers, police and the military, but their impact will be gradual because of programmed throughput from training colleges. Provincial and district grants, while opaque, have brought direct benefits to areas and regions that have not previously experienced much in terms of government services and are part of the Government’s decentralization strategy.

The Government’s Medium Term Fiscal Strategy 2018–22, incorporating requirements of the Fiscal Responsibility Act, limits public debt to within a band of 30 to 35 percent of GDP, trending towards the lower limit in the medium term. Successive Budgets have been designed around this requirement, with the 2019 Budget showing debt falling below 30 percent of GDP in 2021. Earlier this year, new National Accounts data for 2014 and 2015 was released that incorporated a change in deflator methodology. This indicated a significantly lower nominal GDP level than previously reported and therefore a considerably higher debt-to-GDP ratio, threatening a breach of the Fiscal Responsibility Act. The new numbers took the authorities by surprise, with no opportunity for a transition strategy and associated communications strategy. The Budget, the Government’s fiscal strategy and its public communications have been based around the previous methodology, so this abrupt change has been the source of some frustration to the authorities, who are now focusing on the best way forward.

Monetary and financial sector policies

The Bank of Papua New Guinea (BPNG) has maintained its neutral monetary policy stance given the easing in inflation, relative stability of the kina exchange rate and moderate global economic growth. While liquidity levels remain high, lending to the private sector has been relatively weak, although it is expected to pick up with increased economic activity. BPNG is refining its monetary policy framework to improve the transmission of monetary policy and liquidity management. This includes introducing quantitative targets for the reserve money framework, a new overdraft facility (the Intra-day Liquidity Facility), and a collateralized repo facility with an interest rate corridor. The authorities are grateful for the Fund’s policy advice and technical assistance in this area.

The authorities agree with staff on exchange rate flexibility and the need for orderly adjustment. But they consider a more gradual depreciation to be appropriate, especially given structural issues with a shallow domestic market and few dealers. The government’s foreign borrowing, including the bond issue, has helped clear most of the back log of foreign exchange orders. The kina equivalent is being used to restructure and reduce short-term domestic debt. This will reduce high domestic interest costs, reduce refinancing risks and extend the maturity of the government’s debt portfolio. BPNG and Treasury will work together to coordinate their actions and manage liquidity.

PNG’s financial system is sound, and dominated by commercial banks which are well-capitalized, profitable and have low NPL ratios. The authorities agree they should remain vigilant on financial stability in light of the proposed monetary and FX reforms, liquidity management challenges and the proposal to change the Government’s domestic debt maturity structure. In addition, the proposed take-over of ANZ’s retail and SME business operations by Kina bank will require careful monitoring by BPNG.

Structural policies

In the medium term, growth in PNG could be boosted by several major resources projects currently being developed, including expansion of the existing PNG LNG project, development of another LNG project and the Wafi-Golpu gold project. The authorities consider that, subject to overall investment risks, the government’s involvement in future resource projects should be tilted more towards higher payments earlier in the project cycle, to reduce fiscal risk and ensure that revenue is derived from production rather than profitability.

A sovereign wealth fund is currently being established, to invest proceeds from the non-renewable resources sector. A board will be appointed shortly, to start the process of operationalizing the fund. While the resources sector is likely to drive growth in the future, the authorities also recognize the need to diversify the economy into sectors such as agriculture, tourism and services, and have assisted these sectors in the 2019 Budget. The Government is supporting, for example, production of locally-grown rice, vegetables, meat and dairy product. PNG hosted APEC this year and the authorities considered this an important opportunity to showcase the country and promote investment.

The authorities are committed to addressing governance issues, recognizing the important role good governance plays in development. Substantial progress has been made in this area, including enhancing the AML/CFT framework, undertaking a national risk assessment and getting a National Procurement Act and revised Public Finance Management Act approved by Cabinet. Legislation on an Independent Commission Against Corruption (ICAC) is awaiting approval. Civil society organizations in PNG also welcome the new focus of the IMF in addressing governance issues.