Overview

The authorities’ increased engagement with the Fund has supported the Government’s key reforms and the authorities have demonstrated significant progress to achieve the reforms even during the COVID outbreak.

Significant reforms were delivered including positive steps towards the government’s objective of budget repair, improving capital investment through an expenditure rule, reducing government arrears, enhancing information sharing and the implementation of key reforms including the Tax Administration Act, and the establishment of the Independent Commission of Anti-Corruption (ICAC) Act.

The most recent Staff Monitored Program (SMP) built on the previous reform priorities and the authorities have again demonstrated their commitment by meeting all the Quantitative Targets and all the Structural Benchmarks except one, as assessed by the IMF, and completing the review with the IMF. The budget deficit for 2021 was below the program target, including a lower than agreed planned deficit target for 2022, demonstrating the authorities continued commitment to budget repair. As noted in the staff report, PNG’s planned fiscal adjustment places it in the top 12 percent of historical adjustments.

This marks the first successful completion of a program with the IMF in over two decades by PNG, and represents a strengthened engagement with international partners, and international bodies as well as a commitment to transparency and good governance.

Economic Conditions

The PNG Government began a process of budget repair, introducing a 2019 Supplementary Budget that included budget cuts equivalent to over 1 percentage point of GDP. The COVID-19 pandemic then had a severe impact on economic activities in 2020 and thereafter. Despite the challenges, PNG has weathered the pandemic relatively better than its peers reflecting the authority’s swift response to contain COVID-19 in 2020.

Inflation is moderately above recent trends driven by international conditions, supply-chain disruptions, and higher commodities and oil prices resulting from the war in Ukraine. As the higher inflation outcome is expected to continue to be exacerbated by impacts of the war in Ukraine, the authorities have recently implemented short-term measures to provide temporary relief for its citizens. This includes removing excise and the Good and Services Tax on fuel while reducing prices on selected staple food items; increasing the tax-free threshold for Personal Income Tax; and supplementing further the Government’s Tuition Fee Subsidy that allows for widespread transfers of cash to parents of children in schools. To ensure fiscal neutrality, the cost of these measures will be offset by the expected revenue increase from higher commodities prices. Targeting relief in this way is an effective way to provide relief to most people, including the most vulnerable, as PNG does not have a social security system, while also continuing the process of budget repair.

Over the medium-term, PNG’s economic performance will be driven largely by growth in the non-resource sector reflecting the Government’s commitment to achieve 5 percent growth in the non-resource sector. This is expected to generate jobs across the economy, most of it in the informal sector. The Government expects to return to a budget surplus by 2027, with debt to GDP ratios declining rapidly even before then.

There remain risks to this outlook, stemming from the following possibilities: new-COVID-19 variants; weaker external demand for PNG’s exports; large volatility in commodity prices; higher inflation; or climate-related natural disasters.

Despite this, there are also notable upside risks that the authorities do not include in their baseline: relating to higher than-expected commodity prices; falling domestic interest costs, and the possibility of significantly larger LNG revenues in the medium term; and the commencement of several major extractive projects in the medium term (Papua LNG, P’nyang LNG or the Wafi Golpu mining project).

PNG is making notable progress on its planned fiscal consolidation path. The revised Medium Term Fiscal Strategy sets out the key elements of the authorities ongoing plan for budget repair and reconstruction, guided by the principles of ’spend the money we have more wisely’, ’raise the revenues more fairly’ and ’finance the debt more cheaply’. This will be supported by an updated Medium Term Debt Strategy and the Medium-Term Revenue Strategy. The authorities have seen some recent significant successes in reducing the cost of locally issued debt securities; bringing down near-end rates from over 10 percent (for securities around 4 year maturities) to around 6 percent in the most recent auction.

While staff assess that PNG’s public and publicly guaranteed debt is sustainable but at high risk of debt distress, the authorities see their debt carrying capacity as more nuanced. The authorities agree that large financing requirements to dampen the effects of the COVID-19 pandemic have elevated debt levels and a $US500 million bullet bond repayment due in 2028 presents a risk to debt distress. However, the authorities perceive this risk to be manageable with expected increased revenues from the PNG LNG project in 2027 as its debt payments are completed, as well as continued efforts to restructure debt to cheaper financing and an updated public guarantee policy to strengthen oversight of SOE loans.

PNG has a sound financial sector dominated by commercial banks that are well-capitalized and profitable, with ample or indeed excessive liquidity, although non-performing loans have risen. More generally, financial sector inclusion is constrained by low urbanization, a large informal economy, and low financial literacy.

The authorities remain committed to strengthening governance and anti-corruption issues. The Financial Analysis Supervision Unit initiated swift regulatory actions against PNG’s largest commercial bank, Bank South Pacific, to strengthen AML/CFT compliance and reduce risks of disrupting correspondent banking relationships. This has sent strong signals to the other banks to comply with the AML/CFT rules, and a positive signal world-wide on PNG’s dedication to implement sensible and stringent AML/CFT rules. The authorities also successfully implemented the ICAC law, providing ICAC the power to investigate and pursue complex corruption cases. This has improved PNG’s Corruption Perception Index for 2021 and PNG is working with developing partners including UN, EU, ADB and Australia to progress this important work.

PNG is highly vulnerable to climate change with large adaptation needs due to rising sea levels, coastal erosion, flooding, drought, and landslides. While the authorities have strived to make significant efforts to reduce emissions, protect the rainforest and adapt to climate change amidst limited financial support, the authorities welcome the focus the staff placed on climate issues in the staff report. This poses significant financing challenges for PNG, which will require the support from development partners and external sources.

Broad Program Performance

The PNG authorities approached the IMF in 2019, to strengthen the relationship through the development of a SMP. The Treasurer has set out to increase greater international engagement based around greater transparency, move to cheaper international concessional financing and direct engagement with the IMF on financing.

Under both these SMPs, a number of key reforms occurred including:

• 1) Establishing the Arrears Verification Committee, which has led to the identification of over K5 billion in pre-2019 arrears, that the authorities have made strides in clearing – validating and paying down the arrears of K255 million in 2020, and K419 million in 2021.

• 2) Improving information sharing between the Treasury and the Central Bank – particularly on liquidity management, and cash planning with the establishment of an observer position on the Central Bank board for Treasury and the review and formalization of TORs for the public debt committee, including the Central Bank’s role.

• 3) The introduction of the new Tax Administration Act will strengthen the authorities’ powers to enforce tax regulation.

• 4) The implementation of a new Small Business Tax, to simplify the tax code for small companies.

• 5) The passage of the ICAC Act, the establishment of the ICAC authority and the development of supporting regulation.

• 6) Instituting the Temporary Access Facility (TAF) for cash flow management with guidelines around its use, developed with IMF advice.

• 7) The approval of the consequential amendments around the Tax Administration Act, to prevent conflicts with other legislation.

• 8) The completion of a staffing and establishment review, that incorporated details on the issues the authorities face and sets out a plan to resolve them – including key issues like the proper recording of staff under the correct appropriation heads. This report is crucial to allow any other meaningful reforms to occur in this space.

• 9) The completion of the first stage of the Independent Advisory Group (IAG) report into the Central Bank Act, and the passage of some initial amendments to the act that will support the implementation of further reforms. This was passed by the PNG Parliament in December 2021.

Central Bank Reform

The PNG Government undertook an ambitious effort to strengthen and modernize the Central Bank Act which was originally written in 2000. The review was designed based on IMF advice and conducted by the IAG, composed of the former Central Bank Governor who oversaw the development of the 2000 Act, the former Chief Secretary to Government at the time of those reforms and current Chancellor of the University of PNG, and the head of the Development Policy Centre at the Australian National University. The IAG was grateful for advice from a number of sources, including the IMF. The eight recommendations on the Monetary Policy Committee (MPC) were deferred. As stated in PNG Parliament, PNG is inclined to move down an MPC path even though about half the countries in the world have monetary policy decided by the Board. The best structure for monetary policy decision-making, along with financial regulation, will be considered in more detail as part of the Phase 2 of the reforms.

The authorities are of the strong view that the first phase of the reforms, which were unanimously passed by the PNG Parliament, modernized and strengthened the independence, governance, accountability, and transparency of the Central Bank. Indeed, PNG considers it was a transformative set of reforms vital for PNG’s future development and setting the groundwork for the next stage of reforms. The decision-making power for monetary policy and financial regulation was moved from a single person to a collegiate approach through a strengthened Board, which reduces the risk of undermining BPNG’s independence. The Board has stronger merit-based appointment processes and removed the ex-officio positions that previously dominated the Board.

Transparency and reporting requirements to Parliament and the public were strengthened, as was coordination with Treasury while respecting the independence of the central bank. After careful deliberation, PNG moved towards a joint mandate for monetary policy in line with the other countries in the Asia-Pacific and Western Hemisphere regions. Consideration of this revised mandate was the major item in the IAG report to Government, taking up 31 pages of discussion. The change aimed at balancing the importance of price stability with the damage that had flowed from moving away from a market-based exchange rate in 2014. As noted by the IMF in Annex V of the staff report, the foreign exchange rate had become an informal anchor for price stability given the lack of influence of the official cash rate. The focus for the combined mandate was avoiding the negative impacts on growth of using the exchange rate as the monetary policy anchor, while simultaneously introducing strict fixed caps on any government exposure to avoid monetary financing of the budget deficit. The amendments closed down a loophole identified by the IAG as having been an issue in the past on funding the government and put absolute limits on the level of Central Bank purchases of government securities. The cash advance facility was designed to be of limited size, related to within year cash flows, and requiring repayment within the fiscal year to ensure it was not used for budget deficit financing. The weekly volatility of revenues and expenditures means the TAF can move weekly from being fully repaid to being drawn down, although in 2022 this has never exceeded half of the maximum drawdown and there is currently a surplus in the government cash accounts. PNG considers an effective TAF requires this automatic flexibility, all within a fixed limit and with a requirement that it is repaid in full by the end of the financial year and welcomes IMF advice on how this can be further improved.

As indicated in the LOI, the authorities have requested further Fund TA to continue the work on reviewing and amending the CBA, including further consideration of the objectives of BPNG, the role of the Board and the role of BPNG with regards to the government’s cashflow management all within the understanding of PNG’s circumstances. The authorities look forward to the continued support of the IMF during Phase 2 of the review and look forward to working with staff on a pathway forward. However, it will be important that there are no prior expectations or preconceived ideas from the Fund on the necessary reforms ahead of the TA mission.

Fund Relationship

The support from the IMF during COVID through the Rapid Credit Facility was greatly appreciated; and the decision by the IMF Board to undertake a General Allocation of SDR in 2021 helped stabilize economies worldwide including PNG. The authorities are grateful for this support and look forward to continued future engagement.

Under the SMPs the relationship with the Fund has been productive and the authorities have taken steps to strengthen the bilateral flow of information. More can be done, and the authorities look forward to the placement of a Resident Representative in PNG to aid this. In addition, communication will be further strengthened by greater TA engagement, which the authorities look forward to and support.

The authorities are looking forward to continuing a constructive partnership with the Fund that supports the Government’s economic reform agenda and positive development outcomes for PNG.