PNG government budget targets fiscal deficits

Papua New Guinea is facing several fiscal challenges in the wake of falling government revenues and the end of a liquefied natural gas-driven construction boom, with GDP growth falling by about two-thirds between 2015 and 2016. Though the budget deficit narrowed in 2017, this was largely owing to a supplementary budget that slashed capital expenditure. Public spending remains constrained by low levels of tax collection, even as recurrent salary expenditure remains high. Public debt has soared in recent years, and is set to reach new highs in 2018, with efforts to contain debt servicing costs leading to a chronic foreign exchange (forex) shortage.

The government has taken several steps to address these challenges, including unveiling the 100-Day Economic Stimulus Plan in August 2017, implementing reforms to improve revenue collection and public financial management, and attempting to ease forex and debt pressures with a planned $500m eurobond issuance. This should enable the country to mitigate fiscal impacts, paving the way for more sustainable macroeconomic expansion.

Revenues Downturn

Government revenues fell below target every year between 2014 and 2016, and again in the first half of 2017, when it rose by 6.8% against the budget target of 10%. In December 2017 the World Bank reported that no dividends from state-owned enterprises were paid during the first half of 2017, and while the Department of Treasury (DoT) forecast dividends of PGK850m ($265.4m) would be paid by the end of the year, it was still PGK225m ($70.2m) less than the amount projected in the 2017 budget. Meanwhile, tax revenues rose from PGK8.4bn ($2.6bn) in 2016 to PGK8.5bn ($2.7bn) in 2017, against the 2017 target of PGK8.9bn ($2.8bn).

With revenue realisation including income tax collection consistently falling below target, the government was forced to undergo a period of fiscal consolidation between 2014 and 2016. The World Bank reported that total annual spending fell by more than 12% to PGK13.6bn ($4.2bn), driven by a 78% decline in capital expenditure over the same period.

According to the Asian Development Bank (ADB), PNG’s fiscal deficit narrowed from 4.6% of GDP in 2016 to 2.5% in 2017 after spending cuts were implemented under a supplementary budget.

Debt Trap

Meanwhile, PNG’s debt and debt servicing costs could be a cause for concern. According to the ADB, the debt-to-GDP ratio reached 32.6% in 2016 before moderating to 32.1% in 2017. While this is within the legislated debt-to-GDP limit of 35%, the limit was revised from 30% in 2017 as government debt rose significantly from PGK8.5bn ($2.7bn) in 2012 to PGK21.9bn ($6.8bn) in 2016, according to the World Bank.

More notably, debt servicing costs as a percentage of expenditure doubled over the same period, rising from PGK452m ($141.1m) to PGK1.3bn ($405.8m). Interest costs have increased by an annual average of 28% since 2012 to stand at 7.6% in 2016.

PNG’s debt-to-GDP ratio is projected to climb to 35.4% in 2018, which would surpass the legal limit and significantly heighten the risk of debt distress. It is also expected to exacerbate the ongoing forex challenge, with the central bank forced to rein in debt servicing costs by artificially inflating the kina.

In March 2018 credit ratings agency Moody’s revised PNG’s outlook from stable to negative, and in the following month Standard & Poor’s lowered the country’s credit rating from “B+” to “B”. Both agencies attributed the reclassification to rising liquidity risks, a deteriorating debt profile and subdued macroeconomic growth.

100-day Plan & 2018 Budget

The government launched the 100-Day Economic Stimulus Plan in August 2017, establishing 25 policy objectives across areas ranging from public financial management to macroeconomic growth. The plan also aims to reduce recurrent expenditure and redeploy the funds for capital expenditure, with a focus on non-extractive economic diversification (see analysis), improved public sector efficiency and debt management, and a reduced foreign exchange shortfall.

The 2018 budget builds upon the 100-Day Economic Stimulus Plan and includes targets to implement a medium-term fiscal strategy, with the short-term priority of halting declining revenues and the mid-term goal of bolstering revenue income. In addition to emphasising improved tax compliance the 2018 budget also includes measures to halt rising emoluments, placing stricter controls on utilities and office rentals, and ensuring efficiency by amalgamating government agencies.

Revenue Renewal

The 100-Day Economic Stimulus Plan does not include any changes to tax rates, removals of exemptions or other measures to raise revenues, and the 2018 budget did not introduce any new taxes. Nonetheless, the government is taking steps to improve revenue collection and tax compliance, with plans to fully fund both the Internal Revenue Commission (IRC) and PNG Customs in 2018, as well as establish task forces to improve tax compliance and expand the taxpayer identification number registry.

The 2018 budget reiterates these intentions, and includes a mandate to boost tax compliance through the IRC, with an emphasis on improving employer registrations targeting personal and corporate income, which account for about 60% of total tax revenues.

Forex Vs Debt

The 100-Day Economic Stimulus Plan also includes an important measure to ease the forex shortage, which has been a significant challenge for local businesses and potential investors, with the Bank of Papua New Guinea (BPNG) announcing plans to release $100m of new forex supply in August 2018. The government is also negotiating a deal to purchase crude oil from its sole refinery, Napa Napa, in kina, which would free up roughly $20m a month.

The 2018 budget also includes plans to raise a US dollar bond, or to shift the mix of debt from domestic to foreign currency, as well as mandating the use of local currency. For example, local firm Oil Search is required to sell at least 50% of Napa Napa’s crude oil in kina and to use local LNG for future gas-fired power stations.

As of August 2018, the US dollar bond issuance had not yet been announced; however, PNG is expecting its first ever eurobond issuance, after the announcement by Prime Minister Peter O’Neill during a May 2018 visit to London. O’Neill said the government planned to select lead managers for the $500m, 10-year issuance, with the transaction expected to be complete before the end of the year, providing the country another avenue to address its fiscal challenges. Furthermore, the government announced in 2017 plans to shift from commercial to concessional loans as part of continued efforts to address the fiscal deficit. In June 2018 the ADB approved a loan of $195m, with $95m for health infrastructure and $100m for the deficit that year.

Capital Expenditure

Public financial management targets under the economic plan include: limiting the budget deficit to 2.5% of GDP in 2017; strengthening payroll management; and examining development bank budget support in early 2018, with the goal of containing government debt and re-allocating recurrent expenditure to use on new capital projects.

The 100-Day Economic Stimulus Plan also includes a wishlist of 18 capital projects, which were further fleshed out in the 2018 budget, with a projected capital spending of PGK4.6bn ($1.4bn). Given that loans and grants to the country have remained consistent, government capital expenditure is set to rise by PGK660m ($206m), according to Deloitte in November 2017.

Capital expenditure is expected to be allocated to hosting duties for the APEC Summit 2018, which culminates with a leaders’ meeting in Port Moresby in November (see Trade & Investment chapter), as well as sewerage upgrades, redevelopment of the Highlands Highway (see analysis), construction of a power station to be fuelled by locally produced LNG, creation of a state equity fund to encourage investment in agriculture, funding for small and medium-sized enterprises, and social infrastructure including new hospitals and a university in the Western Highlands Province.

Budget Challenges

Limiting the budget deficit could prove challenging, given stubbornly high salary expenditure. According to the World Bank, government employee compensation increased by 120% between 2014 and 2016, while total expenditure on salaries and wages more than doubled over the same period, from PGK2bn ($624.4m), or 13% of total expenditure, to PGK4.5bn ($1.4bn), or 33%.

Altogether, PNG overspent by PGK430m ($134.2m) on salaries by in 2017. The government has exceeded its recurrent budget by an average of 10% every year since 2010. The problem is worse at the provincial level, which reported overspending every year in the 2010-17 period, as opposed to national departments overspending in just two years over the same duration.

Addressing overspend and constraining recurrent expenditure will remain critical priorities moving forward, with the 100-Day Economic Stimulus Plan and 2018 budget both demonstrating government efforts to support inclusive growth and non-oil diversification.