Improving spending of budgeted allocations

While rapid increases in government spending come at the right time in Papua New Guinea’s economic cycle, the key will be the timely execution of budgeted projects. Affected by low disbursement levels, particularly for its capital expenditure, the government is enacting key reforms to streamline projects and strengthen revenue collection. As the Asian Development Bank (ADB) noted in December 2013, “The real challenge for the next year will be one of implementation and delivery.”

Expansion Plans

Seeking to bridge a growth gap between the winding down of construction on the liquefied natural gas (LNG) project and the start of exports, the government has since 2012 used an expansionary fiscal policy focusing on investment in key development enablers. The 30% year-on-year (y-o-y) growth in the 2013 budget and the 18.4% rise in 2014 are largely driven by investment in infrastructure, which was up 70% and 44% in the last two years. Spending on the five key development enablers is set to rise 30% in 2014. The majority of infrastructure funds are budgeted for investment rather than maintenance or operation of the facilities, however. While the Department of Works and Implementation receives 60% more funding y-o-y in 2014, over 97% of the new funds are earmarked for investment, according to figures from the ADB. Meanwhile, 37% of new health funds are dedicated to rehabilitating existing facilities.

Another key feature of budgets since 2013 has been the high degree of devolution in spending to sub-national tiers of government – provincial, district and local – through service improvement programmes. Provinces receive PGK5m ($2m) per district, all 87 districts receive PGK10m ($4.1m) each and local governments PGK500,000 ($203,250) annually. In total, provinces received 26.2% of the budget in 2013 and 23.8%, or PGK3.64bn ($1.5bn), in 2014. The aim of the decentralised spending is to better involve local communities in the development of rural infrastructure such as roads, schools and clinics, while the national government focuses on larger infrastructure projects. Yet although the national government has given guidelines on how to allocate these sub-national funds, Tim Bulman, country economist at the World Bank, notes, “It is unclear how effectively these allocations can be monitored and enforced.”

Under Spending

Whereas recurrent expenditure is typically fully spent, disbursements on the capital components are typically far lower. The Treasury estimates in its 2013 “Mid-Year Fiscal and Economic Outlook” (MYEFO) that a mere 26% of budgeted funds for transport and infrastructure had been spent by the end of the first half of 2013, with only slightly higher disbursement rates of 36% for health and 38% each for education and law and order. In total the government had executed 43% of its recurrent budget but only 29% of its development spending by end-June 2013, according to ANZ. Although spending tends to accelerate towards the end of the year, execution of the infrastructure budget typically remains around the 50% mark. While the MYEFO trimmed the public investment programme from $2.4bn to $1.6bn mid-year, a mere 52% of the revised sum had been spent by November 2013, according to data from the ADB.

“Implementation issues have been particularly acute for new major national infrastructure projects, which suffer from weak oversight and are often funded before feasibility and preparatory design studies have been completed,” the bank noted in December 2013. Meanwhile, with little reporting on sub-national spending, the use of the funds remained unclear, according to the ADB. Under-spending has proved useful in curbing the budget deficit: the 2013 budget recorded a final deficit of 6.3% of GDP, according to the IMF, lower than the 7.3% originally planned. Yet this has also led to the build-up of funds in government trust accounts at commercial banks, contributing to excess domestic liquidity and potentially to leakages to consumption.

New Processes

The 54% of the government budget disbursed in the first three quarters of 2013 represented a 10% improvement y-o-y on 2012, according to ANZ. Execution of recurrent spending, spurred by higher-than-expected expenditure on personnel, according to the Treasury, was up 12% in this period, while development spending was 6.5% higher. Acknowledging the need to improve the quality of expenditure, the government has introduced new processes with assistance from the ADB. For the first time in 2014 the budget has integrated recurrent and development components to improve planning efforts and promote transparency. In addition, since 2013 the Treasury has moved to multi-year budgeting, anchoring fiscal plans over five years to create predictability in funding for agencies and longer-term planning for investments.

In 2014 the budget strengthens project screening and review processes, while rolling out integrated financial management and strengthening oversight of civil servants. Finally, a new branch was also created in the Department of Finance to oversee statutory bodies and migrate to harmonised financial reporting standards, with expenditure warrants published monthly. The government expects accountability in its sub-national Service Improvement Programmes through greater local participation. “We are serious about decentralising government – and genuine decision making – to the levels of governments that are closest to the people and can therefore be most accountable to the people,” Prime Minister Peter O’Neill told Port Moresby’s second Leaders’ Summit in February 2014. To support improvements in public services delivery, however, partners like the ADB and IMF have warned that PNG will need to invest in developing a higher-skilled work force. Advising authorities not to rush spending towards the end of the year and roll over unspent funds to the 2014 budget, the IMF also called for better prioritisation of projects in its 2013 Article IV consultations.

Broader Take

While the government has relied on a burgeoning budget deficit funded through local-currency securities, it expects revenue collections to outpace expenditure growth from 2014 onwards. The Medium Term Fiscal Strategy plans for average 12% rises in revenue annually in the five years to 2018, faster than the 9% annual rises during the commodity upswing from 2006 to 2011, according to the World Bank. Banking on a 21% increase in revenue to PGK12.7bn ($5.2bn) in the 2014 budget, up from 9.6% in 2013, authorities expect rising tax income to provide the bulk of new revenue. As LNG exports started at the end of May 2014, the impact on government finances will be gradual (see analysis). The World Bank calls these projections ambitious, but authorities have launched efforts to strengthen tax compliance and improve transparency. Although PNG achieved a fiscal surplus in five of the seven years to 2013 according to Standard & Poor’s (S&P), its terms of trade for its key mineral exports, gold, copper and oil, deteriorated below budget assumptions in 2013. “PNG’s budget performance will remain vulnerable to volatility in commodity prices,” Craig Michaels, S&P’s sovereign credit analyst for PNG, told OBG. Yet while commodity prices proved a drag on income, the combination of higher tax compliance and better-than-expected company profits drove the 9.6% growth in revenues in 2013, as per ADB figures. The share of personal income tax in total revenues has grown compared to corporate and indirect taxes according to the World Bank, from 16% of revenues in 2008 to 27% in 2013, roughly equivalent to corporate tax receipts, which declined from 40%. The share of indirect taxes has remained flat at 23%.

The bulk of the 21% growth expected in 2014 will come from tax revenue, due to rise 13% y-o-y. The Treasury expects the Inland Revenue Commission to boost collections by PGK600m ($243.9m) in 2014, PGK300m ($122m) in 2015 and PGK150m ($61m) annually from 2016. “We are now tightening up the way in registering and doing business in the country so as to capture everybody,” Prime Minister O’Neill said in January 2014.

The authorities expect to drive compliance by migrating to a computerised system, as well as simplifying the tax system. In 2013 the government established a tax reform committee to review all taxes, receiving submissions from the private sector in 2014 and due to report in March 2015. Aside from harmonising tax exemptions and closing loopholes, the prime minister has also called for the doubling of the threshold for tax-exemption to PGK20,000 ($8130). The first tax review since the 1990s, the committee’s recommendations could be incorporated in the 2016 budget at the earliest. The Treasury has also led efforts to implement the Extractive Industries Transparency Initiative’s audit of resource revenues, with the establishment of a multi-stakeholder group in November 2013. Although the PNG LNG and Ramu Nickel projects will contribute minor corporate tax receipts until the turn of next decade given the tax incentives they benefit from, the government expects mining and petroleum tax to rise some 90% over the next two years as LNG exports come on-stream.

With all eyes on public investment as the key driver of growth in 2014, efforts to strengthen budget execution and improve the quality of spending are welcome. Meanwhile, expanding both compliance and the tax base will be key to funding PNG’s development priorities.