Preserving stability and financing the deficit

By using an expansionary fiscal policy to sustain aggregate demand amid tapering of the Papua New Guinea liquefied natural gas (LNG) construction phase, the government is relying on public markets to finance its deficit. On the central bank’s advice, the Department of Treasury has rebalanced its borrowing profile towards local-currency Treasury bill (T-bill) and inscribed stock (government bonds) in recent years.

While the medium-term debt strategy (MTDS) provides a fiscal anchor for the next five years, PNG will need to balance anticipations of strong revenue growth with growing contingent liabilities, linked to the state’s expanding role in the natural resources sector in particular. Although the government will contract new foreign currency debt in coming years, it is expected to balance domestic and external liabilities to ensure its medium-term debt sustainability. Amidst volatile global financial conditions, however, timing will be key to determining the terms of new liabilities.

Debt Profile

While traditionally reliant on concessional funding from bilateral and multilateral donors such as AusAid and the Asian Development Bank (ADB), its share of PNG’s funding mix has declined as inward foreign direct investment (FDI) and reliance on commercial debt markets has grown. Development assistance has declined from 20% of government revenue in 2003 to around 10% in 2013, according to private equity firm Asia Frontier Capital. Development partners continue to play a significant role beyond budget support, however, with the ADB’s active portfolio committed to PNG reaching $1.1bn in 2014, including $160m in project-based disbursements budgeted for 2014. Meanwhile, surging mining revenues allowed the Treasury to retire a share of public debt over the past decade, with PNG’s aggregate debt, excluding contingent and state-owned enterprises’ (SOEs) liabilities, declining from 39.5% of GDP in 2006 to 22% in 2011, according to Standard & Poor’s (S&P) figures. The drop in debt levels and shift towards lower-cost funding sources cut annual interest payments from 18% of aggregate spending in 2003 to 5.1% in 2013, according to the World Bank. As the incoming administration launched a deficit-funded fiscal expansion from 2012, the nominal value of PNG’s debt rose some 56% in the two years to June 2013 to reach 31% of GDP, as per World Bank figures.

Given abundant kina liquidity, the Bank of PNG successfully lobbied government to rely on domestic funding rather than external sources. The stock of external debt rose only modestly from 7.9% of GDP in 2012 to 8.1% in 2013, while domestic debt ratcheted up from 18.7% of GDP to 24.6% in the same period, according to the Treasury’s 2013 “Mid-Year Economic and Fiscal Outlook”. Most of the rise in external liabilities was caused by the kina’s depreciation against the dollar from late 2012, according to the World Bank. Total external liabilities, including contingent liabilities, expanded from 2011, however, given the PNG LNG project’s reliance on private non-guaranteed debt: total net external liabilities rose from 55% of current account receipts in 2007 to 350% in 2013, according to S&P.

Lengthening The Tenor

The lion’s share of domestic funding has come in the form of short-term T-bills, which accounted for 47% of domestic debt in June 2013, according to the World Bank. With average tenors of six months, however, the refinancing risks are higher for Treasury than for more expensive, longer-term instruments. Under the MTDS, the government aims to reduce T-bills to a quarter of its debt by 2017 and lengthen the maturity of inscribed stock – government bonds. “The 2014 Budget Strategy Paper (BSP) plans to rely mainly on domestic debt issuance and to increase the average debt maturity,” the IMF wrote in its Article IV consultation published in December 2013. Total domestic debt is budgeted to rise 19% to PGK10.5bn ($4.3bn) in 2014. The stock of outstanding bonds will rise from PGK4.64bn ($1.9bn) to PGK6.21bn ($2.5bn) in 2014, up from PGK3.37bn ($1.4bn) in 2012, according to the Bank of PNG (BPNG). In contrast, the Treasury has budgeted PGK5.1bn ($2.1bn) in new T-bill issues in 2014 to cover repayments of PGK4.96bn ($2bn) in outstanding securities, reducing T-bill’s share of debt to 46% in 2014, according to research from Kina Funds. The cost of inscribed stock issues is significantly higher than T-bills, however. While interest rates on six-month T-bills declined from an average of 3.87% in 2011 to 2.52% in 2013, 10-year inscribed stock issued in November 2013 had a yield of 9.16%, down marginally from 10.34% in 2011, according to Kina Funds.

Despite abundant liquidity in the domestic banking sector – with PGK1bn ($406.5m) in government trust accounts held in commercial banks in September 2013, according to BPNG – traditional investors’ appetite for more government issues may become strained. The two Australian banks, ANZ and Westpac, say they are constrained by their sovereign exposure limits for PNG, while BSP may have more space. Yet moving towards the implementation of Basel III rules on risk-weightings per asset class, banks may need to cap any excessive single-borrower exposure. The two main superannuation funds have continued to participate in auctions into 2014, with Nambawan Super buying most of the February issue, for instance. Still, the pool of investors will need to be broadened. Developing a secondary market will be key to attracting smaller retail investors (see Capital Markets chapter).

Off-Balance Sheet

The government has framed its deficit-financed fiscal expansion in its third MTDS from 2012 to 2017, which acts as a “fiscal anchor” for government spending plans, according to Tim Bulman, the World Bank’s country economist for PNG. The MTDS allows for public debt to reach 35% of GDP in 2013 and 2014, before dropping below the 30% mark from 2015, due in large part to the one-time GDP boost from the ramp-up of LNG exports in 2015 and from a planned narrowing of the fiscal deficit. The higher cap in 2014 is likely to be breached, however, according to World Bank projections, with the Treasury tabling legislation to raise the cap temporarily in early 2014.

The official debt figures omit significant off-balance sheet liabilities held by SOEs and through unpaid contributions to Nambawan Super, which amount to roughly 20% of GDP, according to the World Bank. Fully funding the government’s guarantee for PNG LNG amounts to 15% of GDP in 2013, while SOEs’ debt amounted to 7.5% of GDP in 2010, according to the ADB. Competition between banks has kept lending terms relatively competitive. Meanwhile, although the government paid its 2013 superannuation fund contributions and an additional PGK100m ($40.7m) in arrears in 2013, its debt to Nambawan remained close to PGK2bn ($813m) as of February 2014, according to the fund. Given that the arrears compound at an average 14% annually, according to Nambawan, the Treasury may opt to switch lower-yielding government bonds for its PGK2bn ($813m) debt. The PNG LNG liability reflects expanding contingent liabilities linked to the government’s growing role in the natural resources sector. Smaller liabilities include the $118m owed to Nautilus Minerals when the government lost an international arbitration case in October 2013 (see Trade & Investment chapter).

“The Nautilus arbitration case points to government’s growing contingent liabilities stemming from its involvement in key mining projects,” Craig Michaels, Standard & Poor’s sovereign credit analyst for PNG, told OBG. “As government takes equity stakes in large mining projects, it is exposed to cost overruns, as also occurred with the ExxonMobil LNG project.”

Foreign Liabilities

Since 2012 the government has had a range of different foreign-borrowing options, both as sources of budget deficit funding and to refinance current contingent liabilities. The Treasury had contracted Barclays to underwrite a maiden Eurobond offering in early 2013, following the example of neighbouring Fiji that raised $250m and $400m in two bond issues, although this was suspended following global yield hikes from May onwards. The government has also been in discussions with China’s EXIM Bank for a $2.4bn line of credit for specific projects, although the status of talks remains unclear.

In March 2014 the government faced the deadline for refinancing a bond worth $1.6bn – equivalent to roughly 8% of total GDP – issued in 2008 to finance the Independent Public Business Corporation’s stake in the PNG LNG project. The private placement, fully subscribed by Abu Dhabi’s International Petroleum Investment Company, was backed by collateral in the form of the state’s 196.6m shares, or 14.7%, in Oil Search. The government decided to raise $1.6bn to pay off the bond, retain its stake and appointed UBS to handle the bond refinance deal. Having rebalanced its debt profile towards domestic sources, PNG’s liabilities remain sustainable, according to S&P and Moody’s.

While the outlook for state revenues is strong in the medium term, ensuring the sustainability of further spending increases in the meantime will be key to preserving macroeconomic stability. With abundant domestic liquidity, planned T-bill and bond issues should continue to be oversubscribed, though there is space for new offshore debt issues as well. Sustaining strong economic growth will be key for the state to comply with its 30% debt-to-GDP caps from 2015 onwards.