Papua New Guinea's new approach to economic development

Papua New Guinea has an abundance of wealth in hydrocarbons and minerals that provides it with a solid foundation for economic growth, but also leaves the Pacific island nation vulnerable to the volatility of global commodity markets. As such, the government, led by Prime Minister James Marape, is following a long-term economic development strategy that aims to expand the state’s revenue share from lucrative extractive projects, encourage onshore processing of natural resources, promote inclusive growth and attract new investments in sectors deemed to offer significant potential, notably agriculture.

Since the election in May 2019, the Marape administration has seen protracted negotiations with energy and mining multinationals over the development of a number of major resource projects, some of which have not always resulted in conclusive agreements. As the global Covid-19 pandemic disrupts economic activity and policy implementation in 2020, it remains to be seen whether this will lead to a reappraisal of the government’s long-term strategy or the priorities of resource companies seeking profitable opportunities in a rapidly changing global market.

Structure & Oversight

Several government ministries and departments play key roles in the country’s fiscal policy-making and oversight. The Department of Treasury, headed by Dairi Vele, provides the government with fiscal, budgetary and structural policy advice with the aim of facilitating long-term sustainable development. Elsewhere, Rainbo Paita has served as minister for both the Department of Finance and the Department of Rural Development since November 2019, and is tasked with improving the management of public finances and helping to spur inclusive growth beyond the capital Port Moresby.

State-owned enterprises (SOEs) have an important role to play within the structure of PNG’s economy, providing a range of essential utility and transport services, generating employment opportunities and, in some cases, providing foreign exchange (forex) earnings. Government stakes in nine SOEs, as well as other listed investments, assets and projects, are managed through general business trusts overseen by Kumul Consolidated Holdings (KCH). The Ministry of Public Enterprises, which has been led by Sasindran Muthuvel since July 2019, is the body responsible for government policy direction and oversight in this area. Muthuvel has vowed to push through sweeping reforms aimed at improving efficiencies and alleviating SOEs’ debt pressures. Plans include the appointment of new CEOs at several entities and reforms to the KCH Act that would grant more autonomy to SOEs’ executive management. The minister is also looking to improve SOE finances, including through the restructuring and refinancing of existing debts. Speaking to local media in February 2020, he suggested that partial privatisations could be an option for some underperforming SOEs, with the state reducing its stake to 49%.

SOE Reform

Data shows that the country’s nine SOEs recorded losses of PGK62.3m ($18.4m) in 2017 and PGK129.9m ($32.3m) in 2018, and that the consolidated debt of KCH and the nine SOEs totalled PGK5.8bn ($1.7bn) as of March 31, 2019. Breaking this down, Telikom PNG accounts for approximately one-third of the total debt owed by SOEs. In the past, SOEs have accumulated a significant amount of debt from China at market rates, which has worsened their fiscal position.

With the government facing foreign debt obligations and reduced export earnings due to the Covid-19-induced global economic slowdown, partial privatisations may be increasingly viable options in the recovery phase as a way to reverse the fortunes of SOEs that are struggling financially but play central roles in the economy. An influx of private capital and know-how could have positive multiplier effects, spurring efficiencies, innovation and knowledge transfer. “The previous government was generally not receptive to various forms of privatisation, whereas the current government appears to be more open, yet still cautious,” David Hill, country director for PNG at the Asian Development Bank (ADB), told OBG.

Among the country’s SOEs, Hill believes that PNG Power, PNG Ports, Telikom PNG and Water PNG in particular could benefit from institutional and regulatory reforms, including steps towards privatisation. “The process of privatisation can be a painful one and needs to be executed as carefully and as smoothly as possible, such as through a step-by-step approach or hybrid models and partnerships,” Hill said. “For example, the government and the private sector could agree to take on various shares of investment and ownership – and thus economic and financial risks and returns – which collectively can improve performance.”

Led by Loi Bakani since 2009, the Bank of Papua New Guinea (BPNG) plays a key role in monetary policy as the country’s central bank. In recent years BPNG has faced the challenge of ensuring the country has an adequate supply of forex. The shortage of forex in the local market dates back to the end of the construction phase of the country’s first liquefied natural gas (LNG) project, PNG LNG, in 2014, which coincided with a slump in global commodity prices. It has since been compounded by the need for LNG project partners to repay their debts, with capital account outflows equating to between 25% and 28% of GDP in recent years. While BPNG has made progress in improving forex liquidity in the recent past, thanks to increased export earnings, a maiden US dollar sovereign bond issuance and targeted interventions, the problem was exacerbated in the first half of 2020 by the Covid-19 pandemic, which depressed demand for PNG’s exports and caused commodity prices to tumble (see analysis).

Performance

According to the World Bank, real GDP growth rebounded from -0.8% in 2018 to an estimated 6% in 2019, largely as a result of improved performance in extractive sectors – including mining, quarrying, oil and gas – which recovered from the effects of a 7.5-magnitude earthquake that halted production at key resource projects in 2018.

Overall expansion was largely powered by a strong uptick in primary extractive industries in 2019, with the sector growing by 14.9%, compared to -11.9% the previous year. In contrast, the World Bank estimated that growth in the agriculture, forestry and fisheries sector declined from 2.9% in 2018 to 2.5% in 2019.

Estimated growth in the non-resource economy fell from 3.3% to 2.5% over the same period, and slowed from 3.8% to -1.1% in the secondary extractive sector, which comprises construction activity in resource projects. Weakened demand in the domestic economy is also evidenced by a decline in the full-year inflation rate, from 4.7% in 2018 to 3.6% in 2019. Looking ahead, the 2020 budget forecast growth in the non-resource sector to reach 3.3%, with agriculture, forestry and fisheries growing marginally faster, at 3.4%. However, given the effects of the Covid-19 pandemic, the government is leaning towards the IMF’s June 2020 estimate that the non-resource sector will contract by 1% that year.

In the medium term, the budget set a goal of returning non-resource growth to at least 5% annually. This underlines the Marape administration’s determination to diversify PNG’s economy away from dependence on extractive industries and nurture new growth engines such as agriculture, tourism, downstream processing, and small and medium-sized enterprises.

Expansion in the non-extractive sectors is especially important for the government’s goal of generating inclusive growth, as the majority of the working population – 67%, according to the International Labour Organisation – is formally or informally employed in agriculture. Despite accounting for the bulk of employment, agriculture contributed an estimated 18.4% to GDP in 2018 compared to the 28% contributed by extractive industries. Extractive industries were also responsible for 89% of exports that year, showing that disruption to global commodity markets can have a significant impact on the country’s forex reserves. As such, policies geared towards nurturing value-added agriculture, reducing reliance on agri-food imports and boosting exports can all have positive economic effects.

Despite this, the momentum building in this direction has been stalled somewhat by the economic shock caused by the Covid-19 pandemic. In January 2020, before the full extent of the outbreak had more become apparent, the World Bank projected moderate GDP growth: a 2.9% expansion for both 2020 and 2021. However, in June 2020 it adjusted its growth estimates to -1.3% in 2020 and 3.4% in 2021. That same month the ADB forecast full-year growth of -1.5% for PNG, before improving to 2.9% in 2021.

Fiscal & Monetary Policy

Until the sudden shock of the Covid-19 pandemic, PNG’s fiscal and monetary policy had largely been focused on balancing public debt obligations with inclusive growth aspirations, while ensuring there was sufficient forex liquidity in the local market to meet the needs of PNG businesses. In its first year in office, the Marape administration was keen to project an image of transparency and realism in relation to public finances. For example, Ian Ling-Stuckey, the treasurer, revealed that due diligence conducted by his staff and external advisers resulted in a revision of 2019’s fiscal deficit to 5.8% of GDP, up from the 2.1% claimed by the former government when it had published the 2019 budget. The 2020 budget calculated government expenditure for the year at PGK18.7bn ($5.5bn) and state revenue at PGK14.1bn ($4.2bn) – both of which are record totals – accompanied by a historic budget deficit of PGK4.6bn ($1.4bn). The government is aiming to improve the efficiency of the tax system to progressively grow revenue over the medium term. One of the main factors behind the increased expenditure in 2020 was arrears payments to public sector workers, a problem inherited from the previous administration. However, the government is also facing rising debt servicing costs, which were expected to rise from 12.3% of GDP in 2019 to 12.5% in 2020.

The public debt-to-GDP ratio stood at 42% in August 2019, which is within the legally mandated limit of 30-45%, although the 2020 level is likely to be considerably higher due to the impact of Covid-19. The government is aiming to reduce this ratio to 38% by 2024, with Ling-Stuckey outlining his intention to prioritise “cheaper” lending options as opposed to “expensive forms of debt”, citing a 2016 loan of $500m from Credit Suisse and a $500m sovereign bond from 2018 as examples of costly borrowings. In contrast, LingStuckey described a PGK1bn ($294.9m) bilateral loan from Australia announced in November 2019 – seen by many analysts as an attempt by Australia to counteract Chinese encroachment into its sphere of influence – as “cheap and good debt from a long-standing and trusted partner”. As it continues to extend its global reach, China has emerged as PNG’s largest bilateral creditor. PNG’s annual repayments to the world’s second-largest economy are forecast to grow by 25% by 2023.

Covid-19 Response

Trade, however, with nearly all of PNG’s partners was affected by the outbreak of Covid-19 in the first half of 2020. As with other economies around the world, the sudden shock of the pandemic forced the government and central bank to take emergency measures. Although the health impact on PNG was minimal throughout the first half of the year, the economy was hit by demand and price slumps in commodity markets, leaving the government with a PGK1.3bn ($383.4m) budget shortfall. In early June 2020 it seemed likely that PNG would turn to Australia and finance institutions such as the ADB, the World Bank and the IMF to bridge the financing gap. In April 2020 PNG, along with 75 other countries, was granted a moratorium on bilateral debt repayments to G20 members until the end of the year, although China later added caveats to its commitments, which suggests it is not fully aligned with other G20 members on this matter.

As a part of the fiscal response to the immediate challenges of the pandemic, the government announced a PGK5.7bn ($1.7bn) stimulus package, which included PGK2.5bn ($737.4m) in domestic debt financing through a Covid-19 Treasury bond; PGK1.5bn ($442.4m) in concessional financing from foreign multilateral institutions; PGK600m ($177m) in credit support to be channelled to businesses and individuals through commercial banks; and PGK500m ($147.5m) to fund health and security measures, assist micro-, small and medium-sized enterprises (MSMEs) and rural communities, and enhance food security.

Meanwhile, BPNG announced a number of key measures in late March 2020 to lower the cost of funds and maintain liquidity in the market, including a reduction in the kina facility rate (KFR) from 5% to 3%, a reduction in the cash reserves requirement from 10% to 7%. In an effort to encourage interbank lending, BPNG also raised the margin on credit arrangements with commercial banks by 25 basis points either side of the KFR. Additionally, in response to renewed pressures on the reduction of forex stemming from the pandemic’s impact on exports, BPNG directed forex dealers to prioritise US dollar requests from retailers and wholesalers of medical drugs and equipment, particularly for imports of products needed in the fight against Covid-19. Additionally, the central bank ensured that forex would be made available directly to the Department of Health for urgent Covid-19-related purchases overseas.

Diversification & Inclusive Growth

PNG’s medium- and long-term economic planning is officially guided by the third Medium-Term Development Plan 2018-22, the Development Strategic Plan 2010-30 and PNG Vision 2050, all of which were published before Prime Minister Marape came to power. While the Marape administration has not renounced these plans – and the prime minister himself has referenced key aims of PNG Vision 2050 on numerous occasions – its own overarching development strategy can be summed up by the title of the 2020 budget speech: “Take Back PNG”. The administration’s vision is nuanced and focused predominantly on sharing PNG’s resource wealth more evenly across society rather than simply transferring it from foreign interests into the hands of the state.

Research suggests that PNG has not historically received its fair share of fiscal benefits from resource projects in comparison to other developing economies. For example, a 2019 study by two economists found that royalties contributed just 11% of the state’s resource-related revenue in 2017, compared to 37% in Mongolia and 58% in Timor Leste. The study indicated that PNG’s resource deals with multinationals tended to be “back-loaded” – with the state not accruing significant fiscal benefits for a lengthy period of time while companies recoup their development costs – and it advised the government to raise more revenue from upfront royalties. From the outset, the Marape administration has made clear that it intends to reap more fiscal benefits from extractive projects and channel this revenue towards developing other productive sectors.

Ling-Stuckey articulated the vision in his 2020 national budget speech: “Our policy attention is on increasing income for our people, with a particular focus on agriculture, fisheries, forestry, tourism and downstream processing, which together can improve the livelihoods of everyone”. As such, negotiations for major resource projects in the pipeline – most notably the Wafi-Golpu gold mine (see Mining chapter) and the construction of a third LNG train at the P’nyang gas field (see Energy chapter) – have been drawn out and had yet to reach a conclusion as of July 2020.

Human Capital Development

The administration’s focus on utilising the country’s resource wealth to promote inclusive growth can be viewed within the context of PNG’s development challenges. While it is the largest economy among Pacific island nation states – excluding New Zealand – PNG is classified as a lower-middle income country, with GDP per capita at $2730 in 2018. Approximately 37.5% of the population lives below the national poverty line, compared to 9.4% in nearby Indonesia and 28.1% in Fiji, the next-largest Pacific island economy. While only 2.5% of the population is classified as unemployed, 80% work in the informal sector and 21.8% earn less than $1.90 per day.

One challenge facing policymakers is enabling the potential of PNG’s human capital, which would spur productivity and innovation within the economy. According to the World Bank’s Human Capital Index, a child born today in PNG will only be 38% as productive when they grow up as they would be if the country had optimal health and education services. In particular, high rates of malnutrition, stunted growth and communicable diseases such as tuberculosis and malaria are limiting the potential of the country’s human capital, with PNG recording the highest maternal and child mortality rates and lowest life expectancy among Pacific island nations.

In response, in April 2020 the World Bank approved three projects totalling more than $100m in investment to address some of the country’s most pressing human capital needs. These include the $30m IMPACT Health Project aimed at tackling critical bottlenecks in the health sector and improving frontline health care provision; the $40m Agriculture Commercialisation and Diversification Project that will support MSMEs in accessing market opportunities; and $35m for the second phase of the Urban Youth Employment Project, which will aid young people in finding employment opportunities in Port Moresby and Lae.

While such efforts by multilateral partners are a welcome step in the right direction, more targeted investments backed by sound policy over the longer term will be required for the country to address its human capital challenges, which, when overcome, would make the country a more attractive destination for foreign direct investment.

Outlook

PNG’s resource wealth, coupled with its strategic location between the industrial centres of north-east Asia, the rising economies of the Association of South-east Asian Nations and the developed economies of Australasia, means it is well poised for longterm growth. The government took decisive actions to prevent community transmission of Covid-19, which constrained business activity in the first half of the year but also left the country well placed to bounce back without widespread public health consequences. If policymakers can maintain their success in containing the virus and conclude negotiations for resource projects while channelling revenue towards developing other productive sectors and addressing human capital challenges, the prospects for investment are bright.