PNG's industrial reforms lead to value-added potential

While Papua New Guinea has a long history of manufacturing, the sector accounts for only around one-tenth of GDP, and output is mostly confined to staple goods bound for the domestic market. PNG is endowed with a number of highly traded global commodities, including timber, coffee, cocoa, palm oil and fish. With hydrocarbons production pegged to expand the economy by 15% in 2015 and 5% thereafter, there are prospects for more advanced manufacturing to take root, and for locally extracted commodities to receive more in-country value addition prior to export.

However, a range of physical bottlenecks and market shortcomings need to be overcome before the country can emerge as a more competitive industrial player. At present, infrastructure constraints, insufficient power generation, poor labour productivity, corruption and security concerns all contribute to production costs that remain higher than the manufacturing powerhouses that dominate supply within the wider region.

Over Resourceful

In 2012, gold and gold content accounted for 57% of exported products, while crude petroleum oil and timber each made up 11%. Australia was the destination for 44% of exports, followed by Japan and China. Overall, mineral deposits, including copper, gold and oil, account for nearly two-thirds of export earnings. In recent years, the country’s development narrative has been dominated by the $19bn PNG liquefied natural gas (LNG) project led by Exxon Mobil that, according to some studies, could over time double PNG’s GDP and triple its export revenues.

Foreign capital being injected into the country’s extractive sectors is set to provide the government, which has traditionally been heavily dependent on foreign aid and development partner funding, with new-found funds to invest in infrastructure expansion and upgrades. However, there are concerns about an over-dependence on extractive resource exports that are susceptible to swings in global commodity prices, something which the creation of a sustainable and counter-cyclical manufacturing base could mitigate against. “When you are a developing country like PNG, you understandably lack the luxury of giving too much thought to which sectors need to be driven, and work with what you have. In PNG’s case, what they have at the moment is a strong natural resource base,” Gavin Murray, the International Finance Corporation (IFC) country manager for Australia, New Zealand, TimorLeste, PNG and the Pacific Islands, told OBG.

Industry Advocacy

As well as hedging against an over-reliance on the potentially volatile mining and petroleum sectors, the Manufacturing Council of PNG has cited formal job creation and import substitution as motivations for the state to introduce additional incentives to bolster domestic production. According to the Asian Development Bank’s Pacific Economic Monitor, less than 10% of Papua New Guineans are able to access formal sector job opportunities. The Manufacturing Council has adopted an industry-driven initiative to promote the consumption of locally made products through a “Made in PNG” campaign, and the Department of Treasury has adopted the Extractive Industry Transparency Initiative (EITI).

With a GDP per capita of around $1100, the spending power of much of the population is limited, and most consumers are extremely cost-conscious. In turn, the retail price, rather than the country of origin, factors most strongly into any purchase decision. In light of the influx of cheaper imported products to the market, some manufacturers have chosen to import products and shift focus to distribution (see analysis).

Counting the Costs

Challenging geographical circumstances contribute towards high overall operational costs in PNG. According to the World Bank, bureaucratic inefficiencies make doing business in the country particularly expensive. In its “Doing Business” survey in 2015, the multilateral lender ranked PNG in 133rd place, down from 131st in 2014. While better than Kiribati (134th) or the Marshall Islands (139th), other countries in the region such as Samoa (67th), Tonga (69th) and Fiji (81st) fared substantially better.

PNG was ranked poorly in several categories, including the ease of trading across borders (138th), enforcing contracts (181th), the tax system (110th) and resolving insolvency (114th). The country is in the bottom quartile of Transparency International’s most recent Corruption Perception Index, ranking 145th out of 175 countries evaluated in the watchdog’s 2014 study.

Environmental factors also present natural barriers for access to infrastructure. “We are a young country and geologically challenged. There are 7m of us spread over a landmass of nearly 500 sq km. Many parts of the country lie on seismic areas and experience incredibly high rainfall. This makes moving goods a major challenge,” Frank Kramer, the chairman of the National Petroleum Company of PNG (NPCP), told OBG.

Challenges arising from lower-cost imports is also a possibility. “Doing business in PNG continues to be expensive, due to the high cost of basic services such as power and other utilities, as well as poor road infrastructure,” Doug Rosenberg, the general manager for Goodman Fielder Asia Pacific, told OBG. “Due to these relatively high costs, domestic firms will continue to be threatened by lower-cost imports that have the potential to put local manufacturing out of business.”

PNG Power’s industrial rates as of May 2014 were PGK0.63 ($0.24) per KWh, among the highest in the world. The charges are higher than rates in the UK and US, and around the same as the EU average. Phone rates also remain high. According to the Manufacturing Council, the cost of renting factory space comes in at around PGK600-700 ($227-265) per square metre, versus PGK300 ($114) to rent a similar space in Malaysia.

Security problems also add significantly to the cost of doing business. In a 2013 survey by the Institute of National Affairs, 81% of businesses indicated that they were fairly or highly affected by law and order problems, while spending an average of PGK15,000 ($6098) annually on security systems; 55% employed security guards. Of the firms questioned, 67% mentioned crime as an operating constraint, more than four times the 16% regional average for firms in East Asia and the Pacific. In the survey, law and order problems were cited as the foremost hindrance to business and the most pressing issue for the government to address.

Currency Swings

The national currency, the kina, has seen significant swings in its fortune. A near-30% appreciation took place from 2010 to 2012, followed by a sudden drop in 2013 as construction activity for the PNG LNG project tapered off and export revenues contracted. In early 2013, the Bank of PNG (BPNG) moved away from a market-based exchange rate system and opted to deploy an interbank rate to cushion the fall. In June 2014, the central bank appreciated the kina against the US dollar by 15%, a move questioned by some economists during a period in which exporters have been suffering from falling oil and cash crop prices. Those justifying the intervention will counter that a stronger currency makes imported products, including essentials like clothing that are mostly manufactured abroad, cheaper for the average consumer, while reducing the cost for the government of repaying loans.

Wages

In mid-2014 the government implemented a 40% increase in the hourly minimum wage from PGK2.29 ($0.87) to PGK3.20 ($1.21). While manufacturers have voiced concerns that the measure adds to their costs, the PNG Trade Union Congress has countered that a wage hike was long overdue. Indeed, according to the union, only 12.1% of national income now goes to wages, from around 40% as recently as the 1990s.

For employers in PNG, as is the case in most countries, an aversion to paying higher salaries stems from whether or not the increased outlays are matched by improved labour productivity. While accurate labour market statistics for the country are difficult to access, the consensus amongst industry participants OBG has spoken with is that domestic productivity does not match international standards, and that employee motivation can at times be lacking.

“A large portion of the country are subsistent and are not interested in pursuing formal employment,” Murray told OBG. “The broader wantok (clan support) system also creates some disincentives towards seeking one’s own employment.”

While a higher minimum wage could end up having a detrimental effect on labour-intensive companies operating in PNG – by increasing costs without a parallel rise in productivity – it could equally help retailers of consumer goods by increasing disposable incomes.

Tariffs

PNG has a fairly open market when it comes to import duties and tariffs, and is a signatory to a number of global and regional trade agreements. In 2011, tariffs on intermediate rate goods were reduced from 30% to 12.5%, and dropped further to 10% in January 2015. Manufacturing executives, however, contend that as local business costs have not come down at a similar pace, it is increasingly difficult to compete with the imports entering PNG from destinations such as China, Indonesia and Malaysia that possess significant economies of scale and, as a result, lower per-unit fixed costs. “Import tariffs have already fallen by around 80% since the 1980s as PNG has tried to meet and exceed World Trade Organisation and other trade treaty obligations. APEC’s stated aim of abolishing all tariffs by 2020 is a further dark cloud on the horizon for PNG manufacturers,” Rosenberg told OBG.

Excess Inventory

In addition to an inability to compete on market size, allegations persist that some countries within APEC are receiving built-in subsidies from their governments, alongside accusations that dumping, in the form of foreign companies selling excess inventory at cost, continues to take place. However, such claims are difficult to prove, leaving the sector in a challenging position, as increasingly cost-competitive goods are imported into the country and improvements in infrastructure are not able to keep pace.

“It is always in the public’s interest to be able to access the cheapest and best products without market distortion. Tariffs and duties are not the optimal approach to supporting local industry,” the IFC’s Murray told OBG. The price and selection of canned drinks serves to exemplify how tariff reductions can help spur domestic competition to the ultimate benefit of the consumer. According to an article published by EM TV, prior to the reduction of government tariffs, the local drinks market was monopolised by Coca Cola Amatil and Pacific Industries, with the average can selling for around PGK3 ($1.13) five years ago. Conversely, today, due to the entry of imports such as Coca-Cola and Pepsi, the average price has fallen to PGK2.25 ($0.84).

Illicit Trade

Smuggled goods, particularly from the Indonesian province of Papua with which PNG shares a 760-km border, can result in significant lost revenues for both local manufacturers and the government. “The illicit trade in cigarettes amounted to 30m cigarettes a year in 2005 and is now estimated to have reached 200m cigarettes per year, representing 17% of the total market,” Michael Penrose, the general manager for British American Tobacco, told OBG. “We estimate that the government is losing up to PGK100m ($40.6m) per annum through unpaid excise and duties.”

For the NPCP’s Kramer, of equal concern is the fact that many of PNG’s domestic commodities and resources eventually leave the country unaccounted for. “We must improve on the policing of illicit trade as a lot of our trees are being logged, and our fish being caught, without any local benefit.”

Dubious land transfers have become a major problem, with the prime minister publicly acknowledging that foreign logging companies have been engaged in scams to acquire land improperly under the guise of claiming that it will be applied for agricultural purposes. According to Fred Pearce, author of The Land Grabbers, 11% of the country – a land mass the size of Costa Rica – was leased out in a period of less than 10 years. In 2014, a Commission of Inquiry found that 90% of all Special Agriculture and Business Leases (SABLE) were illegally issued through fraud and corruption, and recommended that all SABLE licences be revoked.

Infrastructure Spend

The PNG LNG project will have a multiplier effect well beyond the construction sector and is expected to overcome the bureaucratic hurdles that have plagued larger infrastructure projects in the past. “Now that the plant is moving into production, there is a significant decline in construction activity. To help bridge the gap and keep activity going during the lull, the government is trying to invest in other high-impact infrastructure projects, such as new airports and power plants,” Kramer said. “At the same time, the Pacific Games is providing an impetus to improve infrastructure in and around the capital.”

Cluster Development

The government, when allocating its infrastructure spending – $238.5m in stimulus is earmarked to create 500,000 new businesses and 2m jobs by 2050 – is doing so with the aim of developing four economic centres across the country, each with a distinct focus. Port Moresby, the capital and the home to most corporate head offices, is set to continue its role as the country’s financial centre. Lae, PNG’s second-largest city, will become the focal point for manufacturing, while Mount Hagen will be the centre for agriculture, and Kokop for tourism.

According to the Lae Chamber of Commerce, Lae’s seaport currently handles in excess of 60% of PNG’s import and export cargo each year, while the city and its surroundings have the highest concentration of factories in the country. “Lae lends itself to becoming the national industrial centre and the plan makes sense,” Kramer told OBG. “It has the largest seaport in the country and offers good road connectivity to the hinterland where agriculture, fishing and mining takes place and raw materials can be sourced.”

Retail

Despite a slowdown in retail sales in the months following the end of the PNG LNG project’s construction phase, the long-term trajectory for the retail sector remains bullish. Over 60% of the population in PNG is under the age of 18, and an emerging middle class is fuelling demand for greater product choice, higher-quality goods and a change in environment from the country’s traditional market shops and stalls. Shopping malls with multiplexes are springing up around Port Moresby, with a tenant mix comprising general merchandisers alongside a range of specialty stores that are introducing consumers to designer fashion brands, barista-made coffee and fast food.

The CPL Group, which traces its origins to a single City Pharmacy store in 1987, is the largest retailer in the country, and today has 59 outlets in its portfolio.

Outlook

As a young and resource-rich country, PNG is still far from seeing its production base move up the value chain from primary into secondary manufacturing. The majority of its mining, oil and gas, and agricultural products are extracted and exported in raw form. As government revenues from the PNG LNG project are re-invested into much-needed infrastructure projects, and domestic spending power expands, the business case for downstream investments will improve.

Should ongoing economic reforms and crackdowns on corruption improve perceptions about the ease and predictability of doing business, PNG could emerge as a regional destination for the processing of mid-stream and finished goods. “If we are smart about how we develop the economy and our industries, we have a number of advantages working in our favour,” Kramer said.