Papua New Guinea's fiscal and monetary policies support economic stability

Efforts to increase public governance are gradually bolstering confidence in Papua New Guinea’s economy, despite national performance being heavily dependent on somewhat-unpredictable extractive industries. These were affected in the first half of 2018 by an earthquake in February, and recovered in the second half when international commodities prices rose. Recovery in liquefied natural gas (LNG) production and mining operations after the earthquake continued into 2019, yet weeks of political unrest led to the resignation of Peter O’Neill as prime minister in May. Succeeded by James Marape, the former minster of finance, the new coalition government has inherited significant challenges alongside a host of exciting opportunities.

In a bid to promote resilience, the O’Neill administration adopted a number of policy reforms in 2018 to mitigate the economic effects of commodity price volatility and natural disasters. Enshrined in macroeconomic development plans, the measures are being continued by Prime Minister Marape to improve debt management, reduce foreign exchange imbalances, widen access to social services and provide greater employment opportunities. However, limited availability of land for the private sector, bureaucratic fragmentation and social inequalities remain major hurdles to development objectives.

Nevertheless, PNG’s young population and abundant mineral resources are ingredients for a strong future. The country hosted the APEC Leaders’ Summit in November 2018, which led to greater international engagement and a number of trade agreements (see Trade & Investment chapter). A host of projects are also expected to drive the nation’s next wave of economic expansion, including Papua LNG, the WafiGolpu gold mine and the Coral Sea Cable System for greater phone and internet connectivity.

“Following a difficult 2018, there was cautious optimism among the business community at the start of 2019,” Ed Wilkinson, first secretary at the Australian High Commission, told OBG. “However, the change of leadership has brought some uncertainty. The new government has made a number of pronouncements regarding changes it wants to introduce to the operating environment, but more time is needed to see what priorities it will emphasise and what impact they will have on the economy.”

Economic Drivers 

Home to vast deposits of lucrative metals and hydrocarbons, natural resources have long been a top contributor to economic output. In recent years PNG’s growth has been primarily driven by key resource projects, the most significant being the $19bn PNG LNG project, led by ExxonMobil. This has led to substantial funds being directed to exploration, production, transportation and processing facilities. In addition, in 2018 ExxonMobil spent more than PGK3bn ($910m) on services, PGK866.5m ($262.8m) on landowner companies, and PGK80m ($24.3m) for reinvestment into community and infrastructure programmes focused on education, health, female empowerment, the environment and agriculture, according to the company’s 2018 annual report.

The agriculture, forestry and fishing industries represent another pillar of the economy. These account for approximately one-quarter of GDP and provide livelihoods for around 85% of the population. Coffee, cocoa, copra, palm oil, rubber and tea are PNG’s major agricultural exports. However, fluctuating international prices, rising overhead costs, poor management and land tenure issues continue to hinder performance. Rapid population growth and natural disasters also weigh heavily on subsistence and semi-subsistence operations.

Guidance

The Department of Treasury (DoT) conducts research and advises on economic issues, and leads the financing and resource management of state-owned enterprises and government departments. The DoT is composed of 10 divisions: the strategy division; the macroeconomic policy division, which comprises the fiscal and monetary policy branch and the macroeconomic forecasting branch; the revenue division; the markets policy division; the extractive industry policy division; the financial management division; the financial inspection services division; the corporate services division; the operating budget division; and the budget coordination and analysis division. Meanwhile, the country’s central bank, Bank of PNG (BPNG), is responsible for implementing and managing effective monetary policy, and maintaining a sound financial system.

Despite the positive multiplier effects of major resource projects, the evolution of PNG’s economy has been restricted by a general lack of foreign investment, limited public spending, a legacy of cumbersome land policy, major infrastructure gaps and a severe lack of access to credit for local enterprises. On top of these constraints, a shortage of foreign currency has hindered domestic industry.

MTDP III 

To address these shortcomings, the government adopted new policies and development strategies in 2018 that are aimed at diversifying the economic base, making the business environment more conducive to investment, lessening import dependence, boosting exports and rebalancing debt. Building on the gains and experiences of the Alotau Accord II and the first and second iterations of the Medium-Term Development Plan (MTDP), the MTDP III is the latest roadmap to guide economic growth through to 2022. Launched by the Department of National Planning and Monitoring in September 2018, the MTDP III gears development objectives towards broad-based growth. Some of its priorities include increasing revenue, reducing the deficit, and boosting quality and effectiveness in the delivery of public goods and services (see analysis).

In hand with this, fiscal planning has been given new direction with the Medium-Term Fiscal Strategy (MTFS) 2018-22 and the Medium-Term Revenue Strategy (MTRS) 2018-22. The latter plans to reverse the decline in revenue collection as a percentage of GDP that has occurred since 2015 in order to properly fund national objectives.

Performance & Size

According to the DoT’s “Final Budget Outcome 2018” report, released in March 2019, GDP was an estimated at PGK82bn ($24.9bn) in 2018. After growing by 13.5% in 2014, 9.5% in 2015, 4.1% in 2016 and an estimated 2.7% in 2017, the World Bank reports that GDP contracted by 0.5% in 2018, partially as a consequence of the 7.5-magnitude earthquake that struck in February. This is in line with a revised estimate of -0.6% in the DoT’s “Mid-Year Economic and Fiscal Outlook 2019” report, down from an initial 0.3% expansion. The same report projects GDP growth of 4.4% in 2019, while the World Bank projects a 5.6% expansion in its July 2019 economic update on PNG.

A report by the Asian Development Bank (ADB) at the end of 2018 shows the breakdown of GDP as services at 41%, mining and petroleum at 29%, agriculture at 17%, construction at 7%, manufacturing at 2%, and electricity, gas and water at 1%. Although production restarted faster than anticipated following the natural disaster, the non-renewable resource sector – mining and energy – contracted by 9.6% year-on-year (y-o-y) in 2018. The earthquake disrupted production at the flagship PNG LNG project, leading to a fall of 8.6% in LNG output compared to 2017, while crude oil output declined by 35%. Gold production was up 3% but a decline was seen in copper, nickel and cobalt production of 5.2%, 22.6% and 23.5%, respectively, according to the ADB. The earthquake did not significantly impact the renewable resource sector – agriculture, forestry and fisheries – as this expanded by 3.3%. Meanwhile, non-resource GDP grew by 2.5% in 2018, driven by investment in the lead-up to the APEC Leaders’ Summit and increased availability of foreign currency (see analysis).

Fiscal & Monetary Policy 

Since 2015 PNG has made a concerted effort to undertake public finance management reforms, and most recently a number of recommendations were included in the MTFS and MTRS for 2018 through to 2022. The strategies aim to further improve expenditure planning and income collection. Given declining revenue as a percentage of GDP, the government’s expansionary plans have been financed by debt. Loans were obtained from development partners and an inaugural dollar-denominated bond was issued in September 2018 (see analysis). While rising expenditure and debt cause concerns about fiscal sustainability without matching revenue, the government’s medium-term strategies are viewed as a step in the right direction.

According to the 2019 national budget, growth in both extractive and non-extractive receipts drove government revenue upwards in 2018, with revenue estimated at PGK13.4bn ($4.1bn). However, the 2018 budget outcome report shows total revenue and grants for the year coming in at PGK14.1bn ($4.3bn), 22% higher than in 2017. Breaking the figure down, PGK12.3bn ($3.7bn) was non-grant revenue – PGK10.5bn ($3.2bn) of which came from taxes – while grants equalled PGK1.8bn ($546m). The report also noted a budget deficit of PGK2.05bn ($621.8m), or 2.5% of GDP, which is slightly higher than the initial budgeted deficit of PGK1.98bn ($600.6m). The government stated that it remained within the statutory debt band of 30-35% of GDP in 2018, at 31.1%. Net liabilities for 2018 were PGK3.28bn ($994.9m), of which PGK1.23bn ($373.1m) was retained in the 2019 budget. The budget predicts a slightly lower debt-toGDP ratio of 30.8% for 2019. The IMF, for its part, has reported higher forecasts for the metric, at 37% for 2019 and 2020, due to varying calculations of GDP.

Annual headline inflation decreased from an average of 5.4% in 2017 to 4.5% in 2018, according to BPNG. On the back of a stable outlook for inflation, the central bank maintained a neutral monetary policy stance throughout 2018 and the first half of 2019 by keeping the kina facility rate – the monthly policy signalling rate – at 6.25%. However, this was reduced to 6% in July 2019 and to 5.5% in August. According to BPNG’s March 2019 monetary policy statement, annual headline inflation is anticipated to be 4% in 2019, while underlying inflation is expected between 3.5% (trimmed mean) and 4% (exclusion-based).

Foreign Exchange 

A leading concern for importers and the banking sector has been a lack of access to foreign exchange, especially since BPNG imposed a trading band on the kina in 2014 to limit fluctuations in its value. Per the most recent OBG Business Barometer: PNG CEO Survey, published in June 2019, solving the foreign currency imbalance was the top choice among C-suite executives when asked what should be the number-one policy priority for the government, with 31%. A couple of forces convened to improve the situation in 2018, however, such as the $500m bond issue in September 2018 and improved export receipts. “The overbid dollar-denominated bond issue showed there is huge demand to lend to PNG. Orders for the sovereign bond showed investors are optimistic about future projects in the country,” Edward Faber, country economist at the ADB, told OBG. “A second factor that has boosted investor confidence is the government’s MTFS.” Furthermore, the central bank has been working to improve liquidity in the foreign exchange market, clear the backlog of currency orders and decrease the time it takes to process orders (see analysis).

Reviewing Incentives 

When it comes to benfitting from the country’s resources, there is a debate over commercial interests versus national interests in project development agreements (PDAs), particularly in the extractive industries. While 2018 witnessed higher export receipts, this did not lead to a matching rise in inflows to the foreign exchange market. This is in large part due to tax concessions given to extractive industries, as well as the fact that investors tend to hold export earnings offshore.

To tackle this point, BPNG supports the government’s medium-term tax agenda, which has greater revenue collection as a key objective. In the first half of 2019 various stakeholders including the DoT and BPNG were in the process of reviewing tax concessions. Moreover, in its September 2018 and March 2019 monetary policy statements, BPNG cited the importance of including the planned multibillion-dollar Papua LNG project and the lucrative Wafi-Golpu mining project in the tax review. According to the central bank’s estimates, if a significant portion or all of the export receipts of these projects were banked in PNG, it would more than bridge the supply gap for foreign currency. The historical structure of PDAs has allowed export earnings in foreign currency to be held in offshore foreign currency accounts, but this may be changing as the government seeks to grow the country’s access to foreign exchange.

Trade 

Prices of PNG’s major extractive exports experienced contrasting trends in 2018. For example, crude oil prices mostly trended upwards during the year, while copper and gold were down in the second half. According to BPNG’s All Price Commodity Index, the country’s key commodity export prices increased by 10% y-o-y in the first half of 2018.

Supply-side concerns, including major oil producing countries’ decisions to closely monitor output, political instability in Venezuela and sanctions on Iran, played a significant role in driving oil prices up in 2018. Crude oil prices increased from a yearly low of $42.50 per barrel in June 2017 to $75-85 in October 2018. While PNG benefitted from the uptick in crude oil prices, a number of key agricultural exports including coffee, palm oil and copra oil experienced downward price trends in 2018. Cocoa prices, however, remained above 2017 levels at the end of 2018, despite a fall in the middle of the year.

According to estimates in the 2019 budget, PNG shipped PGK33.4bn ($10.1bn) worth of goods around the world in 2018, while imports of goods totalled PGK8.5bn ($2.6bn). This, combined with the balance of services trade, income and transfers, resulted in a current account surplus of PGK22bn ($6.7bn) – a 19% improvement over 2017. Exports are divided into two main categories: agricultural, forestry and fisheries exports; and mineral exports, including oil and gas. The former was an estimated PGK3.8bn ($1.2bn) in 2018, while the latter equalled PGK29.5bn ($8.9bn). The 2019 budget forecasts a current account surplus of PGK21.1bn ($6.4bn) for the year, a drop of 4.3%.

Because natural resources comprise nearly 100% of exports, many other categories see trade deficits due to importing. The machinery category, for example, which includes computers, recorded a trade deficit of $703.2m in 2017. The same year trade deficits in electrical machinery and equipment, vehicles and articles of iron or steel amounted to $357.3m, $303.6m and $172m, respectively. In an effort to end reliance on imports and improve self-sufficiency, the O’Neill administration introduced a new National Trade Policy in 2017 that included tariffs on select imports. “In the short term tariffs will benefit domestic businesses as they are protected against unfair and unbalanced foreign competition. In the long term, however, tariffs might hurt the economy,” Michael Scantlebury, managing director of local conglomerate Steamships Trading Company, told OBG. “As long as the revenues go towards supporting the development of the domestic market and PNG keeps focusing on diversification – especially in agriculture – then these measures can be effective.”

Investment 

PNG’s year in the spotlight as the chair of APEC allowed it to draw attention to trade and investment opportunities on offer, and strengthen bilateral relations with a host of nations from the region and beyond. “Being the chair of APEC and hosting the APEC Leaders’ Summit offer immense exposure for a country like PNG. Today, everything is about perception, and this gave PNG a platform to tell its story,” Ian Tarutia, CEO of the National Superannuation Fund, more commonly known as NASFUND, told OBG. The $222m Coral Sea Cable System – a 4700-km fibre-optic submarine cable network linking Sydney to Port Moresby and Honiara in the Solomon Islands – is arguably the most important investment in recent years in the non-extractives sector (see ICT chapter). Set to deliver a minimum 20-Tbps capacity to PNG, it will significantly augment existing submarine cable capacity by providing faster and cheaper internet access. This has the potential to support education, the banking sector and government entities, as well as provide a host of economic opportunities. Although the Australian government is providing two-thirds of the funds, PNG and the Solomon Islands will majority own the international cable system and receive all revenue generated once it is complete. According to the World Bank in 2017, the project has the potential to add $5bn to GDP and close to 300,000 additional jobs in the Pacific by 2040. The project will also include a 730-km submarine cable system connecting Honiara to cities on Malaita Island, New Georgia Islands and Taro Island.

Another positive development with APEC members is the $1.7bn Electrification Partnership, which sees the US, Japan, Australia and New Zealand joining forces with PNG to achieve a 70% nationwide electrification rate by 2030 (see Energy chapter). In 2018 only about 13% of the population had access to reliable electricity. If successful, the partnership should help unlock the economic potential of 80% of PNG’s population that currently resides in rural areas.

With an estimated $8bn of investment planned under the MTDP III and the Wafi-Golpu mine anticipated to add around $2.8bn to the national economy if and when it becomes operational, there are reasons for investors to be cautiously optimistic about PNG’s growth trajectory. Meanwhile, the $13bn Papua LNG project – the largest planned investment since the ExxonMobil-led PNG LNG project – is expected to service growing global LNG demand by adding 5.4m tonnes per annum of capacity. Despite an agreement being signed between Total and the previous administration in April 2019, the project’s timeline was interrupted when the Marape administration sent a team to Singapore in mid-August to renegotiate the deal. However, early September brought news from Kerenga Kua, the minster of petroleum, that the government would proceed with the project, however, Total had yet to publicly comment. Having been cleared for implementation, the Papua LNG project and supplementary production at ExxonMobil’s P’nyang gas field are together expected to double LNG exports to approximately 16m tonnes per year. These are proving of utmost importance to the energy sector and the economy as a whole (see Energy chapter).

Labour Snapshot

NG’s labour force is relatively young and the market is hampered by skill shortages, making management positions particularly difficult to fill. This was evidenced in the OBG Business Barometer: PNG CEO Survey, in which leadership was selected by 59% of business leaders when asked what skill was most needed in the domestic workforce.

Despite battling a host of labour issues, employment numbers were up in the first half of 2018. Employment in the formal private sector was supported by an increase in mining and petroleum activity, although employment in the non-mining sector was negatively impacted by the February earthquake. According to BPNG’s Employment Index, total employment grew by 1.6% in the first six months of 2018, with mining sector employment up by 4.4% and non-mining sector employment down by 3.2%.

While the earthquake negatively impacted extractives production, it did not impact employment levels, with all staff maintained at affected mining and petroleum operations. A fall in employment across the non-mining sector was the result of the untimely disaster and ongoing economic challenges in the form of foreign currency shortages, an overvalued domestic currency and fiscal constraints, with state funding being directed to areas affected by the earthquake. Specifically, employment in the building and construction sector fell by 15.8%, while the number of workers in transportation and retail trade fell by 8.9% and 6.3%, respectively. Employment in the agriculture, forestry and fishery industries dropped by 3.8%, while manufacturing jobs decreased by 2.2%.

Income inequality and poverty also affect the strength of the labour market. PNG’s Gini index – a measure of the extent to which the distribution of income among individuals or households deviates from a perfectly equal distribution, wherein 0 denotes complete equality and 1 complete inequality – was measured at 0.42 by the World Bank in 2009, the most recent data available.

Outlook

From a macroeconomic standpoint, provided political stability prevails, there are good reasons to be optimistic about development opportunities in PNG, although output will continue to be guided by cyclical demand for natural resources for the foreseeable future. As measures are being taken to combat limited institutional capacity, the government’s ability to increase revenue and bolster foreign currency availability will be key determinants in the success of medium-term plans. In addition to economic activity being assisted by the government’s external borrowing (see analysis), increases in mining and petroleum tax collection will support the budget in the years ahead, as will greater dividend inflows and development levies from key extractive projects. Therefore, if major mining and energy works move ahead as planned, the entire economy is set to benefit financially and in terms of employment.