Mission Concluding Statement 

Concluding Statement Papua New Guinea—2013 Article IV Consultation

September 23, 2013

This statement summarizes the preliminary findings and policy recommendations of the mission team. It takes into account discussions during the Article IV consultation and information available at the time of the visit to Port Moresby. We wish to thank the Papua New Guinean authorities for their excellent cooperation and warm hospitability during the consultation.

After several years of strong growth, Papua New Guinea (PNG) now faces less certain prospects, as construction winds down on a large LNG project and the external environment evolves rapidly. To bolster growth prospects and maintain the hard-won macroeconomic stability, the government will need to focus on a prudent fiscal policy, making the most of resource revenues by improving the efficiency of public spending. Monetary policy should adjust to the new environment and anchor inflation at a lower rate than during the construction boom. This new environment also requires increased vigilance against financial sector risks arising from slowing domestic activity and possible price corrections in certain segments of the property market. To engender broad-based growth, sustained structural reforms will be needed, with a particular focus on removing key impediments to doing business—particularly for small and medium sized enterprises, improving the efficiency of public enterprises, and strengthening the agricultural sector—the key source of income for the vast majority of Papua New Guineans.

Macroeconomic Outlook and Risks

1. Economic activity is expected to expand by about 5½ percent in 2013. Real GDP growth is projected to rise to about 5¾ percent in 2014 as LNG production commences, but non-resource real GDP growth is projected to slow to about 1 percent, as LNG project-related activities wind down completely. Real non-resource GDP growth is expected to return to PNG’s potential growth rate of about 4½ percent from 2016 onward. Inflation, measured by the official CPI, is projected to rise to around 5⅓ percent in 2013, largely reflecting the relatively low 2012 base, a depreciating kina, and rising government demand as a result of increased spending. The external current account deficit is expected to narrow rapidly and turn into a surplus by 2015 as LNG exports reach full capacity.

2. Risks to economic growth in 2013-15 are broadly balanced, but they are increasingly tilted toward the downside over the longer term. The expected increases in government spending in 2014 will offset part of slowing domestic demand as LNG project-related activities wind down. Risks of delays in the completion of the LNG project have diminished significantly as it enters the final stage of construction. However, a weak global economy could further dampen external demand and commodity prices. Over the longer term, shale gas development around the world could reduce LNG prices and government revenue. Lower LNG and mineral prices, together with higher funding costs in a post-quantitative easing era, may also reduce future inflows of foreign direct investment.

Prudent Fiscal Policy and More Efficient Spending

3. The 2013 fiscal deficit is projected to be about 6.3 percent of GDP, lower than the budgeted 7.3 percent of GDP, on account of the likely under-spending based on recent performance. This expected outcome hinges on continued robust collection of revenue during the second half of the year and stronger control of personnel emoluments, particularly in the provinces. There are concerns that capacity constraints have led to delays in project implementation and mixed spending quality, especially at sub-national levels. The mission therefore advises that spending should not be rushed toward the end of the year for the sake of showing a higher budget implementation rate; any unused resources should be saved for reallocation in the 2014 budget. The mission welcomes the government’s initiative to integrate recurrent and development budgets and to introduce multi-year budgeting. It also supports the establishment of a branch in the Department of Finance to monitor statutory bodies, including through standardizing financial reporting. Continued proliferation of such bodies could undermine budget integrity and reduce the coherence of national resource allocation.

4. The mission recommends an overall fiscal deficit of 4 percent of GDP for 2014, with the budget focused on improving the quality of spending. While there is a need to support non-resource sector growth and deliver critical services, due consideration should be given to capacity constraints and the need to retain fiscal buffers to deal with external shocks. Greater attention should also be given to a clear identification of bottlenecks to spending and service delivery (including in priority areas such as health, education, and roads) and to proper appraisal, design and planning, and rigorous costing of development projects. The mission welcomes the publication of monthly expenditure warrants this year and encourages timely audit of public accounts.

5. Over the medium term, the government should continue to constrain real per capita spending growth in order to stay within its debt cap of 30 percent of GDP, which appears appropriate. Provided that resources that cannot be effectively spent in 2013 are saved for 2014, and that only a moderate increase in expenditure (consistent with a fiscal deficit of 4 percent of GDP) is budgeted for 2014, the government could target a slightly declining level of real per capita expenditure for the period 2015-18. Given the revenue prospects, this consolidation is necessary to stay within the debt target. Nevertheless, a sharper focus on expenditure prioritization and improvements in the quality of spending should allow continued progress on service delivery and other development objectives. A large increase in expenditure in 2014 would likely necessitate significant cuts in real per capita expenditure over the medium term in order to adhere to the debt target.

6. Greater efforts on revenue collection will be essential to keep the fiscal deficit in check and stay within debt ceilings. As domestic activity slows over the course of 2013, it will be challenging to achieve the government’s revenue target this year. Over time, improvements in compliance, including clearance of tax arrears, will be important, as will be rationalization of exemptions and concessions. The mission encourages the authorities to expeditiously implement the recommendations by the IMF technical assistance mission on extractive industries fiscal regimes, with a view of increasing government revenue over time. The mission welcomes the authorities’ plans to join the Extractive Industry Transparency Initiative (EITI) and encourages completion of required follow-on steps.

7. The integrity of the sovereign wealth fund (SWF) should be safeguarded to play its key role in managing PNG’s resource revenues. PNG’s SWF, which was authorized under the Organic Law on Sovereign Wealth Fund Management and approved by Parliament in February 2012, has generally followed international best practices, in particular with regard to its full integration with the budget. Any significant diversion of mineral resources from the SWF and hence potential bypass from the budget process could lead to spending that may not be consistent with the government’s development priorities, countercyclical fiscal policy, or Parliamentary scrutiny associated with the budget process. Moreover, the mission encourages the government to revisit the withdrawal rules early on to ensure that sufficient resources are accumulated in the SWF for stabilization and development purposes.

Ensuring Price and Financial Stability

8. Given low underlying inflationary pressure, the Bank of PNG (BPNG) should maintain its current policy stance, but it should stand ready to tighten monetary policy should price pressures re-emerge. Given prospects of slower domestic demand in the post-construction boom era, the mission would encourage the BPNG to return to its 5 percent inflation reference value. This would help anchor inflation expectations and strengthen the bank’s policy credibility. The BPNG should closely monitor inflationary pressures that may arise from increased government expenditure over the course of 2013 and potential kina depreciation triggered by declines in mineral prices.

9. Continued efforts will be needed to reduce excessive liquidity to minimize inflation risks and strengthen monetary policy transmission. The mission recommends that the Treasury Department consolidate its commercial bank deposits at the BPNG and move trust accounts to the extent possible to the Bank to mute their liquidity impact. If this is not sufficient, the BPNG could conduct further open market operations and raise the cash reserve ratio to absorb liquidity. Moreover, if inflationary pressures intensify, the BPNG could also sell foreign exchange to the market to support a tightening monetary policy stance.

10. The exposure of superannuation funds to the heated real estate sector warrants close monitoring. The BPNG needs to continue to examine the funds’ investment in LNG project-related industries as well as in the real estate sector, which may face price corrections in certain market segments, as supply catches up with demand. Even though banks have limited exposure to the real estate sector, their loan portfolios in construction, transportation, and communication should be scrutinized.

Maintaining the Strong External Position

11. PNG’s external public debt is sustainable under its medium-term policy setting. The preliminary debt sustainability analysis suggests that PNG continues to face a low risk of debt distress. However, this provisional finding assumes that the government will adhere to its debt target of 30 percent of GDP over the medium term. The mission encourages the authorities to continue taking a prudent approach to external borrowing, focusing on available concessional loans and taking into account conditions that may increase implicit costs, such as those associated with procurement restrictions.

12. The rapid increase in private sector external debt warrants close monitoring. PNG’s private sector external debt has grown rapidly in recent years, reaching around 150 percent of GDP at end 2012 based on official data. Much of the debt is owed by LNG project partners and subcontractors and is mostly intra-company. However, the sheer volume of it highlights the importance of analyzing the potential impact of a large decline in LNG prices on the profitability of the project, the capacity of borrowers to service their debts, and the impact on government revenue (through dividend and tax receipts).

Enabling Sustained, Inclusive Growth

13. The mission supports increased resource allocation to medium-term development enablers to improve law and order, infrastructure, education, and health. Addressing law and order problems and other key obstacles to doing business should be a top policy priority. Reforms to secured lending arrangements, together with steps to make more customary land available for development and for use as collateral, should encourage more investment and help reduce business costs. The mission is encouraged by the government’s regular and robust dialogue with the private sector to address business concerns, particularly those related to SMEs, which are vital for job creation. More resources should be mobilized to improve agricultural extension services, market access, and logistic services such as distribution and storage.

14. A robust regulatory framework will be critical to creating a vibrant private sector and improving living standards. The mission welcomes the ongoing efforts to improve electricity supply and services by linking tariffs to service quality. Nevertheless, more remains to be done to increase competition in sectors such as telecommunications and petroleum products, including through opening access to entry. The government should avoid reserving industries for domestic businesses except where the country’s security interest is at stake. Further streamlining of business registration and licensing arrangements would also help attract investment, foreign and domestic alike.

15. Improvements in the efficiency of public enterprises require proper governance and strong accountability. Recent proposals to consolidate and reorganize state-owned enterprises (SOEs) and public investments in mining and hydrocarbon companies through the Kumul Trust have the potential to enhance transparency and improve the management efficiency of state assets. However, the success of this initiative will hinge on adoption of governance structures at the trust and in affected companies to ensure their independence from political interference and focus on stated corporate goals. Moreover, SOEs must be required to operate on a commercial basis with clear expectations for dividend payments to the government and a well-specified framework for community service obligations.

Improving Economic Statistics

16. Shortcomings in consumer price index and national accounts statistics—among others—make it particularly challenging to formulate appropriate policies in PNG. PNG’s CPI basket has not been updated for more than three and a half decades and the National Statistical Office has not released estimates of GDP since 2007. The mission urges the authorities to take early action to address these long-standing issues.