Public Information Notice No. 12/53

Public Information Notice: IMF Executive Board Concludes 2012 Article IV Consultation with Papua New Guinea

June 1, 2012

On May 14, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Papua New Guinea, and considered and endorsed the staff appraisal without a meeting.¹

Background

Papua New Guinea has seen solid economic growth over the past decade, supported by sound macroeconomic policies, improved public finances, moderate inflation, and attractive conditions for foreign investors in the mining and petroleum industries. While Papua New Guinea remains a low-income country, its resource wealth is an opportunity to raise living standards for all. To achieve its development targets, the government is focusing on public services, including education, health, law and order, and infrastructure. Reforms are under way to raise the efficiency of public enterprises and increase competition in the private sector.

Real GDP is estimated to have increased to about 9 percent in 2011 from about 7.6 percent in 2010. Elevated commodity prices, the construction of a liquefied natural gas project, and government spending are boosting the economy and generating inflation pressures. The temporary closure of key mines, caused by natural disasters, and dwindling oil production dampened overall output growth. Headline inflation peaked just below 10 percent in the second quarter of 2011, but subsequently eased to 7 percent at year-end in line with declining international food prices and the appreciation of the kina.

After a large fiscal deficit in 2009, the budget returned to surplus in the last two years. Higher-than-expected commodity prices boosted government revenue and greater spending discipline, including on spending out of trust accounts, resulted in budget surpluses. The Bank of PNG raised its policy rate by 75 basis points to 7¾ percent, increased commercial banks’ cash reserve requirements by 200 basis points to 6 percent, and issued central bank bills to mop up liquidity. The nominal effective exchange rate appreciated by 21 percent in 2011.

The financial sector remains profitable and well capitalized, but vulnerabilities have increased. Exposure to the heated real estate sector continues to fall. However, the non-performing loans ratio increased and provisioning of commercial banks dropped.

The current account deficit widened to 36 percent of GDP in 2011, driven by the rise in imports for the construction of the LNG plant and the compensation of foreign workers. The deficit was, however, largely financed by FDI and private external debt related to the LNG project. Public external debt declined to 9.8 percent of GDP by end-2011.

Executive Board Assessment

We commend the authorities for achieving macroeconomic stability and a sustainable fiscal position.²To preserve these achievements and promote inclusive development, it will be important to combine steady, affordable growth in government spending with improvements in public financial management and expenditure effectiveness. This should be accompanied by structural reforms and a flexible monetary policy.

After 10 years of uninterrupted economic growth, the medium-term outlook remains positive. Risks to the outlook are broadly balanced and predominantly related to the resource sector. ²

Further monetary tightening would likely be needed to anchor inflation expectations at the Bank of PNG’s 5 percent reference value. Reducing excess liquidity by raising banks’ cash reserve requirements and limiting reserve accumulation would be the most effective ways to achieve tighter monetary conditions. Going forward, greater exchange rate flexibility would provide an important buffer against external shocks.

Fiscal policy should target a smooth expenditure path. Such a policy would help sustain solid economic growth with moderate inflation, and provide reliable funding for essential public services. It could be implemented through tighter control of expenditure growth in the current election year, and steady increases in real spending per capita over the medium term.

PNG’s resource sector could make a larger contribution to public revenues. Efforts to promote this could include strengthening revenue collection, reinforcing the internal revenue and customs services, streamlining existing tax concessions, and applying the Additional Profits Tax to mining activities, given that the average effective tax take from resources appears to be on the low side of fiscal regimes across the world.

The SWF provides a strong framework for insulating public expenditure from volatility in resource revenue, and for improving transparency, accountability, and good governance. Withdrawal rules should be set in accordance with the new Medium-Term Fiscal Strategy. Once the SWF is established, all existing trust accounts should be consolidated with the fund.

We welcome the government’s agenda for better public services. Plans to increase the expenditure share of key development priorities—education, health, law and order, and infrastructure—go in the right direction. However, to deliver better public services marked gains in the effectiveness of public spending are needed. Therefore we encourage the authorities to develop a multi-year budget for selected expenditures and invest in the reform of key ministries responsible for planning and service delivery.

More competition would benefit consumers and raise efficiency. We encourage the authorities to strengthen enforcement of competitive behavior and replace existing monopolies. The introduction of exclusive production rights and import protection for rice would go in the wrong direction and hurt consumers. The authorities should proceed with SOE reforms.

The current account deficit is largely financed by FDI and is not expected to threaten external stability. The exchange rate is estimated to be modestly undervalued and reserves are adequate to address potential balance-of-payments needs.

The financial sector remains sound. Banks have high capital adequacy ratios and should be resilient to contagion from the Euro area, but need to maintain appropriate lending standards and further reduce exposure to the real estate sector. Financial supervision has been of high quality, and the planned enhanced cooperation among supervisors is welcome. The authorities should implement the remaining 2011 FSAP recommendations.

The authorities need to urgently tackle structural deficiencies in the provision of national statistics. Gaps in macroeconomic data provision complicate PNG’s public policy-making and Fund surveillance. This requires immediate reform and strengthening of the relevant government agencies.