Press Release No. 00/23

Press Release: IMF Approves US$115 Million Stand-By Credit for Papua New Guinea

March 29, 2000

The International Monetary Fund (IMF) today approved a 14-month stand-by credit for Papua New Guinea in an amount equivalent to SDR 85.54 million (about US$115 million) in support of the government's economic program for 2000-01. The first disbursement of SDR 10 million (about US$13.4 million) is available immediately.

In commenting on the Executive Board's decision on Papua New Guinea, Eduardo Aninat, Deputy Managing Director, said:

"The Papua New Guinea authorities have embarked upon an ambitious economic adjustment program, which is to be supported by the Fund with a stand-by arrangement. The program aims at restoring macroeconomic stability and achieving sustainable growth by reducing inflation, strengthening the external position, and reducing the budget deficit. In order to underpin these objectives, the government has also initiated a broad-based structural reform agenda to improve public sector governance, promote private sector development, and strengthen the financial system.

"The program envisages an overall fiscal deficit of 1½ percent of GDP, with a balanced budget in the coming year and beyond. A key fiscal reform measure is the strengthening of control over government expenditure. Also, on the revenue side, should the government revenues fall below the program targets, the authorities would be prepared to take additional offsetting measures.

"To restore confidence and bring inflation down, the authorities have taken timely action to mop up the large amount of excess liquidity that emerged in 1999. The recent passage of the new Central Bank Act should facilitate the conduct of monetary policy, enhance the powers and independence of the central bank and reduce government's recourse to central bank credit. A new Banks and Financial Institutions Act will also be adopted to strengthen financial sector supervision and regulation.

"Good progress has been made toward implementing the structural agenda established under the program. The Rural Development Program is to be replaced by the District Development Program Grant, to enhance transparency, fairness and cost effectiveness. A detailed framework for the privatization of large public enterprises has also been established," Aninat said.

ANNEX

Background

During the late 1990s, the economy of Papua New Guinea suffered large, adverse shocks related to a severe drought, the Asian economic crisis, and export price declines for copper and gold. Real GDP fell significantly, and the fiscal position deteriorated. Tax revenue fell by 4½% of GDP in 1998, led by large declines in the petroleum sector. Despite cuts in capital spending and an increase in external budgetary grants, the fiscal position shifted from near balance in 1997 to an overall deficit equivalent to 2.1% of GDP in 1998 that widened in the first half of 1999. The overall government deficit was financed mainly by recourse to central bank financing, which resulted in a significant decline in both net official international reserves and the external value of the kina. The annual rate of inflation rose to around 20% at the end of 1998 and early 1999.

A new administration was formed in mid-1999, which outlined an ambitious reform program, and immediately took action to address the deterioration in the public finances. Revenue and expenditure adjustments were introduced that brought about a small overall surplus in central government operations during the second half of 1999. The economic and financial program for 2000 underlying Papua New Guinea's stand-by request seeks to establish the foundations for sustainable growth through the restoration of macroeconomic stability and the implementation of key structural reforms.

Macroeconomic Policies Under the Program

Macroeconomic targets for 2000 include a pickup in growth to about 4½%, a reduction in inflation to 5% by the end of the year, and an increase in gross official reserves to $379 million. The 2000 budget restores fiscal policy to a sustainable course, with the overall government deficit brought down to 1.5% of GDP in 2000, including the clearance of all remaining government arrears. Beyond 2000, the budget is expected to maintain a balanced position. Contingency revenue measures will be implemented if the program's budget targets are jeopardized. The large expansion of central bank credit to government in 1998-99 resulted in rapid growth of reserve money, which, unless quickly mopped up, would have posed a risk of further increases in inflation and exchange market instability. The authorities reacted decisively to such a threat early this year by reducing reserve money by 20% in January 2000. For the year as a whole, reserve money is targeted to decline by 1.3%.

Structural Reforms

Structural reforms focus on measures to strengthen public expenditure control, enhance the effectiveness and transparency of development spending, increase the independence of the central bank, strengthen the supervision of banks and other financial institutions, initiate privatization of large state enterprises, and carry out comprehensive civil service reform.

Major governance reforms are being undertaken to enhance the transparency and improve the efficiency of the public sector. A crucial step has already been taken with the replacement of the Rural Development Program (where an issue of concern was poor governance), with the District Development Program Grant, which will operate under new rules of delivery and accountability. The government is also conducting a review of the tax system aimed at enhancing the fairness of the system and improving its competitiveness and efficiency.

Financial sector reforms are being undertaken on several fronts. To enhance the effectiveness of indirect monetary policy instruments, the central bank will no longer underwrite the issue of treasury securities at a predetermined price but will, instead, receive the auction-determined interest rate from the government. A new Central Bank Act (CBA) has been drafted with extensive technical assistance from the IMF and the Reserve Bank of Australia (RBA). The act is aimed at achieving price stability by strengthening the independence and accountability of the central bank and its governor. A revised Banks and Financial Institutions Act (BFIA) is also being prepared with IMF and RBA assistance to strengthen the licensing and supervision of banks and nonbank financial institutions, in line with best international practice. Among other provisions, the BFIA will outlaw the operation of pyramid-type schemes that had sprung up in 1999.

Financing Needs

In addition to the IMF's stand-by credit, Papua New Guinea's reform program will be supported by financing from the World Bank and bilateral official contributions. A consultative group meeting was held in Port Moresby on November 8-9, 1999. Donor support has firmed, and it is expected that the financing gap of $180 million could be covered by the World Bank and through balance of payments support from bilateral donors.

Papua New Guinea joined the IMF on October 9, 1975 and its quota is SDR 131.60 million (about US$177 million). Its outstanding use of IMF financing currently totals SDR 11.85 million (about US$16 million).