Port Moresby, Papua New Guinea
April 6, 2001
Mr. Horst Köhler
International Monetary Fund
Washington, D.C. 20431
Dear Mr. Köhler:
The attached Memorandum of Economic and Financial Policies supplements the
understandings specified in our letters and attached memoranda to Mr. Fischer on
March 20, 2000, and to you on October 2, 2000. It also describes the progress made to
date in implementing the economic policies and attaining the economic objectives of the
Government of Papua New Guinea, which are supported by the Stand-By Arrangement approved
by the Fund on March 29, 2000. As indicated in the Memorandum, we are committed to
achieving a sustainable fiscal position, reducing inflation, strengthening international reserves,
and implementing structural reforms.
In support of these policies, the Government of Papua New Guinea hereby requests
completion of the second and third reviews and the third and fourth purchases under the
arrangement. All quantitative performance criteria for end-September 2000 were observed. The
Government of Papua New Guinea also requests waivers for the nonobservance of the
performance criteria for end-December 2000 on the floor of the net international reserves of the
central bank of Papua New Guinea (BPNG), the ceiling on the net domestic assets of the BPNG,
and the ceiling on the net domestic financing of the government. These criteria were not observed
largely as a result of a shortfall in external financing relative to the program under the Stand-By
The Government of Papua New Guinea requests a waiver for the nonobservance of the
structural performance criterion on bringing Finance Pacific Group (FPG) to the point of sale by
end-December 2000. Preparations for divesting assets forming part of FPG--including a large
commercial bank (PNGBC) and an insurance company (MVIL)--have taken longer than
anticipated. However, the Government of Papua New Guinea is committed to divesting these
assets in the period ahead. The Government of Papua New Guinea proposes that bringing
PNGBC to the point of sale will be a prior action for completing the second and third reviews.
Also, it proposes that rescinding the central bank guarantee recently extended to PNGBC be a
prior action for completing the second and third reviews.
The Government of Papua New Guinea acknowledges the risk that persistence of a
slowdown could result in lower tax revenue than programmed. Therefore, it has decided to take
compensatory measures for any underperformance through June 2001. Taking such measures
will be a prior action for completing the fourth review under the Stand-By Arrangement.
The Government of Papua New Guinea recognizes the importance of a close relationship
with the Fund including to facilitate continued donor support, particularly in view of the
country's vulnerability to shocks. Consequently, the Government of Papua New Guinea requests
a four-month extension of the current Stand-By Arrangement to September 28, 2001, with the
last purchase contingent on observance of performance criteria for June 2001. Following
successful completion of the present arrangement, the Government of Papua New Guinea will
consider requesting a successor arrangement. We suggest to commence discussions on options in
late June or early July 2001.
During the remaining period of the arrangement, the Government of Papua New Guinea
will stand ready to take any additional measures necessary to keep the program under the
Stand-By Arrangement on track, and it will remain in close consultation with the Fund, in
accordance with Fund policies. A fourth review under the Stand-By Arrangement will be carried
out by the Fund before September 28, 2001.
In the interest of solidifying private sector confidence through a commitment to
transparency, the Government requests that the Fund publish the attached Memorandum.
Hon. Sir Mekere Morauta, Kt, MP
Mr. L. Wilson Kamit, CBE
Governor, Bank of Papua New Guinea
Supplementary Memorandum of Economic and
Financial Policies Second And Third Reviews Under the Stand-by Arrangement
1. The Government's policies continue to be guided by the macroeconomic
adjustment and structural reform program described in the March 2000 Memorandum of
Economic and Financial Policies and its October 2000 supplement.
II. Performance Under the Stand-By
2. Macroeconomic and structural performance in the second half of 2000
remained generally good. While all quantitative performance criteria for end-September
were observed, a shortfall in external financing during the last quarter of 2000 was the main
cause of the nonobservance of performance criteria on the net international reserves of the Bank
of Papua New Guinea (BPNG), the net domestic assets of the BPNG, and the net domestic
financing of the government for end-December 2000. This shortfall was partly related to delays
in preparations for the privatization of a large bank (PNGBC). However, the Government is
committed to bringing PNGBC to the point of sale (prior action for the completion of the second
and third reviews) and maintaining a macroeconomic policy framework consistent with the
achievement of program objectives under the stand-by arrangement. The Government's program
continues to be developed in consultation with multilateral and bilateral donors.
3. Generally tight monetary and fiscal policies helped bring down inflation to
10 percent by end-December 2000, albeit by less than envisaged under the program.
The fiscal situation turned difficult in the last quarter of 2000, in part due to a shortfall in
external financing relative to program projections. However, the overall government deficit
narrowed markedly in 2000, reflecting broad adherence to expenditure targets and
better-than-expected mineral tax revenue. Monetary conditions remained tight during the year,
with monetary aggregates growing broadly in line with targeted inflation. A poor coffee crop and
the trend decline in oil output were major factors in the slowdown of economic activity in 2000.
Depressed import demand by the nonmining sector and the relatively high export price for oil
contributed to a substantial increase in the external current account surplus. As a result, the net
international reserves of the central bank (NIR) rose by over $70 million in 2000,
notwithstanding the large shortfall in external financing. The kina strengthened during the first
half of the year following Board approval of the Fund program, but weakened subsequently, with
the decline in coffee exports.
4. Economic conditions have remained difficult during the first quarter of 2001. Oil
prices have weakened and oil output is trending downward. In this context, the kina depreciated
by 6-7 percent through end-March 2001. In addition, central bank intervention mainly to address
strong pressures related to noneconomic factors resulted in substantial losses in net international
reserves. In early March 2001, the central bank reduced the Kina Facility Rate by 50 basis points
following the news of the fall of inflation registered by end-December 2000 and in overseas
III. Macroeconomic and Structural Policies for 2001
5. Notwithstanding the difficult economic environment, the Government remains
committed to macroeconomic stabilization, public sector reform, tax reform, financial sector
reform, and other actions to improve transparency and enhance confidence. While
output in the mineral sector is projected to decline markedly, output in the nonmineral sector is
expected to experience a recovery in 2001, with overall real GDP growth of 0.3 percent.
In the medium term Papua New Guinea's oil production is projected to decline and world prices
for most of Papua New Guinea's export commodities are expected to remain low. A projected fall
in mineral exports would be reflected in a significant deterioration of the external current account
in 2001, which would be covered in part by external government borrowing, including
unidentified exceptional financing ($15 million). The Government has initiated discussions with
the AsDB on program support and will seek additional donor assistance in a Consultative Group
meeting currently planned for May 2001.
6. Against this background, the Government's financial policy objectives are
to: (1) contain the second-round price effects of the exchange rate
depreciation and recent increases in the domestic price of imported fuel so as to reduce the rate of
inflation to 8 percent by end-2001, and (2) achieve an increase in NIR to
$300 million (three months of nonmineral imports) by end-December 2001, commencing
with a recovery of the NIR by end-June 2001 of at least $15 million to $232 million. Any net
privatization revenue will be used to retire debt or to increase government deposits at the central
Monetary and exchange rate policy
7. Monetary policy will continue to focus on the reduction of inflation. Following a
contraction in 2000, reserve money is projected to grow by close to 10 percent in 2001, in
line with projected nominal nonmineral GDP growth of 10 percent. Broad monetary
aggregates are expected to grow with the monetary base. Growth of net bank credit to
government will be limited to under 5 percent in 2001, which will permit an expansion of credit
to the private sector of about 10 percent. The central bank agrees that inflation must be set
firmly on a declining trend before there can be a significant decline in interest rates and is
prepared to allow interest rates to firm, if necessary, to achieve the program targets.
8. To improve efficiency in its monetary operations, the central bank introduced a new
benchmark interest rate on February 2001. On the first Monday of each month, the central
bank will announce the Kina Facility Rate (KFR) to provide a signal of policy intentions and help
improve management of bank liquidity.
9. Expectations for lower mineral exports along with unfavorable market sentiment
related to noneconomic factors have placed downward pressure on the kina. The central
bank sought to reduce volatility of the currency as it depreciated in response to these external
shocks, and the kina has stabilized in recent weeks. Nevertheless, the central bank remains
committed to meeting the program's targets on NIR and to limit its foreign exchange
interventions to reducing short-term volatility.
Fiscal policy and development spending
10. The overall government deficit is projected to widen to 2.3 percent of GDP in
2001. In view of a lower real GDP growth projection, the Government has revised
downward revenue estimates in the budget for 2001, which was prepared in line with
understandings with the Fund. The Government has decided to defer expenditure under the
District Development Program (formerly the Rural Development Program) by K 30
million (about 0.3 percent of GDP). In addition, the Government will refrain from wage increases
beyond existing commitments as well as increases in staffing (except for priority areas, namely
education, health, revenue collection, law and order, infrastructure, and primary industries),
which will help avoid any rise in the government wage bill in relation to GDP. This will allow
purchases of goods and services to be restored to a level that will enable the Government to meet
its core functions without incurring arrears.
11. The Government will continue to implement a responsible budget while attending to
the fundamental development needs of the country. The composition of expenditure is
programmed to shift in 2001 away from current expenditure, with development spending rising
by over 1 percent of GDP. The Government's development budget for 2001 addresses
the deterioration of infrastructure by substantially increasing road maintenance expenditure. The
Government is committed to adequately fund departments providing priority services, and will
continue to improve financial management, particularly to avoid arrears. In this regard the
Government will strengthen enforcement of the Public Finance Management Act, which
stipulates penalties for financial mismanagement.
12. A number of risks apply to the fiscal plan. It is expected that a decrease in
mineral sector revenues will be offset by higher collections from other tax sources reflecting a
pickup in activity in the nonmineral sector and improvements in tax administration as a result of
additional resources, particularly in inspection, audits, and the prosecution of delinquencies.
Recognizing the risk of underperformance in tax collections, the Government agrees that if at the
time of the fourth review, tax revenue trends through end-June 2001 cast doubt about projected
performance during the remainder of the year, compensatory measures (prior action for fourth
review) will be taken before that review may be completed. More generally, the revenue,
expenditure, and financing situation will be monitored very closely in the months ahead, with
additional measures taken, if necessary, to achieve the fiscal targets for 2001. Given the
Government's intention to maintain a stable tax system following an independent tax review,
further adjustment measures, if needed, would focus on reductions in spending.
Structural reform policies
13. The Government's record demonstrates its commitment to implement economic
reforms within the broad framework of its structural adjustment program. The reform
agenda includes safeguarding the sustainability of the fiscal position over the medium term,
improving the effectiveness with which government funds are deployed, and improving
conditions for private sector development. Additional reforms aimed at improving public service
delivery and enhancing accountability and transparency in the public sector are under way with
support from multilateral and bilateral donors.
14. Progress is being made on a comprehensive public sector reform program
aimed at ensuring efficient use of budgetary resources and improving public service
delivery. The program, which was endorsed by the National Executive Council (Cabinet) in
late August 2000, specifies reform goals, a timetable, and the roles to be played by multilateral
agencies and bilateral donors. Functional and expenditure reviews have been completed in
various departments; and the Government intends to move forward with reviews of priority
agencies. These reviews will involve net fiscal savings over the medium term resulting from the
recent decision to close eight diplomatic representations. To improve efficiency in service
delivery, the Fisheries Authority was restructured in late 2000 and the Civil Aviation Authority
was established on January 1, 2001. The Government will continue to implement the District
Development Program in accordance with guidelines designed with support from the World
Bank in 2000.
15. The Government remains committed to improving the efficiency of the civil service
and the management of human resources. The Government retrenched about 1,700 civil
servants in 2000, mainly unattached officers or civil servants older than 50 years of age, and
initiated a plan to remove additional uniformed and civil servants from the Defense Department
payroll. About 240 soldiers were repatriated to their villages in 2000 and about 650 soldiers will
be repatriated in the first half of 2001. The Government is committed to replacing the payroll
system and manual personnel records by an integrated payroll and human resources management
system. The Government has committed K 5 million for the new system, and a
tender will be awarded by end-June 2001.
16. Privatization is a main pillar of the Government's strategy to improve the efficiency
of the public sector. In the first half of 2000, the Government identified enterprises to be
privatized, approved a privatization policy, and made amendments to the Privatization
Commission Act to enhance accountability. An International Advisory Group is providing
assistance with the implementation of the privatization strategy. The Privatization Commission
has appointed project managers to prepare enterprises for sale and oversee the necessary legal
and financial due diligence. To enhance transparency in the privatization process, the
Privatization Commission has recently appointed an Independent Probity Officer, who will
monitor the tender process and work to ensure its integrity.
17. The Government will bring PNGBC to the point of sale by issuing an Information
Memorandum satisfactory to the Fund by mid-April 2001 (prior action for the second and third
reviews). Due diligence of PNGBC by major international accounting and legal firms has
been completed and an Information Memorandum and supporting documentation for the offering
will be issued shortly, including specification of the Community Service Obligations (CSOs) of
PNGBC. The Government will ensure that any expenditure to defray the cost of meeting the
CSOs will be fully reflected in the budget, and will take compensatory measures to ensure that
the original budget targets can be achieved.
18. The Central Bank has rescinded a guarantee extended earlier this year to provide
support for PNGBC (prior action for the second and third reviews). This guarantee was
extended to alleviate perceived uncertainties in the financial system and facilitate bringing
PNGBC to the point of sale. On March 8, 2001, the Government extended a guarantee to the
state-owned Motor Vehicle Insurance Ltd. (MVIL) for compulsory third party insurance claims
and an indemnity to PNGBC for any future claims of MVIL creditors. While the Government is
of the view that this guarantee will not involve any fiscal costs, it will take compensatory
measures if any such costs materialize. The Government intends to terminate this guarantee as
soon as MVIL is privatized, which should be facilitated by the expected improvement in its
financial position following the recent increases in insurance rates.
19. The Government has brought Air Niugini to the point of sale, and has called for
expressions of interest. Audits of Telikom, Elcom, and Harbours Board are in the process of
being completed. In addition, to facilitate the sale of key state-owned enterprises, the
Government has engaged a reputable international firm through public tender to develop
regulatory frameworks and community service obligation arrangements. A final report has been
20. The Government has addressed the solvency problems of the National Provident
Fund (NPF). The latter involved reaching understandings in December 2000 with employers
and unions on equitable and affordable burden-sharing to deal with the NPF's poor past
performance. As part of the agreement, members' accounts in the NPF have been written down
by an average of 15 percent, employer contributions relative to the payroll were raised by
2 percentage points (for three years), and legislation was enacted to provide an annual
government grant to the NPF of K 4 million (K 3 million in 2001) for
15 years, indexed to the CPI. This permitted the resumption of payouts, beginning in
January 2001, that had been suspended in October 2000. Funding for the Government's
contribution to the NPF resolution is available within the agreed budget for 2001.
21. The Government is taking steps to reform and strengthen the pension industry.
In December 2000, Parliament passed the Life Insurance and Superannuation Acts that provide a
comprehensive framework for the regulation and supervision of these industries.
22. A taxation review was completed and endorsed by Cabinet in November 2000, and
its recommendations have been incorporated in the 2001 budget. These include:
(a) adjusting personal income tax brackets for inflation; (b) reducing the cost of
compliance for corporate income taxpayers; (c) changing the mining and hydrocarbon tax
regime to encourage development of marginal projects while adequately taxing highly profitable
ones, and removing tax loopholes; and (d) simplifying the excise tax regime.
23. The Government will allocate sufficient resources to support revenue
collection. In particular, resources will be made available to strengthen the administration of
the VAT and to increase the number of tax audits. The Government intends to redeploy staff to
support tax and nontax revenue collections.
24. The Government recognizes that the current form of price regulation has created
uncertainty in parts of the business community. The Government is carrying out a review of
its competition policy, including price regulation, and is working toward the repeal of recent
amendments to the gazetted list of declared goods and services for the purposes of the Price
IV. Program Monitoring
25. Quantitative performance criteria for end-June, 2001 have been set as
follows: (i) a ceiling on net domestic assets of the central bank; (ii) a ceiling on net
domestic financing of the Government; (iii) a floor on the net international reserves of the
BPNG; (iv) ceilings on new short-term and medium- and long-term external
nonconcessional debt, including loan guarantees; and (v) the continuing nonaccumulation
of external payments arrears.
26. The following quantitative benchmarks will be observed at the levels specified in Table 4: (i) the floor on mining and petroleum tax receipts;
(ii) the floor on nonmining and petroleum tax revenue; (iii) the limit on total
central government noninterest recurrent expenditure; and (iv) the limit on central
government wages and salaries. No domestic government arrears have been or will be incurred in
27. Despite recent progress, including compilation of a full set of national accounts for
1993-98, the Government recognizes that remaining statistical weaknesses hamper
policy formulation. Particularly important are the shortcomings in price, government finance,
balance of payments statistics, and contemporaneous indicators of economic activity. The
Government will work to implement the recommendations of the FAD mission that visited Port
Moresby in December 2000 to address inconsistencies in the coverage and timing between
monetary and fiscal statistics. In addition, the Government will take early action to improve the
statistical coordination between the Departments of Finance and Treasury and the Central Bank,
and has requested technical assistance from the Fund for this purpose. The recommendation of
the recent PFTAC mission will be considered as part of a strategy designed to strengthen the
institutional framework of the statistical system. The Government intends to request technical
assistance from the Fund to further improve compilation of the balance of payments. Also, it will
implement the recommendations of the recent PFTAC report, including on ways to improve the
compilation of the CPI. In addition, the Government will seek donor support for conducting a
household income and expenditure survey in the second half of 2001 that should permit the
improvement of the CPI in 2002.
28. The Government has made substantial progress in improving fiscal reporting during
the last 12 months. Nevertheless, it is committed to improving fiscal information
to the public and will introduce a new monthly bulletin containing data on payrolls, arrears, cash
flows, and more general reporting on the activities of the Government. The Government is
working to create a database that captures external financial and operational leases. In this regard,
it has requested departments and statutory bodies to report on financial and operational leases,
focusing on those with a value of $0.5 million and above.
29. The Central Bank will reintroduce an electronic registry for treasury bills.
Besides enhancing efficiency and clarity of reporting, this will facilitate the introduction of a
secondary market for treasury bills.
30. The Bank of Papua New Guinea has provided the information requested by the Fund
for its safeguards assessment, including audited financial reports and management letters for
1997 and 1998. The 1999 audited reports will be provided by mid-April 2001, and for
subsequent years, audit reports will also be provided to Fund staff.
Attachments (Please use the free Adobe Acrobat Reader to view the following Tables)
|Table 1. ||Papua New Guinea: Performance Criteria and
Indicative Targets Under the Stand-By Arrangement, 2000|
|Table 2. ||Papua New Guinea: Performance Criteria and
Indicative Targets Under the Stand-By Arrangement, 2001|
|Table 3. ||Papua New Guinea: Prior Actions, Structural
Performance Criteria, and Benchmarks Under the Stand-By Arrangement, 2000–01|
|Table 4. ||Papua New Guinea: Quantitative Benchmarks Under
the Stand-By Arrangement, |