Public Information Notice: IMF Concludes Article IV Consultation with Papua New Guinea and the First Review Under the Stand-By Arrangement
October 26, 2000
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
In the late 1990s Papua New Guinea was adversely affected by a large terms-of-trade shock, a severe drought, a relaxation of macroeconomic policies, and widespread governance problems. Depressed export earnings resulted in low tax revenue, which contributed to weak government finances in 1998 and 1999. As confidence deteriorated, private capital outflows intensified, and gross official international reserves fell sharply. Despite intervention by the central bank, the kina lost nearly one-third of its value against the U.S. dollar between end-1997 and mid-1999, pushing inflation up from under 5 percent to around 20 percent.
At the conclusion of the last Article IV consultation in June 1999, Executive Directors expressed concern about the economic situation and outlook. Directors recommended sustained implementation of tight monetary and fiscal policies, including the reining-in of domestic credit to government. They also strongly encouraged the authorities to improve transparency and accountability in the public sector, develop a concrete action plan for privatization, and improve the quality of macroeconomic statistics.
With an economic crisis looming, parliament formed a new government in July 1999 with a mandate to undertake fundamental reforms. The new government initiated policy discussions with the IMF and World Bank, quickly implemented a supplementary budget that included significant revenue measures, and pledged to undertake reforms to improve the governance, transparency, and efficiency of the public sector.
In March 2000 the Executive Board approved a 14-month Stand-By Arrangement in the amount of SDR 85.5 million (65 percent of quota). The program aims at macroeconomic stabilization and laying the basis for sustained growth over the medium term. It targets a reduction in inflation to 5 percent by the end of the year, and an increase in gross international reserves to $408 million (3.8 months of import cover). This is to be achieved through a tightening of monetary policy and a reduction in the overall government deficit. Structural policies are focused on public sector reforms; enhancing the independence and accountability of the central bank and strengthening the supervision of the financial system; and promoting private sector development through privatization and tax reform. The program is also supported by a $90 million World Bank Governance Promotion Structural Adjustment Loan approved in June 2000, and sizable financial packages from Australia, Japan, and other donors. Performance under the Stand-By Arrangement has been satisfactory, and all quantitative performance criteria for end-June 2000 were met.
Macroeconomic performance and market sentiment improved following approval of the arrangement in March. The overall government balance recorded a small surplus during the first half of the year. This was the result mainly of buoyant tax revenue, reflecting strong mineral export prices and better collection efforts. Renewed confidence in the economy prompted exporters to accelerate the repatriation of export receipts in the second quarter of 2000, triggering an appreciation of the kina and foreign exchange purchases by the central bank. Subsequently, the central bank sold foreign currency in the face of some downward exchange rate pressure resulting from expectations for lower coffee exports. In all, net international reserves increased from $180 million at end-1999 to $260 million at end-August 2000, and the kina appreciated from a low of $0.32 in late February to $0.42 in early June, and has since settled at around $0.37. The quarter-on-quarter inflation rate rose from 2.6 percent at end-March to 4.4 percent at end-June, due in part to recent tax increases.
Executive Board Assessment
Executive Directors agreed with the thrust of the staff appraisal. They commended the authorities’ achievement in launching a comprehensive and ambitious program of macroeconomic stabilization and structural reform. Directors emphasized that continued determined implementation of the program will be needed to create the conditions for economic diversification and sustained private-sector-led growth, which would help to increase the economy’s resilience to external shocks and, more generally, to ensure that the authorities’ efforts bring a lasting break from the disappointing performance of earlier years. Directors expressed confidence that the authorities would move decisively in facing up to these challenges.
Directors welcomed the improved fiscal performance during 2000, which has resulted in an overall surplus in the first half of the year. Higher oil prices and tax measures have raised revenues, and expenditure control has improved. Looking forward, Directors supported the authorities’ policy of consolidation in order to contain the government debt, and ensure fiscal sustainability. They noted that petroleum output, and thus revenues from that sector, are expected to decline, and that the public sector needs to be prepared to play a key role over time in promoting rural development and in poverty reduction. Directors considered that the required consolidation would have to rely heavily on further efforts to raise and diversify budget revenue over the medium term, including through improved administration.
Directors welcomed the authorities’ plan for the 2001 budget, now under preparation, to be in broad overall balance. They emphasized the importance of limiting the increase in the wage bill—including through continuation of the temporary hiring freeze—and of proceeding as rapidly as possible in implementing public sector reforms aimed at rationalizing the civil service. They also emphasized the importance of further improving expenditure controls to prevent unbudgeted commitments by certain agencies, which in the past has led to arrears, and of preparing contingency measures to ensure the attainment of budget targets.
Directors noted that the authorities had succeeded in mopping up the large overhang of liquidity that had accumulated in late 1999. They also noted, however, that inflation in the first half of 2000 was still relatively high. This partly reflected temporary influences, which would likely abate, notably the depreciation of the kina and recent excise tax increases. Directors considered that achieving the targeted reduction in inflation by end-2000 would require the maintenance of a tight monetary policy. In this connection, they noted that the recent decline in nominal interest rates was partly a sign of improved confidence, and welcomed the authorities’ intention to avoid any further reduction in interest rates until inflation was on a clearly declining trend. In this context, they also considered that particularly close attention to price developments and their measurement would be warranted.
Directors considered Papua New Guinea’s flexible exchange rate policy appropriate for a commodity export-based economy susceptible to price and output shocks. They welcomed the passage of the revised Central Bank Act and the Banks and Financial Institutions Act, which has improved the framework for monetary policy and for supervision of financial institutions.
Directors commended the authorities for the progress in implementing structural reforms to improve the governance, transparency, and efficiency of the public sector, as indicated by the recent assessment of Papua New Guinea’s observance of the code on fiscal transparency (ROSC). The introduction earlier this year of new procedures and institutional structures for rural development spending was seen as a signal of the authorities’ determination to tackle difficult issues. Directors welcomed the preparations underway to bring the conglomerate, Finance Pacific, to the point of sale by end-2000 and urged the authorities to proceed with their privatization program without delay, but on the basis of a careful consideration of the options. Directors welcomed the openness of Papua New Guinea’s trade regime, but noted the need for some caution regarding the establishment of free trade zones.
Directors noted that audits conducted earlier this year had revealed serious financial and monetary problems at the National Provident Fund, which needed to be urgently and comprehensively addressed with careful attention to the social and all other aspects of the issues. While recognizing the important steps that the authorities had already taken, Directors stressed the importance of implementing the recently designed Public Sector Reform Program as rapidly as possible to meet the overall goal of improving the efficiency of the public sector.
Directors appreciated the authorities’ efforts to improve the quality of economic and financial statistics, but considered that improvements are still needed, including in the compilation of more timely price statistics that could provide a better guide for monthly policy action, and in reconciling monetary and fiscal data. Directors indicated that strengthening the technical and managerial capacity of the National Statistical Office should be given high priority, and noted the potential role of technical assistance in improving statistics.
It is expected that the next Article IV consultation with Papua New Guinea will be held on the standard 12-month cycle.