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Papua New Guinea and the IMF

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Public Information Notice (PIN) No. 04/125
November 10, 2004
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2004 Article IV Consultation with
Papua New Guinea

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2004 Article IV consultation with Papua New Guinea is also available.

On June 2, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Papua New Guinea.1

Background

Papua New Guinea's macroeconomic performance improved from mid-2003, helped importantly by the favorable temporary factors that boosted the mineral and agricultural sectors. In 2003, real GDP is estimated to have grown by 2.7 percent, following three years of decline. Coffee and cocoa production benefited from better weather conditions and production of palm oil, rubber, tea, and copra oil also increased. The mining sector was not disrupted by election-related violence, as in 2002, and output of petroleum, gold, and copper was higher. The rate of inflation declined to 8½ percent in the year to the December quarter, primarily because of the improved fiscal situation and exchange rate stability. Yet, the economic situation remains fragile, and improved policy implementation is essential to secure higher sustained growth and to alleviate poverty.

Assisted by higher revenue from the mining and petroleum sector and tighter expenditure controls, the budget was in overall balance during the second half of 2003, and the annual deficit was held at about 2 percent of GDP. This outcome facilitated a decline in treasury bill rates from over 20 percent in August to about 16 percent in December 2003. Rates fell further to 10 percent for 28-day bills and 12 percent for 182-day bills in late April 2004. However, the required reallocation of spending toward health, education, and infrastructure has been largely held in abeyance, until the wage bill is reduced.

Monetary policy was geared from late 2002 to keeping a firm grip on inflation and protecting the external position. It was tightened during the period November 2002-June 2003, when the central bank increased its benchmark Kina Facility Rate (KFR) from 12½ percent to 16 percent. Subsequently, in response to the declining rate of inflation and the relatively stable exchange rate, the authorities progressively reduced the KFR to 10 percent in May 2004. Nevertheless, the easing of monetary policy failed to lead to an expansion of commercial bank credit to the private sector, which declined by almost 3 percent in 2003 and remained weak in early 2004.

The balance of payments situation has improved. Higher world commodity prices underpinned a sharp rise in export receipts and the external current account registered a surplus of 10 percent of GDP, compared with a small deficit in 2002. As a result, official gross international reserves rose to about 6 months of nonmineral imports at end-December 2003, and remained broadly unchanged in the first quarter of 2004. The kina appreciated in real effective terms by an estimated 8 percent during January 2003-April 2004, in contrast to the depreciation experienced in the preceding several years. The nominal exchange rate rose by about 20 percent against the U.S. dollar, while falling somewhat against the buoyant Australian dollar.

Unfortunately, progress in implementing structural reforms has been limited. With regard to public sector reform, progress has been slow in implementing the recommendations of the World Bank-led Public Expenditure Review and Rationalization. Efforts have also been minimal to strengthen the efficiency of provincial expenditure and tighten monitoring and reporting systems of their accounts. The financial condition of the main public enterprises remains poor. The structural impediments to private sector growth are formidable with governance issues and weak infrastructure affecting agricultural, mineral, forestry, fisheries, and urban activity.

Papua New Guinea's medium-term economic outlook as outlined in the government's development strategy is to achieve real GDP growth of 2½ percent annually over the period 2004-09, with growth in nonmineral activity increasing gradually to about 3½ percent by the end of the forecast period. Inflation, which has now been brought down to single digits, is expected to decline steadily to 2 percent by 2009, assuming that fiscal and monetary discipline is maintained. The external current account is projected to move toward approximate balance during 2006-09, with higher nonmineral exports only partly offsetting the decline in mining and petroleum exports as existing resources are depleted. The main fiscal challenge is to ensure that the budget deficit averages under 1 percent of GDP in 2005 and beyond to permit a gradual decline in the public debt-to-GDP ratio.

Executive Board Assessment

Executive Directors welcomed the improvement in Papua New Guinea's macroeconomic performance, including a return to positive growth supported by higher agricultural and mineral output, a sharp decline in inflation, and a strengthening of the external current account and international reserves position. While these developments partly reflect the large increases in commodity export prices, Directors also highlighted the positive role being played by the authorities' efforts to restore macroeconomic stability. Going forward, they saw as priorities to further strengthen macroeconomic policies and press ahead with wide-ranging reforms to address remaining vulnerabilities and improve the outlook for higher and broad-based private sector growth and employment.

Directors commended the authorities for holding the fiscal deficit to 2 percent of GDP in 2003, in line with the budget target, which reflected tightened expenditure controls in the second half of the year as well as higher mineral tax receipts. To contain domestic debt and interest payments, they supported the 2004 budget objective of further reducing the deficit to 1.5 percent of GDP. Expenditure restraint should be at the core of the fiscal adjustment effort, and in particular the authorities should make every effort to contain the public sector wage bill. Directors also urged the authorities to accelerate the repayment of domestic arrears, and to eliminate them as soon as possible. A detailed, audited accounting of the outstanding stock of arrears should support this process.

Directors commended the authorities' prudent monetary policy stance, which has contributed to the fall in inflation and the strengthening of the external position. They considered the recent lowering of interest rates to be helpful to encourage private sector activity, but it will remain important to monitor conditions closely, and to maintain a cautious monetary policy stance in order to keep inflation restrained. Directors saw the recent appreciation of the kina as appropriately reflecting the strengthened fiscal position and improving external debt dynamics, and supported maintenance of the flexible exchange rate system, given the country's vulnerability to external shocks.

Directors noted that Papua New Guinea's financial system is generally sound. The profitability of the commercial banks is satisfactory, and the asset quality of all banks has improved, reflecting improvements in credit procedures and the overall cautious approach to new lending. However, further efforts are needed to enforce bank supervisory decisions more effectively, and in that vein, Directors were encouraged that the authorities had indicated that the recommendations of Fund technical assistance in this area would be progressively implemented. Directors welcomed the improvement in the financial performance of the public and private sector pension funds over the past two years. They also welcomed the progress being made on legislative steps to combat money laundering and the financing of terrorism, and encouraged the authorities to press ahead with their efforts in this area.

Directors underscored the importance of a sustained reform effort aimed at improving public sector efficiency and strengthening the foundations of private sector activity. This will be essential to improve social conditions, support economic diversification in the face of a prospective decline in mineral output, and address remaining fiscal and external vulnerabilities. To ensure a steady decline in the public debt-to-GDP ratio, further fiscal consolidation, with deficits below 1 percent of GDP, will be required over the medium term. Directors urged the authorities to accelerate public sector reform in line with the recommendations of the recent World Bank-led Public Expenditure Review and Rationalization study. Action is needed to further reduce the government wage bill, including through a stricter hiring freeze, removal of ghost workers, elimination of unauthorized allowances, and retrenchments. Progress in this area would permit the reallocation of resources to health, education and infrastructure, and reinforce the fight against poverty. Directors also noted the importance of efforts to strengthen and broaden the revenue basis over time. They welcomed the temporary nature of the import levy.

Directors urged the authorities to address the longstanding structural impediments to private sector growth, and higher investment and employment. In particular, decisive efforts will be required to overcome the poor state of governance, reduce corruption, improve the law and order situation and the transparency of government operations, address land tenure issues, and simplify regulatory requirements for domestic and foreign investors. The need to give new momentum to the privatization program was also highlighted. Directors were encouraged that the authorities' medium term development strategy is designed to tackle these challenges in a comprehensive manner. They stressed that success will depend crucially on a sustained record of policy implementation, and urged the authorities to build on their improved macroeconomic policies to mobilize support for the needed institutional and structural reforms.

Directors underscored the importance of a prudent debt management strategy, including reliance on concessional financing based on close cooperation with the donor community. They welcomed in this regard the authorities' recent announcement to defer proceeding with an international bond issue to allow further assessment. They discouraged new public external commercial borrowing, in light of the strategy of reducing the public debt-to-GDP ratio, the absence of a balance of payments need, and the questions it could raise about the commitment to macroeconomic stability.

While the quality of economic statistics has improved, Directors saw a need for further efforts, in particular to improve the quality and timeliness of national accounts, and budgetary and balance of payments data.



Papua New Guinea: Selected Economic Indicators, 2000-04


       

Est.

Proj.

 

2000

2001

2002

2003

2004


Real sector (percentage change)

         

Real GDP

-1.2

-2.3

-0.8

2.7

2.5

Mineral

-0.5

4.5

-18.7

3.0

2.0

Nonmineral

-0.5

-4.1

4.5

2.6

2.6

CPI (period average)

15.6

9.3

11.8

14.7

7.4

           

Central government budget (percent of GDP)

         

Revenue and grants

31.2

31.0

29.4

30.0

30.2

Expenditure and net lending

32.3

34.7

33.8

31.2

31.7

Overall balance, cash basis (including grants) 1/

-1.4

-4.1

-5.7

-2.0

-1.5

Domestic financing (net) 2/

1.2

0.9

6.2

3.8

2.2

Of which: Banking system

-1.4

-2.5

5.2

-0.8

0.5

External financing (net)

0.2

3.1

-0.9

-2.2

-1.6

Privatization (net)

0.3

0.0

1.8

0.3

0.5

           

Money and credit (percentage change; end-of-period)

         

Domestic credit

-4.5

-12.3

20.9

-6.9

4.9

Net credit to government

-12.5

-26.1

82.0

-7.9

5.7

Credit to the private sector

3.0

-1.2

-6.3

-2.8

4.5

Broad money

5.4

1.9

4.2

-3.3

5.5

           

Balance of payments (in millions of U.S. dollars; unless otherwise indicated)

       

Exports, f.o.b.

2,215

1,878

1,646

2,213

2,329

Imports, c.i.f.

-1,490

-1,326

-1,292

-1,431

-1,610

Current account (including grants)

299

204

-20

346

176

(In percent of GDP)

8.7

6.9

-0.7

10.1

4.5

Overall balance

78

66

-96

183

32

           

Reserves and external debt (end-of-period)

       

Gross international reserves (millions of U.S. dollars)

304

440

343

523

515

(In months of nonmining imports, c.i.f.)

3.2

5.7

4.6

5.8

5.0

Public external debt-to-GDP ratio (in percent) 3/

42.8

54.7

56.4

44.1

36.0

Public external debt-service ratio (percent of GNFS)

6.8

8.0

7.9

7.3

8.0

           

Exchange and interest rates

         

US$/kina (period average)

0.3624

0.2976

0.2573

0.2816

...

US$/kina (end-of-period)

0.3255

0.2625

0.2488

0.3000

...

Interest rate (182-day Treasury bills, end-of-period)

14.9

10.2

13.5

16.9

...

           

Nominal GDP (millions of kina)

9,515

9,948

10,992

12,204

12,596


Sources: Data provided by the Papua New Guinea authorities; and IMF staff estimates and projections.

1/ Measured from below the line in the fiscal accounts.
2/ Includes changes in check float.
3/ The decline in the debt ratio in 2003 is mainly due to a significant increase in nominal GDP and exchange rate effects.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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