IMF Executive Board Concludes 2006 Article IV Consultation with Papua New Guinea

Public Information Notice (PIN) No. 07/36
March 21, 2007

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.

On March 7, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Papua New Guinea.1

Background

Papua New Guinea is enjoying its fourth year of recovery and macroeconomic stability, but major challenges lie ahead. Sound macroeconomic policies over the past several years have reduced fiscal vulnerabilities, lowered inflation, spurred business confidence, and boosted growth. High prices for key export commodities (petroleum, copper, gold, and most agricultural products) have strengthened the fiscal and external positions. However, progress toward achieving the country's Medium-Term Development Strategy objectives or Millennium Development Goals has been limited. In particular, structural reforms needed to stimulate activity in the nonmineral economy have stalled in advance of the June 2007 general elections.

Reflecting past years of political instability and weak economic management, per capita income is little improved since independence in 1975. As a result of earlier election-year fiscal policy excesses, the current government faced a near crisis situation when it took office in 2002; its efforts during its initial years mainly—and successfully—focused on

stabilizing the fiscal situation and promoting economic recovery. However, underlying development needs in Papua New Guinea still remain to be fully addressed. The dominance of the natural resource sector has hindered the development of nonmineral sectors of the economy. Poor infrastructure, weak governance, and an unattractive business environment have constrained more rapid growth. Although recent growth rates have been strong relative to the past, the growth performance gap relative to comparator countries is widening. Poverty and unemployment remain high as the economy is unable to absorb a rapidly growing labor force.

Recent developments and the near-term outlook remain favorable. High commodity prices and expanding mineral production should contribute to continued growth and large fiscal and external surpluses. The recovery is expected to gain steam in 2007, with growth rising to over 4 percent, as new mines begin production and increased government spending stimulates activity in the nonmineral sector. Inflation is expected to rise slightly, as fiscal spending increases pressure on prices, but remain within the low single digits.

The current account surplus should narrow in 2007 as the value of mineral exports begins to decline with lower prices expected for key exports. Official external reserves should increase to about $1.6 billion (4 months of goods and services imports). After a steep rise in the kina's value in 2003-05, it appreciated by 3 percent against the U.S. dollar and 6 percent on a real effective basis in 2006.

An overall fiscal surplus is expected for the third successive year in 2007, although the underlying nonmineral deficit would further widen due to higher spending and lower nonmineral tax revenue. The 2006-07 budgets provide for large spending increases mainly for development expenditure (over three quarters of the total increase), much of it one-off, and smaller allotments for public enterprise investment, natural disaster victims, and domestic arrears clearance. Given weak implementation capacity and the late timing of the 2006 supplementary budgets, it is estimated that a limited amount of the expenditure appropriations was spent in 2006, and the remainder deposited in trust fund accounts for future spending. Repayment of 0.5 percent of GDP of external debt in 2006 combined with positive debt dynamics (real GDP growth, kina appreciation, and low interest rates) should contribute to a public sector debt-to-GDP ratio of 40 percent in 2007.

The macroeconomic outlook should remain positive, if fiscal and monetary policies are maintained on their current path. Real GDP growth of about 4 percent is expected over the medium term, together with continued low inflation rates. Falling export prices should underlie narrowing external current account surpluses. The nonmineral fiscal deficit is expected to improve gradually after 2007, if one-off spending in the 2006-07 budgets is not carried over, and the "right sizing" program to streamline the government is implemented.

However, the balance of risks is to the downside. Higher-than-expected election-related spending could lead to increasing price pressure; the resulting rise in interest rates as monetary policy is tightened could choke off economic growth. Still weak fiscal accountability, especially for many trust funds, also poses risks of higher or inefficient spending. A steeper-than-anticipated decline in world export commodity prices or postponement of large mineral projects would heighten the need for fiscal adjustment to allow room for essential development spending. Inaction or unwinding of previous progress on structural reform would dampen investor confidence. The further spread of HIV/AIDs would have consequences for growth and human development. On the upside, rapid development of gas reserves could improve the longer-term outlook for growth.

A doubling of the baseline growth rates would be needed to significantly reduce poverty and unemployment. Stronger annual growth of 7-8 percent is within reach, but would require more effective use of Papua New Guinea's mineral wealth, including a sustainable medium-term fiscal policy that efficiently delivers needed development expenditure, and decisive efforts on structural reform to encourage greater activity in the nonmineral sector. The resulting strengthened fiscal position would improve the debt sustainability outlook.

Executive Board Assessment

The Directors commended the Papua New Guinea authorities for their sound and supportive macroeconomic policies. Along with favorable commodity export prices, these have led to a sustained economic recovery, macroeconomic stability, a strong external position, and a declining debt-to-GDP ratio in recent years. However, Directors recognized that significant challenges remain, including the need to reduce unemployment and poverty and the economy's vulnerability to external shocks. They encouraged the authorities to maintain prudent macroeconomic policies and to step up the pace of structural reform, in order to accelerate economic diversification, boost private investment and growth, and move more quickly toward the Millennium Development Goals.

Directors welcomed the central bank's focus on price stability and its readiness to tighten monetary policy should inflation pressures emerge. Directors considered the managed float of the exchange rate to be an appropriate response to appreciation pressures stemming from the temporary influx of mineral export revenues. While recognizing the importance of maintaining the competitiveness of the non-mineral sector, they advised that the potential inflationary pressures from increased liquidity be carefully monitored, and that, in the event of sustained revenue inflows, a more flexible exchange rate would help contain such pressures.

Directors welcomed the shift of emphasis from recurrent to development spending, particularly for infrastructure and human capital, in the 2006 supplementary budgets and the 2007 budget. At the same time, they expressed some concern about the potential size of the spending increases and the risk that spending might not always be used as appropriated, given the weak budget implementation capacity, the approach of the mid-2007 parliamentary elections, and the economy's limited absorptive capacity. In this regard, Directors were encouraged by the authorities' commitment to maintain fiscal prudence in the run-up to the elections. They encouraged strengthened public expenditure management, subjection of all major spending agencies to basic accountability procedures, pressing ahead with the closure of unneeded trust accounts, and a resumption of the "right-sizing" initiative to streamline government spending.

Directors emphasized the importance of preserving the non-mineral revenue base and containing the non-mineral fiscal deficit to maintain long-term fiscal sustainability. They supported plans to improve tax administration, and welcomed the progress made in implementing the government's medium-term debt strategy. Looking ahead, Directors saw merit in continuing to cautiously spend any mineral revenue windfalls in future years for priority infrastructure and projects that enhance social welfare, to the extent that absorptive capacity permits, and to use the remainder to further reduce debt as much as possible.

Directors welcomed the overall soundness of the financial system. They viewed the recent expansion of bank credit to the private sector as a sign of re-intermediation and business confidence, while cautioning that credit quality should be monitored closely. They encouraged the authorities to further strengthen supervision, particularly of non-banks, and to implement the recently-passed legislation against money laundering and terrorism financing. Directors expressed concern that the Rural Development Bank's planned expansion into microfinance operations would lack adequate prudential oversight.

While appreciating the institutional constraints facing Papua New Guinea, Directors stressed that greater progress is needed in removing the structural impediments to private sector activity and more rapid growth. They highlighted, in particular, the importance of improving the business environment, the governance and law enforcement systems, and the transport and communications infrastructure. As basic utility services remain costly and unreliable, Directors recommended that the necessary regulatory framework be quickly finalized as a first step toward introducing competition in the public enterprise sector. Beyond this, the authorities were also encouraged to reconsider their decision not to move forward on privatization.

Directors recommended that a stronger effort be made to improve the quality and timelines of macroeconomic statistics.


Papua New Guinea: Selected Economic Indicators, 2002-06

  2002 2003 2004 2005 2006
        Est.

Real sector (percent change)

         

Real GDP growth

-0.2 2.2 2.7 3.3 3.7

Mineral

-15.9 2.8 0.3 5.0 0.2

Nonmineral

2.5 2.1 3.1 3.1 4.1

CPI (annual average)

11.8 14.7 2.1 1.7 3.5
   
Central government budget (percent of GDP)  

Revenue and grants

27.8 29.1 34.1 34.2 36.1

Expenditure and net lending

31.9 30.3 32.4 30.6 29.7

Overall balance, cash basis (including grants) 1/

-5.3 -1.8 0.0 4.1 6.4

Domestic financing (net) 2/

6.1 4.0 1.8 -2.7 -5.2

Of which: Banking system

6.3 -0.9 0.3 -1.2 -2.4

External financing (net)

-0.9 -2.1 -1.8 -1.4 -1.3
           
           

Money and credit (end-period percentage change)

         

Domestic credit

30.7 -7.1 1.5 8.6 5.4

Net credit to government

114.4 -8.3 3.2 -13.9 -37.3

Credit to the private sector

1.4 -4.1 0.9 23.7 27.9

Broad money

7.3 -4.4 14.8 29.5 33.0

Interest rate (182-day T-bills, period average)

10.9 18.7 3.1 3.8 3.4
           

Balance of payments (in millions of U.S. dollars)

         

Exports, f.o.b.

1,646 2,153 2,554 3,278 4.379

Imports, c.i.f.

-1,302 -1,435 -1,794 -2,462 -2,895

Current account (including grants)

-31 159 88 190 421

(In percent of GDP)

-1.0 4.5 2.2 3.8 7.4

Overall balance

-101 187 206 161 686
   

Reserves and external debt (end-period, in millions of U.S. dollars)

         

Net international reserves

223 399 599 765 1,450

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

3.0 4.3 5.5 5.2 8.3

Gross international reserves

339 523 663 765 1,451

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

4.5 5.7 6.1 5.2 8.3

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

54.2 42.9 36.8 25.3 20.7

Public external debt-service ratio (percent of GNFS)

7.9 7.5 8.7 6.0 3.5
           

Exchange and interest rates

         

US$/kina (period average)

0.2573 0.2814 0.3104 0.3223 0.3274

US$/kina (end-period)

0.2488 0.3000 0.3200 0.3230 0.3300
           

Nominal GDP (millions of kina)

11,656 12,567 12,652 15,339 17,269

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

1/ Measured from below the line in the fiscal accounts.

2/ Includes changes in check float.

3/ Includes central government, central bank external debt, and statutory authorities.


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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