IMF Executive Board Concludes 2007 Article IV Consultation with Papua New Guinea

Public Information Notice (PIN) No. 08/32
March 12, 2008

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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with Papua New Guinea is also available.

On February 15, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Papua New Guinea.1

Background

Supported by a combination of prudent fiscal and monetary policies and high global prices for key mineral export commodities, Papua New Guinea's growth has accelerated over the past five years with increasing momentum from the nonmineral sector since the recession ended in 2003. Inflation has remained in the low single digits, and international reserves are at a record high.

At the same time, the country has significant underlying vulnerabilities. There has been little improvement in development indicators, and urban unemployment is estimated at around 40 percent. The economy is exposed to commodity price shocks, and mineral production is expected to decline over the medium to longer term. An unattractive investment environment, including weak infrastructure and governance, constrains more rapid and sustained growth of the nonmineral sector. Although Papua New Guinea's recent growth performance is an improvement relative to the past, it is not expected to be sustained and falls short of that needed to reduce poverty, raise development, and close the performance gap with respect to comparator countries over time.

Buoyant growth of over 6 percent is estimated for 2007, based on robust mineral and nonmineral growth. The pickup reflects the combination of several one-off factors, including a strong rebound in mineral and agriculture production following drought in 2006, and expansion in telecommunications and mining-related construction. Strong nonmineral activity should continue in 2008, with some easing. Annual average CPI inflation is estimated at under 2 percent in 2007. In 2008, annual average inflation is expected to trend upward toward the middle single digits, with pass-through of rising petroleum prices, some kina depreciation on a nominal effective exchange rate (NEER) basis, and higher demand pressure from increased budget spending.

Large foreign exchange inflows related to buoyant mineral exports boosted official reserves to over $2 billion at end-2007, equivalent to about 5 months of goods and services imports, and kept the current account balance in surplus. The kina continued to appreciate against the U.S. dollar, 7 percent over the year to November. On a nominal and real effective basis, it depreciated by about 4 and 5 percent, respectively, over the year through September.

Overall fiscal surpluses will continue through 2007-08. High mineral revenue inflows, combined with restraint of recurrent costs and implementation capacity constraints, helped boost fiscal savings since 2002 relative to comparators. However, the nonmineral deficit, measured on a cash basis, is now likely to further worsen as mineral revenue eases and spending increases. Positive debt dynamics and some repayment lowered the public debt-to-GDP ratio to about 35 percent at end-2007, down sharply from a peak of 77 percent in 2002.

The financial sector appears sound, based on backward-looking indicators. Reflecting the improved growth prospects and low interest rates, credit growth continues to be strong, though decelerating.

Progress on the structural reform agenda set out under the Medium-Term Development Strategy (MTDS) has stalled over the past year, particularly with respect to public sector reform. Constraints to private activity remain formidable, including unreliable services from basic utilities, poor transportation infrastructure, high crime, low public sector capacity to provide services, unclear licensing and regulation policies, weak human capacity, delays in work-visas, and land tenure issues. For these reasons, foreign and domestic investment outside of the enclave mineral sector is low.

Competitiveness of the nonmineral sector has not improved over the recent period, resulting in little or no increase in nonmineral export volumes. Agricultural exports, the largest share of nonmineral exports, were additionally affected by bad weather in the recent period.

Over the medium term, the outlook is for a return to moderate growth of about 3.5 percent, mainly reflecting the onset of production at new mines. Nonmineral growth is expected to decelerate from current peaks to trend growth rates in the absence of structural reform. Inflation should remain in the middle single digits.

However, macroeconomic vulnerabilities have intensified, in particular, the potential for higher unproductive fiscal spending to raise demand pressures and spur inflation. Additional downside risks include a weaker global economy leading to lower commodity prices, and no action or a reversal of progress on the structural reform agenda. Upside risks include further sustained higher commodity prices, crowding-in of private activity from the increase in public investment, and additional production from existing or new gas and mining projects.

The baseline nonmineral GDP growth rate needs to roughly double over a sustained period to meet the objectives of reduced poverty, significant job creation, and higher development. Given Papua New Guinea's resources, these higher growth rates could be realized if a fiscal-monetary policy mix is pursued that maintains macroeconomic stability, mineral revenues are used productively, and structural reforms are undertaken to remove rigidities constraining private activity so that productivity and investment are raised and sustained.

Executive Board Assessment

Executive Directors commended Papua New Guinea's recent strong economic performance, which reflects a combination of prudent policies and high mineral export prices. Growth has accelerated, inflation has remained low, and external and fiscal vulnerabilities have declined.

While welcoming these achievements, Directors noted that important challenges remain. In particular, conditions need to be created for achieving sustained higher economic growth and putting Papua New Guinea on a solid track to achieve the Millennium Development Goals. Directors encouraged the authorities to continue following an appropriate fiscal-monetary policy mix that would maintain macroeconomic stability, to make productive use of mineral resources, and to accelerate structural reforms in order to remove constraints on non-mineral private-sector activity.

Directors welcomed the generally prudent fiscal policies followed in recent years. They commended the one-off spending increases that have been undertaken to meet infrastructure and social development needs in line with the Medium Term Development Strategy, and the prepayment of public debt. At the same time, Directors stressed that the authorities need to give careful thought to the scale of fiscal expansion over the medium term, given absorptive and administrative capacity constraints and the projected downturn in mineral revenue. They welcomed the authorities' plans to improve expenditure management capacity at the subnational level, and underscored the importance of focusing expenditure on the Medium Term Development Strategy priorities.

Directors encouraged approval of the proposed new Medium-Term Fiscal Strategy, which appropriately focuses on maintaining a stable and sustainable non-mineral fiscal balance. They welcomed the government's debt strategy and the intention to contract new debt only on concessional terms. Directors encouraged the authorities to reinvigorate public sector reforms, particularly measures to improve transparency and accountability, notably with respect to trust funds, publication of audited central government accounts, and public administration. They welcomed recent initiatives to limit tax exemptions and encouraged a resumption of the right-sizing initiative.

Directors considered the current stance of monetary policy to be appropriate, given its success in maintaining low inflation. With the risk of price pressures building from additional fiscal stimulus, Directors welcomed the authorities' readiness to tighten monetary policy as needed, while noting that a tighter fiscal stance may have to contribute to keeping inflation in check. Directors considered that the current managed floating exchange rate policy, which has allowed some reserve build up while protecting competitiveness, is appropriate. They noted the assessment that the level of the exchange rate is broadly in line with fundamentals, and agreed that greater exchange rate flexibility will be needed should sustained pressures emerge.

Directors welcomed the indications that Papua New Guinea's financial sector remains sound. They looked forward to steps to further deepen financial intermediation, strengthen supervision and regulation, and remove institutional rigidities such as weak enforcement of creditor rights and contracts. They also encouraged the authorities to follow through on their stated intention to request a Financial Sector Assessment Program. Regarding the recently-revived Development Bank, Directors recommended that its lending activities be based on proper credit evaluation without political interference.

Directors encouraged the authorities to accelerate structural reform and improve infrastructure. This will be crucial to enhance the investment environment and the competitiveness of the non-mining sectors of the economy, and ultimately to diversify the economic base. Directors highlighted, in particular, the need to strengthen the transportation, communication and power infrastructure, the legal and institutional framework, labor skills and education, and governance. They also noted the improvements in service provision and efficiency that would result from further opening the state-owned enterprise sector to competition.

Directors welcomed the authorities' intention to accelerate efforts to strengthen the quality and timeliness of macroeconomic statistics. They encouraged the authorities to take the steps needed to trigger implementation of the multi-donor technical assistance plan.


Papua New Guinea: Selected Economic Indicators, 200307
 
  2003 2004 2005 2006 2007
        Est.
 

Real sector (percent change)

         

Real GDP growth

2.2 2.7 3.4 2.6 6.2

Mineral

2.8 0.3 5.0 -5.9 4.1

Nonmineral

2.1 3.1 3.1 3.7 6.5

CPI (annual average)

14.7 2.1 1.7 2.3 1.7

Central government budget (percent of GDP)

         

Revenue and grants

29.2 34.1 34.8 36.9 37.8

Expenditure and net lending

30.3 32.4 31.1 30.1 31.8

Overall balance, cash basis (including grants) 1/

-1.8 0.0 3.8 5.7 6.0

Domestic financing (net) 2/

4.0 1.8 -2.7 -4.3 -3.8

Of which: Banking system

-0.9 0.3 -1.2 -1.8 -3.9

External financing (net)

-2.1 -1.8 -1.1 -1.3 -2.1

Money and credit (end-period percentage change)

         

Domestic credit

-7.1 0.7 8.6 19.4 3.7

Net credit to government

-8.3 3.2 -13.9 -13.3 -75.3

Credit to the private sector

-4.1 0.9 23.7 38.2 29.7

Broad money

-4.4 14.8 29.5 38.9 24.7

Interest rate (182-day T-bills, period average) 3/

18.7 3.1 3.8 3.4 4.1

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

         

Exports, f.o.b.

2,153 2,554 3,278 4,205 4,994

Imports, c.i.f.

-1,435 -1,794 -2,462 -2,805 -3,346

Current account (including grants)

159 88 207 163 262

(In percent of GDP)

4.5 2.2 4.2 2.9 4.3

Overall balance

187 206 161 662 673

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

         

Net international reserves

399 599 765 1,427 2,100

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

4.3 5.5 5.2 8.5 11.1

(In months of goods and services imports)

2.1 2.6 2.4 3.8 4.7

Public external debt-to-GDP ratio (in percent) 4/

42.9 36.8 25.8 21.2 17.8

Public external debt-service ratio (percent of GNFS)

7.5 8.7 6.0 3.5 4.0

Exchange rates 3/

         

US$/kina (period average)

0.2814 0.3104 0.3224 0.3272 0.3332

US$/kina (end-period)

0.3000 0.3200 0.3230 0.3300 0.3400

Nominal GDP (millions of kina)

12,567 12,652 15,263 17,051 18,551
 

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/ Figures for 2007 are as of September.
4/ 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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