## CR1722 - 2016. The staff team comprised Clinton Shiells (head), David

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### Recent developments
- Political context and governance
  - Prime Minister survived a vote of no confidence by a margin of 85 to 21.
- Resource endowment and structural constraints
  - PNG is resource-rich (mineral, oil, gas, fisheries, forestry) but structural factors impede private sector development and poverty remains widespread; most recent official poverty rate estimate is 40 percent (from the 2009/10 Household Income and Expenditure Survey).
- Growth, inflation, and external position
  - Strong real GDP growth driven by PNG LNG project during construction through 2014 and as LNG production reached full capacity in 2015; underlying (non-resource sector) growth has moderated since 2012 and is below staff’s rough proxy for potential of 3½–4½ percent per annum.
  - Headline inflation rose from 6 percent in 2015 to 7 percent in 2016.
  - Current account surplus reflects LNG exports and import compression, largely offset by financial account outflows; FX receipts largely held offshore.
  - Gross foreign reserves were US$1.7 billion (3 months of imports) as of October 21.
- Shocks and policy responses
  - Decline in commodity prices and El Niño-related drought in 2015 and early 2016 weakened external and fiscal positions and lowered economic growth; drought caused food shortages and temporary closure of Ok Tedi mine.
  - Authorities cut budgetary expenditures in supplementary 2015 and 2016 budgets and adopted a prudent 2017 budget.
  - Bank of Papua New Guinea (BPNG) imposed an FX trading margin in June 2014; Kina initially appreciated by about 17 percent vis-à-vis the U.S. dollar, then depreciated by 23½ percent; exchange rate largely stable since May 2016 despite FX rationing and unmet demand.
  - Monetary policy transmission impeded by excess liquidity.
- Data revision
  - NSO revised nominal GDP estimates for 2006–13, finding 2013 nominal GDP around 40 percent above earlier estimates; revised nominal GDP implies lower tax, fiscal deficit, and debt ratios (final real GDP levels yet to be released; staff assumes unchanged GDP deflators).

### Outlook and risks
- Near-term outlook
  - Near-term economic growth expected to decline from recent highs due to base effects from LNG production and more modest non-resource growth; modest support from pre-election and APEC-related spending in 2017.
  - Continued moderate real GDP growth consistent with moderate expansion of private sector credit; banks expected to remain highly liquid, sound, and profitable.
- Inflation
  - Headline inflation expected to continue edging upwards in the near term.
- Downside risks (near term)
  - Fiscal consolidation could have a greater-than-expected contractionary impact.
  - Political cycle could increase fiscal pressures.
  - Current FX allocation mechanism may prove unsustainable, risking more rapid and possibly disorderly currency depreciation.
  - Further declines in commodity prices would weaken external and fiscal positions.
  - Natural disasters and weather-related shocks (e.g., drought) remain a risk.
- Upside risks (medium term)
  - Additional LNG capacity expansion: Papua LNG (final investment decision could be taken in 2017, with construction to commence as early as 2018, timetable subject to delays) and PNG LNG extensions could together amount to around the same size as the initial PNG LNG project (which had an approximately US$19 billion investment cost) but are not included in the baseline pending final investment decisions.
  - Other resource developments (e.g., Wafi-Golpu) and improved structural reform implementation and regional trade integration could boost non-resource growth.
- Debt sustainability
  - Debt Sustainability Analysis: risk of debt distress remains low for public and publicly-guaranteed external debt; when factoring public domestic and private external debt the overall risk remains heightened.

### Staff view on macroeconomic policy mix
- General approach
  - Modify policy mix to facilitate adjustment to large terms of trade shock: 2017 budget targets a prudent fiscal deficit balancing debt reduction against growth and poverty impacts, with goal of bringing gross government debt-to-GDP below 30 percent by 2021 consistent with MTFS.
- Fiscal policy
  - Additional revenue measures should be implemented to lessen need for expenditure cuts.
- Exchange rate and monetary policy
  - Greater exchange rate flexibility would strengthen external and fiscal positions and boost net exports contribution to growth.
  - More rapid exchange rate adjustment requires monetary policy tightening to moderate inflationary effects; measures to strengthen monetary policy transmission are needed given large stock of excess liquidity.
  - Excess liquidity partly reflects partially sterilized FX intervention and large money-financed fiscal deficits; limited central bank independence and weak government cash management constrain absorption efforts.

### Improving fiscal stability — findings and measures
- Near-term priorities
  - Expenditure cuts should offset revenue shortfalls and any financing gap; 2017 budget targets strike an appropriate balance though financing constraints may force additional expenditure cuts in remainder of 2016.
- 2015 fiscal outcomes and adjustment
  - Revenues were K3.0 billion (or 5.0 percent of GDP) below original budget estimates, with three-quarters of the shortfall due to lower resource revenues.
  - Expenditures were reduced by K2.7 billion (or 4.6 percent of GDP) relative to the budget.
  - Spending cuts concentrated at national government level with large reductions relative to original projections for health and education and virtually no reduction in provincial/district government expenditure; reports of payment arrears (particularly public sector wages).
  - Proceeds from a large asset sale included in 2015 budget delayed; asset is a 4.27 percent interest in the PNG LNG project, budgeted at K2.5 billion; sale delayed due to disagreements on price and slow landowner vetting; timing unclear.
  - Government securities auctions undersubscribed and financing costs increased; BPNG’s share of domestic debt reached 20 percent in June 2016.
- 2016 financing and supplementary measures
  - A 5-year US$500 million syndicated bank loan will likely finance the 2016 budget deficit; US$200 million first tranche disbursed in August, second tranche under discussion.
  - A debut sovereign bond issuance for $500 million is planned for 2017, market conditions permitting.
  - World Bank and ADB providing project-related support.
  - Domestic financing prospects limited as banks and superannuation funds near internal limits for government securities holdings.
  - 2016 supplementary budget: total revenue and grants expected to fall K1.9 billion (or 3.1 percent of GDP) short of the budget; parliament approved expenditure cuts of K0.9 billion (1.5 percent of GDP) and K1.0 billion in higher revenues from SOE and statutory authority dividends and asset sales (timing and feasibility uncertain).
  - Given external financing of US$500 million (nearly K1.6 billion) from syndicated loan, securing financing for entire projected K3.1 billion deficit is unlikely, necessitating further expenditure cuts; staff suggests concentrating further cuts in provincial/district government spending to minimize adverse growth impact and address weakest PFM and governance.
- 2017 budget and medium-term path
  - 2017 budget: revenues and grants budgeted at K11.5 billion, an increase of K0.7 billion over projected 2016 level (declining by 0.7 percentage points of GDP); expenditures budgeted at K13.4 billion, K0.2 billion lower than 2016 level.
  - Implies fiscal deficit of K1.9 billion (equivalent to 2.8 percent of GDP) and a debt-to-GDP ratio of 33½ percent.
  - Public debt-to-GDP ratio expected to decline over medium term to just under 30 percent of GDP in 2021, in line with MTFS legislated limit of 30 percent.
  - Pace of fiscal consolidation should be carefully calibrated to avoid sharp contraction, implying a more gradual adjustment than specified in MTFS.
  - Over medium term, authorities need to specify revenue and expenditure measures to achieve targeted deficit reduction; National Tax Review offers revenue-side recommendations but contributions must be assessed and quantified.
  - Significant scope exists to increase expenditure efficiency, particularly for provincial/district government capital expenditures.

### Revenue reform: recommendations and rationale
- National Tax Review (completed in October 2015) assessed changes needed to PNG’s tax and non-tax revenue systems to support the government’s sustainable development objectives.
- Key recommendations included:
  - Reductions in personal and corporate income tax rates.
  - Broadening the personal and corporate income tax bases through reduced tax exemptions.
  - Improving the return from natural resource extraction.
  - Increasing consumption tax rates.
  - Reduced state equity participation in the resources sector, to be offset by reforms to the Additional Profit Tax, as well as reforms to other aspects of the mining and petroleum tax regime.
- The Tax Review echoed 2013 FAD TA: the tax arrangements for PNG’s mining and petroleum sectors are very generous compared to other resource rich countries and do not reflect the maturity of the PNG resource sector.
- Fiscal revenues from the resource sector may not improve significantly unless the government avoids granting tax holidays and concessions for subsequent resource projects.

### Tax administration, PFM, and SOF reforms
- Tax administration and compliance
  - Modernization of the Internal Revenue Commission (IRC) and the PNG Customs Service is urgently needed to improve tax administration and compliance.
  - Authorities are assessing and evaluating the National Tax Review recommendations.
  - Authorities indicated it will be difficult to include revenue raising tax policy measures in the 2017 budget given upcoming elections, but will consider raising indirect taxes such as ‘sin taxes’ (excises on alcohol, gambling, and tobacco) and the General Sales Tax (GST).
  - Modernization of IRC and Customs will continue.
- PFM findings and priorities
  - PEFA Assessment underscored need to strengthen PFM.
  - First priority: strengthen core PFM functions to underpin more advanced reforms, including roll out of the new information management system (IFMIS).
  - Passage of an amended PFM Act in August enhances accountability through mandatory audits and enhanced financial controls to statutory bodies such as the IRC and local level governments.
- IFMIS, cash management, and SOE monitoring
  - IFMIS coverage: Thirty-three agencies that account for 95 percent of the national budget are nearly covered by the IFMIS.
  - Cash management: further steps to improve cash management are urgently needed, beginning with tracking inflows from tax and other sources, and ending with tracking of outflows through payments by line ministries.
  - Severe cash management problems should be urgently addressed, including by implementing a new government banking framework, drawing upon recent IMF cash management TA recommendations.
  - Plans exist to improve the public procurement act next year.
  - Financial monitoring and performance of SOEs should be improved.
- Sovereign Wealth Fund (SWF)
  - Legislation to establish the SWF is in place; the SWF should be operationalized as planned in 2016.
  - Little is expected to be saved in the near term under the current contribution rules and conditions.
  - Treasury is working on formation of the board; BPNG is examining possible models for an administrative secretariat at BPNG.
  - A technical report on assessment of existing capacity and possible models was completed in July 2016; BPNG is now developing a suitable model for the secretariat.

### Monetary policy, FX, and liquidity issues
- Exchange rate and FX market
  - The current FX allocation mechanism poses risks for sustainability of the external position and could result in disorderly exchange rate adjustment.
  - Since mid-2014:
    - The nominal value of the Kina depreciated by around 5 percent against the Australian dollar.
    - In real effective terms the Kina depreciated by only 2 percent.
  - Trading margin introduced in 2014: 75 basis points above and below the daily interbank rate.
  - FX market shortages and rationing:
    - Staff found an additional restriction on current international payments and two multiple currency practices (MCPs) inconsistent with Article VIII.
    - FX orders were prioritized for import payments and among these prioritized for selected importers, causing shortages, delays, and arrears in current international payments.
    - Indications that the reference rate/mid-rate is not truly market determined.
    - Two MCPs observed: (1) deviation of more than 2 percent between rates used by BPNG for allocations to AFEDs and rates used by AFEDs with clients; (2) potential spread deviations of more than 2 percent between rates set by BPNG for its transactions and rates used by AFEDs with clients.
  - BPNG FX intervention:
    - In 2015 BPNG spent nearly US$830 million in FX intervention, which was insufficient to clear FX demand.
    - By limiting FX sales, BPNG avoided large reserve losses.
  - Staff recommendations on FX and exchange rate policy:
    - Allow greater flexibility in the Kina/USD exchange rate to act as a shock absorber.
    - Return to a more effective auction system for FX to allocate reserves more transparently and efficiently.
    - Follow-up Fund TA could help develop measures to increase market efficiency and transparency.
    - Risks of faster depreciation include higher inflation; these should be contained by tightening liquidity.
- Liquidity, monetary transmission, and policy recommendations
  - The Kina Facility Rate (KFR) has been on hold at 6.25 percent since early 2013, which is roughly zero in real terms.
  - Monetary policy effectiveness is constrained by excess liquidity; changes in the monetary policy interest rate are not effective due to excess liquidity.
  - Staff advised BPNG to absorb excess liquidity by:
    - Active sterilization.
    - Stop monetizing the fiscal deficit.
    - Improve liquidity management, drawing on MCM TA recommendations.
    - Move government funds from the banks to the BPNG.
    - Apply an additional reserve requirement to government funds held in commercial banks until transfer is complete.
    - Issue central bank bills to absorb liquidity and allow higher reserve requirements to be phased out.
  - BPNG announced plans in March to change the policy interest rate specification from the overnight KFR to the 63-day Treasury bill yield; staff noted that without liquidity adjustments this change is unlikely to be effective and that any new policy rate should be an overnight or shorter-term rate.

### Banking system and financial sector
- Banking system soundness and key indicators (June 2016)
  - Three large banks (two Australian and one domestic) dominate credit provision.
  - Return on assets is around 2.0 percent (June 2016) and has averaged a healthy 2.5 percent over the last 10 years.
  - Capital adequacy ratio is 32.3 percent (June 2016).
  - The ratio of non-performing plus past-due loans to total risk-weighted assets is currently around 6 percent (June 2016), above the stable 10-year average of around 5 percent.
  - Banks hold around half of their assets as loans, with the other half held largely as short-term securities and cash.
  - Banks’ holdings of government securities account for nearly one third of their total assets.
  - Commercial bank lending to SOEs has been minimal, with one exception where an SOE borrowed to make a dividend payment.
  - Given high banking system liquidity and structural constraints on private credit growth, BPNG should focus macro-financial surveillance on identifying any pockets of credit growth that could create spillover risks.
- Financial depth, inclusion, and payments
  - PNG’s ratio of domestic private credit to GDP is well below the average for East Asia and Pacific developing countries, Pacific Island Small States, and other Middle Income Countries.
  - PNG remains among the most underbanked countries on several indicators (numbers of branches, ATMs, and loan penetration).
  - Mobile access has been expanding.
  - The Bank of Papua New Guinea’s new KATS system represents substantial progress in payment system development and efficiency.
  - Credit unions, though tiny compared to banks, play a critical role in rural financial service provision and are in some cases the only provider.
  - New credit union legislation will help modernize the sector but requires supporting regulations and guidelines.
- AML/CFT and correspondent banking
  - PNG exited the Financial Action Task Force (FATF) “gray” list in June 2016 due to significant progress in enhancing the legal and regulatory framework.
  - Measures implemented after July 2015 AML/CFT legislation included recruitment of key personnel for the Financial Analysis and Supervision Unit (FASU).
  - Some financial institutions and money remitters previously experienced withdrawal of CBRs amid increased regulatory compliance costs and FATF listing; however, the volume of CBR transactions increased, suggesting consolidation of CBRs in other institutions.
  - Authorities are encouraged to continue enhancing compliance of regulatory and supervisory frameworks with international standards, including for AML/CFT, to mitigate risks of further CBR withdrawals.

### Major fiscal, external, and monetary statistics (selected exact figures)
- Nominal GDP (2015): US$21.2 billion 1/
- Population (2015): 7.6 million
- GDP per capita (2015): US$2,745
- Real GDP growth (annual): 2012 "6.1"; 2013 "4.7"; 2014 "7.4"; 2015 "6.6"; 2016 "2.5"; 2017 "3.0"
- Terms of trade (2010=100, end-period): 2012 "116.3"; 2013 "113.9"; 2014 "106.2"; 2015 "100.0"; 2016 "93.1"; 2017 "92.6"
- Gross official international reserves (millions of U.S. dollars): 2012 "4,001"; 2013 "2,826"; 2014 "2,305"; 2015 "1,865"; 2016 "1,744"; 2017 "1,829"
- Central government revenue and grants (millions of Kina): 2012 "9,419"; 2013 "9,897"; 2014 "11,875"; 2015 "10,776"; 2016 "10,764"; 2017 Proj.: "11,449"
- Resource revenue (millions of Kina): 2012 "1,117"; 2013 "667"; 2014 "1,301"; 2015 "652"; 2016 "478"; 2017 Proj.: "729"
- Expenditure and net lending (millions of Kina): Expenditure (2012) "9,947"; (2017 Proj.) "13,350"; Net lending(+)/borrowing(-) (2012) "-528"; (2017 Proj.) "-1,901"
- Gross government debt (millions of Kina): 2012 "8,486"; 2013 "11,878"; 2014 "15,365"; 2015 "17,967"; 2016 "20,752"; 2017 Proj.: "23,010"
- Gross government debt, percent of GDP (2012–2017): 2012 "19.1"; 2013 "25.0"; 2014 "28.1"; 2015 "30.4"; 2016 "33.5"; 2017 Proj.: "33.5"

### Medium-term projections (selected from Table 5, 2018–2021)
- Real GDP growth: 2018 "3.2"; 2019 "3.4"; 2020 "3.4"; 2021 "3.4"
- Resource growth: 2018 "-0.3"; 2019 "-0.3"; 2020 "-0.3"; 2021 "-0.3"
- Nonresource growth: 2018 "3.8"; 2019 "3.9"; 2020 "3.9"; 2021 "3.9"
- CPI (period average): 2018 "6.5"; 2019 "6.0"; 2020 "6.0"; 2021 "6.0"
- Gross public debt (percent of GDP): 2018 "33.5"; 2019 "33.3"; 2020 "32.6"; 2021 "31.6"
- Current account (millions of U.S. dollars): 2018 "1,371"; 2019 "1,302"; 2020 "1,259"; 2021 "1,123"
- Gross official reserves (millions of U.S. dollars): 2018 "2,200"; 2019 "2,343"; 2020 "2,650"; 2021 "3,272"
- Assumed commodity prices (selected): Oil (U.S. dollars per barrel) 2018 "50.64"; 2019 "53.09"; 2020 "54.44"; 2021 "56.29"

### Debt Sustainability Analysis — key findings and exact figures
- DSA conclusion: risk of debt distress remains low for PPG external debt; overall risk heightened when public domestic and private external debt are included.
- Selected exact numeric indicators and projections cited in the DSA:
  - Central government debt to GDP: 30 percent as of end-2015.
  - Treasury bills share of total domestic financing: 45 percent in 2012; 48 percent in 2015.
  - Unfunded superannuation liabilities: 3½ percent of 2016 GDP.
  - New commercial loan: US$500 million (assumed 5-year term at 7 percent; assumed continually refinanced).
  - Interest payments: doubled between 2012 and 2015; expected to triple in 2016.
  - Primary fiscal balance: 2.0 percent of GDP in deficit in 2016; projected to improve to a deficit of around 0.3 percent thereafter.
  - Real GDP growth assumption (medium/long run): 3.4 percent.
  - Inflation assumptions: peak 7.5 percent in 2017; 6 percent in medium/long term.

### Public Expenditure and Financial Accountability (PEFA) — principal findings (Box 3)
- Policy-based planning and medium-term budgeting: orderly and well understood; medium-term dimension embedded though expenditure ceilings applied one year ahead and did not cover half of capital/development expenditure.
- Budget comprehensiveness and transparency: limited; presentation could be more analytical and open to scrutiny; unreported government operations appear large.
- Predictability and control in budget execution: weak; transfers poorly accounted; bank reconciliations delayed; cash flow forecasts unreliable to executing departments; payroll controls weak.
- External scrutiny and audit performance: weak; little evidence recommendations followed up; accountability mechanisms lacking.
- Asset and liability management, and investment appraisal: weak; statutory bodies have long delays in reporting; capital budgets fragmented; few departments undertake rigorous investment analysis.
- Accounting, recording, and reporting: hampered by unreliable records; public financial statements submitted for audit 15-16 months after year-end (3-6 months is standard).

### Risk Assessment Matrix — selected risks and staff advice
- External risks
  - Structurally weak growth in key advanced and emerging economies: Relative Likelihood H/M; Impact if Realized H. Staff advice: Allow the kina to depreciate; accelerate structural reforms; allow automatic stabilizers if financing permits.
  - Reduced financial services by global/regional banks ("de-risking"): Relative Likelihood H; Impact if Realized M. Staff advice: Upgrade regulatory and supervisory frameworks, especially AML/CFT and tax transparency.
- Domestic risks
  - Further shortfalls in financing leading to monetization of the fiscal deficit and/or spending cuts: Relative Likelihood M/H; Impact if Realized M/H. Staff advice: Avoid deficit financing by the central bank; focus spending cuts on low impact areas; improve cash management.
  - Political instability and worsening security: Relative Likelihood M; Impact if Realized M/H. Staff advice: Resist monetary accommodation of fiscal expansion; focus increased spending on security with greater fiscal transparency.
  - Natural disasters: Relative Likelihood M; Impact if Realized M/H. Staff advice: Ensure fiscal buffers; spend more on preparation and prevention; encourage disaster insurance uptake.
- Relative Likelihood terminology note:
  - “low” = probability below 10 percent; “medium” = between 10 and 30 percent; “high” = 30 percent or more.

### Authorities’ responses to Fund advice (selected)
- Monetary, Financial and Exchange Rate Policies
  - Policy actions: Increased issuance of government securities and BPNG FX intervention diffused some excess liquidity; CRR kept at 10 percent since September 2014; BPNG considers tightening if necessary.
  - Official interbank exchange rate almost unchanged since May 2016 because BPNG considers greater depreciation inflationary.
  - Legal and regulatory framework established to address AML/CFT deficiencies; PNG no longer subject to FATF monitoring since June 2016.
- Fiscal Policy
  - Policy actions: 2017 budget passed to address revenue shortfalls and cut expenditures in November 2016; budget seeks expenditure savings from overseas travel and recruitment and control of capital expenditures.
  - Tax reforms: only minor amendments in 2016; plans to begin implementing National Tax Review reforms in 2017 including: extending the tax base via compliance; increasing taxable component of employer provided housing benefit; imposing additional profits tax to new mining and petroleum projects; uplifting exemption from interest withholding tax for foreign lenders lending to resource companies; raising some tax rates.
  - Formalizing SWF administrative secretariat at BPNG.

### Technical assistance, data, and IMF relations (selected)
- Technical assistance from Headquarters in FAD, LEG, MFD/MCM, STA across fiscal transparency, tax administration, bank regulation, liquidity management, statistics, and SWF.
- PFTAC assistance highlighted in PFM, tax administration IT system rollout, national accounts support, and IFMS expansion.
- Statistical issues: NSO published nominal GDP estimates for 2006–2013 in May 2016; real GDP estimates for 2006–2013 still being verified; source data gaps remain for extractive and financial industries; CPI updated in May 2014 using 2009–2010 HIES.
- Fund relations key data (as of September 30, 2016): Quota: 131.60 SDR Million (100.00 percent quota); Fund holdings of currency: 131.16 SDR Million (99.66 percent quota).

*IMF staff report: CR1722 - 2016.*

### 2016. The staff team comprised Clinton Shiells (head), David

### CR1722 - 2016. The staff team comprised Clinton Shiells (head), David

### Recent developments
- Political context and governance
  - Prime Minister survived a vote of no confidence by a margin of 85 to 21.
- Resource endowment and structural constraints
  - PNG is resource-rich (mineral, oil, gas, fisheries, forestry) but structural factors impede private sector development and poverty remains widespread; most recent official poverty rate estimate is 40 percent (from the 2009/10 Household Income and Expenditure Survey).
- Growth, inflation, and external position
  - Strong real GDP growth driven by PNG LNG project during construction through 2014 and as LNG production reached full capacity in 2015; underlying (non-resource sector) growth has moderated since 2012 and is below staff’s rough proxy for potential of 3½–4½ percent per annum.
  - Headline inflation rose from 6 percent in 2015 to 7 percent in 2016.
  - Current account surplus reflects LNG exports and import compression, largely offset by financial account outflows; FX receipts largely held offshore.
  - Gross foreign reserves were US$1.7 billion (3 months of imports) as of October 21.
- Shocks and policy responses
  - Decline in commodity prices and El Niño-related drought in 2015 and early 2016 weakened external and fiscal positions and lowered economic growth; drought caused food shortages and temporary closure of Ok Tedi mine.
  - Authorities cut budgetary expenditures in supplementary 2015 and 2016 budgets and adopted a prudent 2017 budget.
  - Bank of Papua New Guinea (BPNG) imposed an FX trading margin in June 2014; Kina initially appreciated by about 17 percent vis-à-vis the U.S. dollar, then depreciated by 23½ percent; exchange rate largely stable since May 2016 despite FX rationing and unmet demand.
  - Monetary policy transmission impeded by excess liquidity.
- Data revision
  - NSO revised nominal GDP estimates for 2006–13, finding 2013 nominal GDP around 40 percent above earlier estimates; revised nominal GDP implies lower tax, fiscal deficit, and debt ratios (final real GDP levels yet to be released; staff assumes unchanged GDP deflators).

### Outlook and risks
- Near-term outlook
  - Near-term economic growth expected to decline from recent highs due to base effects from LNG production and more modest non-resource growth; modest support from pre-election and APEC-related spending in 2017.
  - Continued moderate real GDP growth consistent with moderate expansion of private sector credit; banks expected to remain highly liquid, sound, and profitable.
- Inflation
  - Headline inflation expected to continue edging upwards in the near term.
- Downside risks (near term)
  - Fiscal consolidation could have a greater-than-expected contractionary impact.
  - Political cycle could increase fiscal pressures.
  - Current FX allocation mechanism may prove unsustainable, risking more rapid and possibly disorderly currency depreciation.
  - Further declines in commodity prices would weaken external and fiscal positions.
  - Natural disasters and weather-related shocks (e.g., drought) remain a risk.
- Upside risks (medium term)
  - Additional LNG capacity expansion: Papua LNG (final investment decision could be taken in 2017, with construction to commence as early as 2018, timetable subject to delays) and PNG LNG extensions could together amount to around the same size as the initial PNG LNG project (which had an approximately US$19 billion investment cost) but are not included in the baseline pending final investment decisions.
  - Other resource developments (e.g., Wafi-Golpu) and improved structural reform implementation and regional trade integration could boost non-resource growth.
- Debt sustainability
  - Debt Sustainability Analysis: risk of debt distress remains low for public and publicly-guaranteed external debt; when factoring public domestic and private external debt the overall risk remains heightened.

### Staff view on macroeconomic policy mix
- General approach
  - Modify policy mix to facilitate adjustment to large terms of trade shock: 2017 budget targets a prudent fiscal deficit balancing debt reduction against growth and poverty impacts, with goal of bringing gross government debt-to-GDP below 30 percent by 2021 consistent with MTFS.
- Fiscal policy
  - Additional revenue measures should be implemented to lessen need for expenditure cuts.
- Exchange rate and monetary policy
  - Greater exchange rate flexibility would strengthen external and fiscal positions and boost net exports contribution to growth.
  - More rapid exchange rate adjustment requires monetary policy tightening to moderate inflationary effects; measures to strengthen monetary policy transmission are needed given large stock of excess liquidity.
  - Excess liquidity partly reflects partially sterilized FX intervention and large money-financed fiscal deficits; limited central bank independence and weak government cash management constrain absorption efforts.

### Improving fiscal stability — findings and measures
- Near-term priorities
  - Expenditure cuts should offset revenue shortfalls and any financing gap; 2017 budget targets strike an appropriate balance though financing constraints may force additional expenditure cuts in remainder of 2016.
- 2015 fiscal outcomes and adjustment
  - Revenues were K3.0 billion (or 5.0 percent of GDP) below original budget estimates, with three-quarters of the shortfall due to lower resource revenues.
  - Expenditures were reduced by K2.7 billion (or 4.6 percent of GDP) relative to the budget.
  - Spending cuts concentrated at national government level with large reductions relative to original projections for health and education and virtually no reduction in provincial/district government expenditure; reports of payment arrears (particularly public sector wages).
  - Proceeds from a large asset sale included in 2015 budget delayed; asset is a 4.27 percent interest in the PNG LNG project, budgeted at K2.5 billion; sale delayed due to disagreements on price and slow landowner vetting; timing unclear.
  - Government securities auctions undersubscribed and financing costs increased; BPNG’s share of domestic debt reached 20 percent in June 2016.
- 2016 financing and supplementary measures
  - A 5-year US$500 million syndicated bank loan will likely finance the 2016 budget deficit; US$200 million first tranche disbursed in August, second tranche under discussion.
  - A debut sovereign bond issuance for $500 million is planned for 2017, market conditions permitting.
  - World Bank and ADB providing project-related support.
  - Domestic financing prospects limited as banks and superannuation funds near internal limits for government securities holdings.
  - 2016 supplementary budget: total revenue and grants expected to fall K1.9 billion (or 3.1 percent of GDP) short of the budget; parliament approved expenditure cuts of K0.9 billion (1.5 percent of GDP) and K1.0 billion in higher revenues from SOE and statutory authority dividends and asset sales (timing and feasibility uncertain).
  - Given external financing of US$500 million (nearly K1.6 billion) from syndicated loan, securing financing for entire projected K3.1 billion deficit is unlikely, necessitating further expenditure cuts; staff suggests concentrating further cuts in provincial/district government spending to minimize adverse growth impact and address weakest PFM and governance.
- 2017 budget and medium-term path
  - 2017 budget: revenues and grants budgeted at K11.5 billion, an increase of K0.7 billion over projected 2016 level (declining by 0.7 percentage points of GDP); expenditures budgeted at K13.4 billion, K0.2 billion lower than 2016 level.
  - Implies fiscal deficit of K1.9 billion (equivalent to 2.8 percent of GDP) and a debt-to-GDP ratio of 33½ percent.
  - Public debt-to-GDP ratio expected to decline over medium term to just under 30 percent of GDP in 2021, in line with MTFS legislated limit of 30 percent.
  - Pace of fiscal consolidation should be carefully calibrated to avoid sharp contraction, implying a more gradual adjustment than specified in MTFS.
  - Over medium term, authorities need to specify revenue and expenditure measures to achieve targeted deficit reduction; National Tax Review offers revenue-side recommendations but contributions must be assessed and quantified.
  - Significant scope exists to increase expenditure efficiency, particularly for provincial/district government capital expenditures.

*IMF staff report: CR1722 - 2016.*

### 14. Going forward, a comprehensive revenue reform would help raise revenue collections

### 14. Going forward, a comprehensive revenue reform would help raise revenue collections

### Revenue reform: recommendations and rationale
- National Tax Review (completed in October 2015) assessed changes needed to PNG’s tax and non-tax revenue systems to support the government’s sustainable development objectives.
- Key recommendations included:
  - Reductions in personal and corporate income tax rates.
  - Broadening the personal and corporate income tax bases through reduced tax exemptions.
  - Improving the return from natural resource extraction.
  - Increasing consumption tax rates.
  - Reduced state equity participation in the resources sector, to be offset by reforms to the Additional Profit Tax, as well as reforms to other aspects of the mining and petroleum tax regime.
- The Tax Review echoed 2013 FAD TA: the tax arrangements for PNG’s mining and petroleum sectors are very generous compared to other resource rich countries and do not reflect the maturity of the PNG resource sector.
- Fiscal revenues from the resource sector may not improve significantly unless the government avoids granting tax holidays and concessions for subsequent resource projects.

### Tax administration and compliance
- Modernization of the Internal Revenue Commission (IRC) and the PNG Customs Service is urgently needed to improve tax administration and compliance.
- The authorities are assessing and evaluating the National Tax Review recommendations.
- Authorities indicated it will be difficult to include revenue raising tax policy measures in the 2017 budget given upcoming elections, but will consider raising indirect taxes such as ‘sin taxes’ (excises on alcohol, gambling, and tobacco) and the General Sales Tax (GST).
- Modernization of IRC and Customs will continue.

### Public financial management (PFM): findings and reform priorities
- The recently published Public Expenditure and Financial Accountability (PEFA) Assessment underscored the need to strengthen PFM.
- Much scope remains to better deploy existing public sector resources towards effective public service delivery, including in education, health, and law and order.
- The authorities developed a high-level PFM reform strategy, the PEFA Road Map 2015-18, to address deficiencies identified in the PEFA.
- First priority: strengthen core PFM functions to underpin more advanced reforms, including roll out of the new information management system (IFMIS).
- The road map should be complemented by fully articulated action plans and present more explicitly the role of line ministries.
- Passage of an amended PFM Act in August enhances accountability through mandatory audits and enhanced financial controls to statutory bodies such as the IRC and local level governments.

### IFMIS rollout, cash management, and SOE monitoring
- IFMIS coverage: Thirty-three agencies that account for 95 percent of the national budget are nearly covered by the IFMIS.
- Cash management: further steps to improve cash management are urgently needed, beginning with tracking inflows from tax and other sources, and ending with tracking of outflows through payments by line ministries.
- Severe cash management problems should be urgently addressed, including by implementing a new government banking framework, drawing upon recent IMF cash management TA recommendations.
- Plans exist to improve the public procurement act next year.
- Financial monitoring and performance of SOEs should be improved.

### Sovereign Wealth Fund (SWF)
- Legislation to establish the SWF is in place; the SWF should be operationalized as planned in 2016.
- Little is expected to be saved in the near term under the current contribution rules and conditions.
- Treasury is working on formation of the board; BPNG is examining possible models for an administrative secretariat at BPNG.
- A technical report on assessment of existing capacity and possible models was completed in July 2016; BPNG is now developing a suitable model for the secretariat.

### Fiscal stance, targets, and key fiscal statistics
- Authorities aim to achieve the MTFS objective of a balanced budget by 2021; public debt will remain sustainable through the medium term.
- Fiscal deficit trajectory (in percent of GDP) shown in source:
  - -5.1
  - -4.4
  - -2.8
  - -2.4
  - -2.0
  - -1.5
  - -0.8
- Public debt (in percent of GDP) shown in source:
  - 30.4
  - 33.5
  - 33.5
  - 33.3
  - 32.6
  - 31.6
  - 29.9

### Monetary policy, exchange rate, and FX market issues
- The current FX allocation mechanism poses risks for sustainability of the external position and could result in disorderly exchange rate adjustment.
- Greater exchange rate flexibility and improved market efficiency and transparency would reduce the cost of adjustment to lower commodity prices and curtail risks.
- Since mid-2014:
  - The nominal value of the Kina depreciated by around 5 percent against the Australian dollar.
  - In real effective terms the Kina depreciated by only 2 percent.
- Trading margin introduced in 2014: 75 basis points above and below the daily interbank rate.
- FX market shortages and rationing:
  - Staff found an additional restriction on current international payments and two multiple currency practices (MCPs) inconsistent with Article VIII.
  - FX orders were prioritized for import payments and among these prioritized for selected importers, causing shortages, delays, and arrears in current international payments.
  - Indications that the reference rate/mid-rate is not truly market determined.
  - Two MCPs observed: (1) deviation of more than 2 percent between rates used by BPNG for allocations to AFEDs and rates used by AFEDs with clients; (2) potential spread deviations of more than 2 percent between rates set by BPNG for its transactions and rates used by AFEDs with clients.
- BPNG FX intervention:
  - Between 2010 and 2012 FX supply was abundant; reversed in 2013 as FDI inflows declined and commodity prices fell.
  - In 2015 BPNG spent nearly US$830 million in FX intervention, which was insufficient to clear FX demand.
  - By limiting FX sales, BPNG avoided large reserve losses.
- Staff recommendations on FX and exchange rate policy:
  - Allow greater flexibility in the Kina/USD exchange rate to act as a shock absorber.
  - Return to a more effective auction system for FX to allocate reserves more transparently and efficiently.
  - Follow-up Fund TA could help develop measures to increase market efficiency and transparency.
  - Risks of faster depreciation include higher inflation; these should be contained by tightening liquidity.

### Liquidity, monetary transmission, and policy recommendations
- The Kina Facility Rate (KFR) has been on hold at 6.25 percent since early 2013, which is roughly zero in real terms.
- Monetary policy effectiveness is constrained by excess liquidity; changes in the monetary policy interest rate are not effective due to excess liquidity.
- The current liquidity overhang has not produced rapid private credit growth because of long-standing structural impediments (law and order, contract enforceability, property rights, land tenure).
- Staff advised BPNG to absorb excess liquidity by:
  - Active sterilization.
  - Stop monetizing the fiscal deficit.
  - Improve liquidity management, drawing on MCM TA recommendations.
  - Move government funds from the banks to the BPNG.
  - Apply an additional reserve requirement to government funds held in commercial banks until transfer is complete.
  - Issue central bank bills to absorb liquidity and allow higher reserve requirements to be phased out.
- BPNG announced plans in March to change the policy interest rate specification from the overnight KFR to the 63-day Treasury bill yield; staff noted that without liquidity adjustments this change is unlikely to be effective and that any new policy rate should be an overnight or shorter-term rate.

### Authorities’ views (selected)
- Government remains committed to existing fiscal anchors; fiscal discipline through expenditure cuts and supplementary budgets are important.
- Two priorities for the 2017 budget: the general election and APEC preparations; government will likely be unable to increase national infrastructure spending next year.
- The prospect of issuing a debut sovereign bond has served as a disciplining device for macro policies.
- Authorities reported an increase in FX inflows starting in Q2 2016, particularly from mining and agriculture, and argued the Kina is not overvalued in BPNG’s view.
- Authorities disagreed with staff’s findings of Article VIII breaches; BPNG states it does not impose restrictions on commercial banks’ operations in the spot FX market.
- BPNG considers inflation outcomes manageable and plans to maintain a neutral monetary policy stance in the coming months; it may adjust the stance if necessary.
- Authorities agreed to open new trust accounts at the BPNG, with payments to be made using the Kina Automated Transfer System (KATS), while leaving existing trust accounts in place.

*Source: IMF country report section titled "14. Going forward, a comprehensive revenue reform would help raise revenue collections."*

### 30. The highly liquid banking system is sound and profitable, while PNG’s financial sector

### The highly liquid banking system is sound and profitable, while PNG’s financial sector

### Banking system soundness and key indicators
- Three large banks (two Australian and one domestic) dominate credit provision.
- Return on assets is around 2.0 percent (June 2016) and has averaged a healthy 2.5 percent over the last 10 years.
- Capital adequacy ratio is 32.3 percent (June 2016).
- The ratio of non-performing plus past-due loans to total risk-weighted assets is currently around 6 percent (June 2016), above the stable 10-year average of around 5 percent.
- Banks hold around half of their assets as loans, with the other half held largely as short-term securities and cash.
- Banks’ holdings of government securities account for nearly one third of their total assets.
- Commercial bank lending to SOEs has been minimal, with one exception where an SOE borrowed to make a dividend payment.
- Given high banking system liquidity and structural constraints on private credit growth, BPNG should focus macro-financial surveillance on identifying any pockets of credit growth that could create spillover risks.

### Financial depth, inclusion, and payment system developments
- PNG’s ratio of domestic private credit to GDP is well below the average for East Asia and Pacific developing countries, Pacific Island Small States, and other Middle Income Countries.
- PNG remains among the most underbanked countries on several indicators (numbers of branches, ATMs, and loan penetration).
- Mobile access has been expanding.
- The Bank of Papua New Guinea’s new KATS system represents substantial progress in payment system development and efficiency.
- Credit unions, though tiny compared to banks, play a critical role in rural financial service provision and are in some cases the only provider.
- New credit union legislation will help modernize the sector but requires supporting regulations and guidelines.

### AML/CFT progress and correspondent banking relationships (CBRs)
- PNG exited the Financial Action Task Force (FATF) “gray” list in June 2016 due to significant progress in enhancing the legal and regulatory framework.
- Measures implemented after July 2015 AML/CFT legislation included recruitment of key personnel for the Financial Analysis and Supervision Unit (FASU).
- In May 2016, the Asia Pacific Group conducted an onsite audit of progress, contributing to FATF delisting in June 2016.
- Some financial institutions and money remitters previously experienced withdrawal of CBRs amid increased regulatory compliance costs and FATF listing; however, the volume of CBR transactions increased, suggesting consolidation of CBRs in other institutions.
- Authorities are encouraged to continue enhancing compliance of regulatory and supervisory frameworks with international standards, including for AML/CFT, to mitigate risks of further CBR withdrawals.

### Authorities’ views on financial sector conditions
- The banking system remains sound and stable.
- Credit growth was slow last year reflecting the drought and Ok Tedi mine closure.
- Real estate prices grew modestly; excess office space and rentals have come down since 2012-13, and banks are very cautious.
- A new law on credit unions is potentially important for increasing financial inclusion.
- The authorities will continue to implement structural reforms to boost investments and broaden the tax base through non-mineral sector growth, especially agriculture, and will encourage and support SMEs via training and financial inclusion initiatives.

### Structural reforms for inclusive growth and private sector development
- Priority reforms to support non-resource sector SMEs:
  - Improve infrastructure, notably access to affordable electricity, road construction, air and sea transportation.
  - Implement the authorities’ financial inclusion strategy to improve access to financing.
  - Strengthen law and order.
- Agriculture and tourism identified as important sources of diversification and employment.
- Restrictions on foreign investors may adversely affect private sector growth; measures to increase competition are recommended.
- Tax reform and enhanced transparency can better leverage non-renewable resource sector wealth.
- PNG published its first Extractive Industries Transparency Initiative (EITI) report, highlighting deficiencies in resource sector reporting, including by large multinational firms.

### Major mining and petroleum project pipeline (selected facts)
- As of March 2016:
  - 123 active exploration licenses.
  - 68 exploration licenses pending renewal.
  - 72 new applications for exploration licenses with the Mineral Resources Authority of PNG.
- Papua LNG project: joint venture participants and expected production:
  - Total SA (40.1 percent, operator), InterOil (36.5 percent), Oil Search (23 percent).
  - Expected to produce around 7 million tons annually.
  - Construction had been earmarked for 2018 but could be delayed.
- Nautilus Solwara 1: world’s first deep seabed mining project; mining was expected to start in the first half of 2018 but could be delayed due to funding constraints.
- Wafi-Golpu: 4.8 million tons of copper and 11 million ounces of gold; peak annual production expected at 150,000 tons of copper and 320,000 ounces of gold; estimated mine life of 23–30 years.
- Other notable projects include Frieda River, Crater Mountain, Mt. Kare, Yandera, Hessen Bay, Woodlark, Mayur Resources projects, Kili Teke, Paguna re-development possibilities, and several potential gas developments (Stanley condensate stripping, P’nyang field, aggregation in Western province, Pandora gas project).

### Statistics, PFM, and fiscal policy priorities
- Sustained effort to improve macroeconomic statistics is underway, but further progress is needed, especially in balance of payments, international investment position, and public data dissemination.
- Government Financial Statistics framework is being updated; PNG is about to report in the Government Financial Statistics Yearbook for the first time.
- The first PEFA Assessment since 2009 (finalized August 2015) found mixed performance:
  - Stronger scores for credibility of fiscal strategy and budget, and policy-based planning and budgeting.
  - Weaker performance in fiscal accounting/reporting, management and acquisition of assets and liabilities, transparency and auditing, and budget control and execution.
- Authorities have developed a high-level PFM reform strategy with first priority on strengthening core PFM functions, including roll out of the new information management system.
- The SWF should be put into operation as soon as possible to improve transparency and ensure consistent use of resource revenue for macroeconomic stabilization and saving.

### Staff appraisal and policy recommendations
- PNG has been hit hard by lower world commodity prices and a major drought; authorities responded with fiscal tightening, modest exchange rate depreciation, and FX sales.
- Additional fiscal adjustment is needed to ensure debt sustainability over the medium term.
- Passage of a prudent 2017 budget is commended; continued fiscal consolidation should be anchored by the existing 30 percent public debt-to-GDP fiscal anchor.
- Greater revenue mobilization is needed; measures from the National Tax Review should be adopted and tax compliance improved.
- Government expenditure quality should be improved through PFM reform and better deployment of public resources, especially for health and education.
- Greater exchange rate flexibility and a more efficient and transparent FX allocation mechanism are urgently needed:
  - Lack of exchange rate flexibility has impeded adjustment to lower commodity prices and weakened external and fiscal positions.
  - Monetary policy tightening would be needed to counter pass-through of depreciation into inflation, but transmission is impeded by excessive banking system liquidity, implying need for measures to absorb excess liquidity.
  - Staff does not recommend Fund approval of retention of exchange restriction arising from FX prioritization and rationing of FX, of the tax clearance certificate requirement, and of the MCPs because they are not temporary and lack a timetable for elimination.
- Acceleration of structural reform is key to private sector development; business environment improvements, especially for agriculture and SMEs, are essential.
- More decisive action is needed to improve macroeconomic statistics; priorities include balance of payments, international investment position, and debt data.
- It is proposed that the next Article IV consultation with PNG will be held on the standard 12-month cycle.

_International Monetary Fund staff summary as presented in the source document._

### Box 3. Papua New Guinea: Public Expenditure and Financial Accountability Assessment

### Box 3. Papua New Guinea: Public Expenditure and Financial Accountability Assessment

### Policy-based planning and medium-term budgeting
- Policy-based planning and budgeting was orderly and well understood.
- Progress has been made in embedding the medium-term dimension into fiscal planning.
- Expenditure and ceilings for agencies were only applied one year into the future.
- Expenditure ceilings did not cover half of the budget representing capital/development expenditure.

### Budget comprehensiveness and transparency
- The comprehensiveness and transparency of the budget was limited.
- The presentation could be more analytical and open to external scrutiny and policy accountability.
- The extent of unreported government operations appears to be large.

### Predictability and control in budget execution
- Predictability and control in budget execution is weak.
- Transfers related to the government’s main operational account are poorly accounted for.
- Bank reconciliations are often delayed.
- Cash flow forecasts are prepared, but information provided to executing departments is not reliable.
- Rules for reallocation are not always respected.
- Payroll controls are weak and compromised by the decentralization of responsibility to departments and provinces/districts.

### External scrutiny, audit performance, and accountability
- External scrutiny and audit performance is weak.
- There is little evidence that recommendations are followed up systematically.
- The absence of effective accountability mechanisms, legal recourse to impose penalties on non-complying officials, and related concerns undermine follow-up.

### Asset and liability management, and investment appraisal
- Asset and liability management is weak.
- Numerous statutory bodies fulfill a range of commercial, social and regulatory functions, often with long delays in reporting.
- Preparation of capital budgets appeared fragmented.
- Few departments undertake rigorous economic analyses of investment projects.
- The legal basis for borrowing and issuing guarantees was deemed unclear, fragmented, and contradictory.

### Accounting, recording, and reporting
- Accounting, recording, and reporting are hampered by unreliable records.
- Bank reconciliations are not carried out in a timely manner.
- The coverage and classification of data do not allow direct comparisons with the original budget.
- No recognized accounting standards are used to prepare public financial statements.
- Public financial statements are only submitted for audit 15-16 months after the end of the year (3-6 months is standard).

*IMF staff assessment as presented in Box 3 of the Papua New Guinea Public Expenditure and Financial Accountability Assessment (concluded).*

### Introduction

### cr1722 - Introduction

### External Sector
- Commencement of LNG exports:
  - "has pulled the current account into surplus."
- Exports composition:
  - "hydrocarbons now represent the bulk of exports, alongside metals."
- External flows and exchange rate:
  - "Higher exports are offset by financial account outflows, contributing to a shortage of FX and nominal exchange rate depreciation..."
  - "less adjustment has occurred in the real effective exchange rate and against key trading partner currencies."
  - "The BPNG has intervened to slow the pace of exchange rate depreciation..."
  - "and as a result reserves have fallen (equivalent to about 3 months of imports)."
- Current account (figure annotations):
  - Time series 2008–2016 (proj.) showing Current Account, Trade balance, Income balance, Services balance (values shown in charts in the source).
- Exchange rate indices (2010 =100; 2007–2016 series shown):
  - "Real Effective Exchange Rate (REER)" and "NEER" series plotted with 2010=100.

*Sources: Country authorities; and IMF staff estimates and projections.*

### Fiscal Sector
- Debt composition and funding:
  - "PNG has a moderate debt ratio relative to peer countries..."
  - "over the years PNG has switched from external to domestic debt funding."
- Debt dynamics:
  - "debt has grown sharply, as a result of successive deficits..."
- Banks and government securities:
  - "having increased holdings of government securities since 2013, banks have moved more to Treasury bills."
- Recent financing shift:
  - "More recently, deficit financing has turned back to external sources."
- Expenditure composition:
  - "A large share of expenditure on grants represents allocation to provinces, and interest payments have been growing."

*Sources: Country authorities; and IMF staff estimates and projections.*

### Monetary Sector
- Policy stance and liquidity:
  - "The policy stance has remained unchanged..."
  - "excess liquidity has increased reflecting money-financed fiscal deficits ..."
  - "...and insufficient sterilization of FX inflows."
  - Sterilization ratio note: "Not fully sterilized"
- Banking sector soundness:
  - "Banks have solid capital buffers and NPLs are relatively low."
- Credit conditions:
  - "Private sector credit growth remains weak."
  - "Agriculture needs more credit to increase yields and improve the quality of production."
- Interest and reserve measures (chart annotations):
  - Policy Rate, Deposit Rate, Lending Rate series; CRR ratio and Sterilization ratio series (values shown in charts in the source).

*Sources: Country authorities; and IMF staff estimates and projections.*

### Selected Economic and Financial Indicators (Table 1 highlights)
- Nominal GDP (2015): "US$21.2 billion 1/"
- Population (2015): "7.6 million"
- GDP per capita (2015): "US$2,745"
- Quota: "SDR 131.6 million (14th Review: SDR 263.2 million)"
- Real GDP growth (annual series 2012–2017 Est./Proj. in the table):
  - 2012: "6.1"
  - 2013: "4.7"
  - 2014: "7.4"
  - 2015: "6.6"
  - 2016: "2.5"
  - 2017: "3.0"
- Terms of trade (2010=100, end-period): 2012 "116.3", 2013 "113.9", 2014 "106.2", 2015 "100.0", 2016 "93.1", 2017 "92.6"
- Gross official international reserves (Table 1 series and Table 5 projections):
  - 2012: "4,001" (millions of U.S. dollars)
  - 2013: "2,826"
  - 2014: "2,305"
  - 2015: "1,865"
  - 2016: "1,744"
  - 2017: "1,829"

*Sources: Department of Treasury; Bank of Papua New Guinea; and IMF staff estimates and projections.*

### Central Government Operations (Tables 2a and 2b key figures)
- Revenue and Grants (in millions of Kina; 2012–2017 Proj.):
  - 2012: "9,419"
  - 2013: "9,897"
  - 2014: "11,875"
  - 2015: "10,776"
  - 2016: "10,764"
  - 2017 Proj.: "11,449"
- Taxes (2012–2017):
  - 2012: "8,219"
  - 2013: "8,880"
  - 2014: "10,232"
  - 2015: "8,931"
  - 2016: "8,827"
  - 2017 Proj.: "9,158"
- Resource revenue (2012–2017):
  - 2012: "1,117"
  - 2013: "667"
  - 2014: "1,301"
  - 2015: "652"
  - 2016: "478"
  - 2017 Proj.: "729"
- Expenditure and net lending (2012–2017):
  - Expenditure (2012): "9,947"; (2017 Proj.): "13,350"
  - Net lending (+)/borrowing (-) (2012): "-528"; (2017 Proj.): "-1,901"
  - Primary balance (2012): "-76"; (2017 Proj.): "-518"
- Gross government debt (in millions of Kina; 2012–2017):
  - 2012: "8,486"
  - 2013: "11,878"
  - 2014: "15,365"
  - 2015: "17,967"
  - 2016: "20,752"
  - 2017 Proj.: "23,010"
- Memorandum: Gross government debt, percentage of GDP (2012–2017):
  - 2012: "19.1"
  - 2013: "25.0"
  - 2014: "28.1"
  - 2015: "30.4"
  - 2016: "33.5"
  - 2017 Proj.: "33.5"

*Sources: Department of Treasury; and IMF staff estimates and projections.*

### Balance of Payments (Table 3 highlights)
- Current account balance (in millions of U.S. dollars; 2012–2021 series):
  - 2012: "-7,679"
  - 2013: "-6,660"
  - 2014: "655"
  - 2015: "2,301"
  - 2016 Est.: "1,542"
  - 2017 Proj.: "1,371"
  - 2018 Proj.: "1,302"
  - 2019 Proj.: "1,259"
  - 2020 Proj.: "1,123"
  - 2021 Proj.: "1,138"
- Exports (f.o.b.) (2012–2021 series):
  - 2012: "6,332"
  - 2013: "5,951"
  - 2014: "8,758"
  - 2015: "8,900"
  - 2016 Est.: "8,334"
  - 2017 Proj.: "8,588"
  - 2018 Proj.: "8,760"
  - 2019 Proj.: "8,920"
  - 2020 Proj.: "9,043"
  - 2021 Proj.: "9,189"
- Imports (f.o.b.) (2012–2021 series):
  - 2012: "-7,705"
  - 2013: "-6,468"
  - 2014: "-4,112"
  - 2015: "-2,749"
  - 2016 Est.: "-3,029"
  - 2017 Proj.: "-3,268"
  - 2018 Proj.: "-3,466"
  - 2019 Proj.: "-3,677"
  - 2020 Proj.: "-3,911"
  - 2021 Proj.: "-3,994"
- Capital and financial account balance (2012–2021 series):
  - 2012: "119"
  - 2013: "983"
  - 2014: "444"
  - 2015: "-289"
  - 2016 Est.: "7"
  - 2017 Proj.: "-271"
  - 2018 Proj.: "5"
  - 2019 Proj.: "-166"
  - 2020 Proj.: "-4"
  - 2021 Proj.: "-1286"
- Net international reserves (end-year, millions of U.S. dollars; series shown in table):
  - 2012: "4,001"
  - 2013: "2,826"
  - 2014: "2,305"
  - 2015: "1,865"
  - 2016 Est.: "1,744"
  - 2017 Proj.: "1,829"

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

### Monetary Developments (Table 4 highlights)
- Bank of Papua New Guinea (end-period, millions of kina):
  - Net foreign assets (2012–2017): 2012 "8,004"; 2013 "6,363"; 2014 "5,501"; 2015 "4,695"; 2016 "5,007"; 2017 "5,569"
  - Reserve money (2012–2017): 2012 "3,834"; 2013 "3,853"; 2014 "5,283"; 2015 "5,171"; 2016 "5,371"; 2017 "5,968"
  - Currency in circulation (2012–2017): 2012 "1,679"; 2013 "1,749"; 2014 "1,852"; 2015 "1,891"; 2016 "1,907"; 2017 "2,042"
- Depository Corporations Survey (end-period, millions of kina):
  - Broad money (2012–2017): 2012 "16,967"; 2013 "18,104"; 2014 "18,716"; 2015 "20,219"; 2016 "20,645"; 2017 "21,805"
  - Claims on the private sector (2012–2017): 2012 "8,434"; 2013 "9,914"; 2014 "10,264"; 2015 "10,612"; 2016 "11,222"; 2017 "12,118"
- Annual percentage changes:
  - Net foreign assets: "-6.3", "-12.7", "-17.5", "-13.9", "6.3", "11.2" (2012–2017 series)
  - Broad money: "10.9", "6.7", "3.4", "8.0", "2.1", "5.6" (2012–2017 series)
- Memorandum:
  - Gross international reserves (millions of U.S. dollars): 2012 "4,001"; 2013 "2,826"; 2014 "2,305"; 2015 "1,865"; 2016 "1,744"; 2017 "1,829"
  - Nominal nonresource GDP/Broad money (2012–2017 series): "2.3", "2.3", "2.4", "2.4", "2.5", "2.6"

*Sources: Bank of Papua New Guinea; and IMF staff estimates and projections.*

### Medium-Term Scenario (Table 5 projections, 2018–2021)
- Real GDP growth (2018–2021 projections):
  - 2018: "3.2"
  - 2019: "3.4"
  - 2020: "3.4"
  - 2021: "3.4"
- Resource and nonresource growth (2018–2021):
  - Resource: 2018 "-0.3"; 2019 "-0.3"; 2020 "-0.3"; 2021 "-0.3"
  - Nonresource: 2018 "3.8"; 2019 "3.9"; 2020 "3.9"; 2021 "3.9"
- CPI (period average) and end-period (2018–2021):
  - CPI (period average): 2018 "6.5"; 2019 "6.0"; 2020 "6.0"; 2021 "6.0"
  - CPI (end-period): 2018 "7.5"; 2019 "6.0"; 2020 "6.0"; 2021 "6.0"
- Central government operations (percent of GDP, 2018–2021 projections):
  - Total revenue and grants: 2018 "16.7"; 2019 "16.9"; 2020 "17.1"; 2021 "17.3"
  - Total expenditure: 2018 "19.2"; 2019 "18.8"; 2020 "18.5"; 2021 "18.1"
  - Primary balance: 2018 "-0.2"; 2019 "0.2"; 2020 "0.7"; 2021 "1.2"
  - Net lending(+)/borrowing(-) [Overall balance]: 2018 "-2.4"; 2019 "-2.0"; 2020 "-1.5"; 2021 "-0.8"
- Gross public debt (percent of GDP, 2018–2021):
  - 2018 "33.5"; 2019 "33.3"; 2020 "32.6"; 2021 "31.6"
- Balance of payments projections (2018–2021):
  - Exports, f.o.b. (2018–2021): "8,588", "8,760", "8,920", "9,043"
  - Imports, c.i.f. (2018–2021): "-3,268", "-3,466", "-3,677", "-3,911"
  - Current account (millions of U.S. dollars): 2018 "1,371"; 2019 "1,302"; 2020 "1,259"; 2021 "1,123"
  - Gross official reserves (millions of U.S. dollars): 2018 "2,200"; 2019 "2,343"; 2020 "2,650"; 2021 "3,272"
- Assumed commodity prices (series 2012–2021 from IMF WEO):
  - Gold (U.S. dollars per ounce): 2018 "1,357"; 2019 "1,374"; 2020 "1,391"; 2021 "1,404"
  - Copper (U.S. dollars per ton): 2018 "4,839"; 2019 "4,879"; 2020 "4,910"; 2021 "4,937"
  - Liquefied Natural Gas Price Index (2005=100): 2018 "101"; 2019 "101"; 2020 "101"; 2021 "101"
  - Oil (U.S. dollars per barrel): 2018 "50.64"; 2019 "53.09"; 2020 "54.44"; 2021 "56.29"

*Sources: Department of Treasury; Bank of Papua New Guinea; and IMF staff estimates and projections. IMF World Economic Outlook for commodity prices.*

### Financial Soundness Indicators (Table 6, 2011–2015)
- Capital adequacy (2011–2015):
  - Capital to risk-weighted assets: "26.9", "28.0", "27.9", "34.5", "33.4"
  - Tier 1 capital to risk-weighted assets: "19.6", "20.1", "21.0", "27.2", "27.6"
- Asset quality:
  - Nonperforming loans to total loans: "2.0", "2.0", "1.2", "1.4", "2.6"
  - Past due loans to total loans: "5.1", "2.8", "2.2", "2.7", "3.9"
  - Provision for losses to NPL: "158.2", "170.9", "288.0", "240.9", "143.8"
- Earnings and profitability:
  - Return on assets: "2.2", "2.3", "2.4", "2.0", "1.7"
  - Return on equity: "23.1", "23.7", "21.2", "26.2", "21.4"
- Liquidity:
  - Liquid assets to total assets: "58.5", "56.6", "55.2", "51.5", "49.0"
  - Loan-to-deposit ratio: "46.3", "46.9", "50.3", "57.2", "60.5"

*Sources: Bank of Papua New Guinea; and IMF staff calculations.*

### Millennium Development Goals (Table 7 selected indicators, 1991–2015)
- Poverty and employment:
  - Poverty headcount ratio at $1.90 a day (2011 PPP) (2015): "39.3"
  - Employment-to-population ratio, 15+, total (%) (series includes 1991–2015; 2015: "70.4")
- Education:
  - Literacy rate, youth female (%) (2015): "64.1"
  - Primary completion rate, total (%) (series includes 1991–2015; 2015: "78.6")
- Health and mortality:
  - Mortality rate, infant (per 1,000 live births) (2015): "45.7"
  - Mortality rate, under-5 (per 1,000 live births) (2015): "59.1"
  - Maternal mortality ratio (per 100,000 live births) (2015): "215"
  - Immunization, measles (% of children ages 12-23 months) (2015): "65.0"
- Other social and development indicators (selected 2015 values where provided):
  - Improved water source (% of population with access) (2015): "40.0"
  - Improved sanitation facilities (% of population with access) (2015): "18.9"
  - GNI per capita, Atlas method (current US$) (series includes 2015): "2,240"
  - Population, total (millions) (2015): "7.6"
  - Life expectancy at birth, total (years) (2015): "62.6"

*Source: World Bank, World Development Indicators database, 2016.*

*Sources: Country authorities; and IMF staff estimates and projections.*

### Appendix I. Risk Assessment Matrix

### Appendix I. Risk Assessment Matrix

### External Risks
- Structurally weak growth in key advanced and emerging economies
  - Relative Likelihood: H/M
  - Impact if Realized: H
  - Potential Impact: Potential for a further drop in commodity prices. Lower export demand would worsen the trade balance, weaken fiscal revenue/reserves.
  - Staff Advice on Policy Response:
    - Allow the kina to depreciate to boost non-resource exports;
    - Accelerate structural reforms to improve competitiveness;
    - Allow automatic stabilizers to work if financing constraints permit.
- Sharp rise in risk premium with flight to safety
  - Relative Likelihood: M
  - Impact if Realized: L/M
  - Potential Impact: Global financial volatility may affect the climate for raising external debt. However, the low external debt stock and financial integration would limit impacts on PNG.
  - Staff Advice on Policy Response:
    - Tighten the fiscal position further to reduce financing needs.
- Reduced financial services by global/regional banks ("de-risking")
  - Relative Likelihood: H
  - Impact if Realized: M
  - Potential Impact: Loss of correspondent banking services could curtail cross-border payments, trade finance, and remittances. However, the low level of remittances would moderate the impact on PNG.
  - Staff Advice on Policy Response:
    - Upgrade regulatory and supervisory frameworks to enhance compliance with international standards, especially in the areas of AML/CFT and tax transparency.

### Domestic Risks
- Further shortfalls in financing leading to monetization of the fiscal deficit and/or spending cuts in priority areas
  - Relative Likelihood: M/H
  - Impact if Realized: M/H
  - Potential Impact: Monetization of the deficit would add to excess liquidity and create inflation or depreciation pressures. Spending cuts to infrastructure/front line services would impact growth.
  - Staff Advice on Policy Response:
    - Avoid deficit financing by the central bank, and focus spending cuts on low impact areas.
    - Improve cash management to ensure effective utilization of existing financial resources.
- Political instability and worsening security
  - Relative Likelihood: M
  - Impact if Realized: M/H
  - Potential Impact: Potential increase in rent-seeking behavior and non-productive expenditures. Confidence and investment could falter.
  - Staff Advice on Policy Response:
    - Resist monetary accommodation of a fiscal expansion, focusing any increased spending on improving security, but with greater fiscal transparency.
- Natural disasters
  - Relative Likelihood: M
  - Impact if Realized: M/H
  - Potential Impact: Given PNG’s poor infrastructure and weak capacity, the economic impact could be significant.
  - Staff Advice on Policy Response:
    - Ensure fiscal buffers are adequate to support affected groups and spend more on preparation and prevention;
    - Encourage take-up of disaster insurance.

- Note on Relative Likelihood terminology:
  - “low” is meant to indicate a probability below 10 percent,
  - “medium” a probability between 10 and 30 percent,
  - and “high” a probability of 30 percent or more.
  - The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

### Appendix II. Authorities’ Responses to Fund Advice

- Monetary, Financial and Exchange Rate Policies
  - Fund Recommendations:
    - Remove excess liquidity to improve monetary policy effectiveness and reduce downside pressure on the kina exchange rate.
    - Allow greater exchange rate flexibility to clear the FX market.
    - Continue to implement AML/CFT legislation.
  - Policy Actions by Authorities:
    - The increased issuance of government securities and the BPNG’s intervention in FX market assisted in diffusing some of the excess liquidity. While the CRR has kept at 10 percent since September 2014, the BPNG considers options to tighten monetary policy if necessary.
    - Although excess demand for foreign currency has persisted, the official interbank exchange rate has been almost unchanged since May 2016 because the BPNG thinks that a greater exchange rate depreciation would only be inflationary.
    - The authorities have established the legal and regulatory framework to meet a high-level political commitment to address AML/CFT regulatory and operational deficiencies. In recognition of significant progress made in improving its AML/CFT regime, PNG is no longer subject to the FATF’s monitoring since June 2016.

- Fiscal Policy
  - Fund Recommendations:
    - Adopt a fiscal policy stance consistent with putting public debt in line with the government’s targets and ensuring debt sustainability.
    - Improve the quality of spending.
    - Strengthen revenue collection through rationalizing tax exemptions and concessions and other measures recommended by the Tax Review Committee.
    - Safeguard the integrity of the SWF for it to play a key role in managing PNG’s resource revenues.
  - Policy Actions by Authorities:
    - The authorities passed the 2017 budget to address the revenue shortfalls and cut expenditures in November 2016. This brings the public debt to GDP ratio below the fiscal anchor in the Fiscal Responsibility Act over the medium term.
    - The budget seeks to identify expenditure-saving measures from overseas travel and recruitment activities etc., whereas it also seeks to improve outcomes by controlling capital expenditures through improved project approval, monitoring and evaluation activities.
    - Only minor amendments have done in the tax system in 2016, and the authorities plan to begin implementing tax reforms based on National Tax Review in the 2017 budget. The tax reforms include:
      - extending the tax base via compliance,
      - increasing the taxable component of employer provided housing benefit,
      - imposing additional profits tax to new mining and petroleum projects,
      - uplifting exemption from interest withholding tax for foreign lenders lending to resource companies, and
      - raising some tax rates.
    - The authorities are formalizing the establishment of the SWF’s administrative secretariat at BPNG.

*PAPUA NEW GUINEA — INTERNATIONAL MONETARY FUND*

### Appendix II. Authorities’ Responses to Fund Advice (concluded)

### Appendix II. Authorities’ Responses to Fund Advice (concluded)

### Structural Reform — Fund Recommendation and Authorities’ Policy Actions
- Fund recommendation: Continue investments in health and education and improve infrastructure and law and order for the better business environment. Strengthen the SME sector by financial inclusion.
- Authorities’ response: The 2017 budget supports key policy priorities such as free education for children, free primary healthcare, transport infrastructure and SMEs. It safeguards expenditure impacting low-skilled jobs and development enablers such as health, education, key infrastructure, agriculture, tourism and law and order.
- Fund recommendation: Strengthen PFM by implementing further reforms identified in the PEFA assessment and SOE reform to enhance transparency and governance.
- Authorities’ response: The IFMIS was rolled out and an amended PFM act was passed in August 2016. The 2016 budget promoted more efficient SOEs through a dividend policy that requires them to operate in accordance with commercial principles.

### Statistics — Fund Recommendation and Authorities’ Policy Actions
- Fund recommendation: Improve macroeconomic statistics and move forward with the publication of new GDP estimates.
- Authorities’ response: The NSO released new GDP estimates for 2006-13 in March 2016.

### Fund Relations — Key Institutional and Financial Data (as of September 30, 2016)
- Membership Status: Joined: October 9, 1975; Article VIII
- Quota and holdings:
  - Quota: 131.60 SDR Million (100.00 percent quota)
  - Fund holdings of currency: 131.16 SDR Million (99.66 percent quota)
  - Reserve position in Fund: 0.45 SDR Million (0.34 percent quota)
- SDR Department:
  - Net cumulative allocation: 125.49 SDR Million (100.00 percent)
  - Holdings: 9.11 SDR Million (7.26 percent)
- Outstanding Purchases and Loans: 0.00 SDR Million (0.00 percent quota)
- Latest Financial Arrangements (selected):
  - Stand-by approved 3/29/2000, expiration 9/28/2001, Amount Approved 85.54 SDR million, Amount Drawn 85.54 SDR million
  - Stand-by approved 7/14/1995, expiration 12/15/1997, Amount Approved 71.48 SDR million, Amount Drawn 35.34 SDR million
  - Stand-by approved 7/31/1991, expiration 9/30/1992, Amount Approved 26.36 SDR million, Amount Drawn 0.00 SDR million
- Projected Payments to Fund (SDR million; based on existing use of resources and present holding of SDRs):
  - Charges/interest: 2016: 0.01; 2017: 0.06; 2018: 0.06; 2019: 0.06; 2020: 0.06
  - Total: 2016: 0.01; 2017: 0.06; 2018: 0.06; 2019: 0.06; 2020: 0.06
- Safeguards Assessments: BPNG was subject to a transitional assessment completed on May 4, 2001; currently not subject to the Safeguards Assessments policy.
- Exchange Rate Arrangement:
  - De jure arrangement: floating.
  - From April 2014 the Kina followed a trend within a 2 percent band against the U.S. dollar; de facto reclassified to a crawl-like arrangement, effective April 11, 2014.
  - Exchange restrictions and MCPs retained under Article VIII approvals: (i) tax clearance certificate requirement for certain current international transactions; (ii) rationing of FX and its allocation by BPNG to certain priority items; MCPs arising from spreads of more than 2 percent between rates set by BPNG and AFEDs, and potential spread deviations between rates set by BPNG for government/embassies and rates used by AFEDs.

### Technical Assistance from Headquarters — Areas and Missions (selected)
- FAD: ROSC Fiscal Transparency Module (October 2000); missions on fiscal reporting reconciliation (December 2000), fiscal transparency assessment (February 2002), sovereign wealth fund management (May 2011), extractive industries fiscal regime (March 2013), Land and Property Tax and Non-Tax Revenue Reforms (October 2015).
- LEG: Tax administration law drafting (November 2005); AML/CFT development (July 2006); Revenue Administration Bill assistance (August–September 2007).
- MFD/MCM: TA on bank regulation and supervision (2001, February–March 2007, July–August 2009, February 2010), medium-term monetary policy formulation (October 2004, September 2005), reserve management (June 2006, September 2007, March/July–August 2009, January–February 2010), internal audits (2004, August 2007), accounting (September–October 2006; February 2007; February–March/June–July/November 2009), liquidity management (January 2009), monetary and forex operations (July–August 2009, February 2010, March 2015), macroprudential oversight (September 2012), sovereign wealth fund (July 2013).
- STA: Multisector statistics mission (September 2006); multiple missions on monetary and financial statistics, balance of payments, government finance statistics, and GDDS metadata spanning 2005–2016; joint mission with ABS on NSO reform (July–August 2014).

### Resident Representation
- Regional Resident Representative Office for Pacific Island Countries opened September 13, 2010 (Suva, Fiji). Current resident representative: Mr. Tubagus Feridhanusetyawan.

### Relations with the Pacific Financial Technical Assistance Centre (PFTAC) — Assistance and Outcomes (as of July 2016)
A. Public Financial Management (PFM)
- PFTAC assisted in ROSC preparation (published October 2000) and participated in PEFA self-assessment training in early 2014 and external PEFA assessment in March 2015.
- PFTAC and FAD worked with Department of Finance to develop a PFM Reform Roadmap (PNG's September 2015 PFM Reform Roadmap).
- IFMS roll-out support:
  - IFMS originally purchased in 2005; as of early 2014 only 3 ministries were connected (Finance, Treasury, Planning).
  - Series of missions from May 2014 led to Department of Finance ICT reforms and IFMS expansion.
  - As of the end of July 2016, IFMS expanded to 30 central government departments (compared to 3 connected when assistance commenced). The remaining 30 due to be implemented by the end of 2016, depending on resource availability.
  - IFMS is used regularly by over 2,000 users across government.
  - IFMS pilot planned for a provincial/district environment targeting East New Britain province and its districts.
- PFTAC supported short-term missions in 2015 to review cash management, reconciliation, and reporting processes.

B. Tax Administration and Policy
- PFTAC has not supported the Internal Revenue Commission (IRC) directly due to strong Australian program support: Strongim Gavman Program (SGP) and Economic Public Sector Program (EPSP).
- New IT system rollout for tax processing:
  - Over 120,000 transactions on average per month processed through the new system.
  - Next phase targets modern risk management, case management for audit and collection, e-filing, e-payment, and a taxpayer self-service portal.
  - Peripheral modules scheduled over the next twelve months, with project completion by 2017.
- Tax review diagnostic recommendations under discussion; Taxpayer Identification number implementation in progress.

C. Financial Sector Regulation and Supervision
- No current PFTAC involvement as of the report. Historical attachment support in 2007–2008; no subsequent requests from BPNG.

D. Economic and Financial Statistics
- From 2013 PFTAC conducted six TA missions to assist NSO, BPNG, and Treasury with national accounts; support coordinated with ABS.
- Two ABS staff seconded to PNG NSO from July 2015 until June 2016.
- PNG NSO staff attended three annual sub-regional statistics workshops since 2013 focused on GDP by expenditure and linkage of household surveys to CPI.

E. Macroeconomic Analysis
- Development of a PNG-specific financial programming framework started in 2011; training for BPNG and Treasury staff provided.
- Further framework simplification started in 2014 to make updates less resource-intensive.
- Work undertaken to improve BPNG’s inflation forecasting methodology after CPI revisions by NSO in June 2014.

### Joint Matrix of Bank-Fund Collaboration (JMAP) — Selected Items
- IMF work program: 2016 Article IV mission September 2016; Board consideration expected in December 2016.
- World Bank and ADB items and timelines listed (selected completions and ongoing items), including completed support for the 2009-2010 Household Income and Expenditure Survey (Completed March 2015), support for PNG Sovereign Wealth Fund (Completed October 2012, January 2013), and ongoing programs with final delivery dates ranging into 2018 and 2017.

### Relations with the Asian Development Bank (ADB) — Strategy and Financing (as of October 12, 2016)
- ADB CPS focus: supporting rural populations via transport infrastructure, health services, water and urban infrastructure; aligned with Development Strategic Plan, 2010–2030 and National Strategy for Responsible Sustainable Development, 2014–2030.
- Country operations business plan, 2017–2019 — indicative lending program: $1,363.0 million total comprising $129.0 million in Concessional Ordinary Capital Resources lending (COL) and $1,234.0 million in Ordinary Capital Resources (OCR).
- Indicative nonlending program: $5.35 million (including project preparatory TA).
- Cofinancing included: $300 million.
- ADB will increase total financing by 125 percent, from $743.7 million (2016–2018) to $1,668.4 million (2017–2019).
- ADB support to help PNG with calibrated fiscal consolidation, expenditure reform, and strengthening PFM; standby policy-based lending option included for 2017 at the request of the government.

Selected ADB public sector loan approvals and disbursements (US$ millions):
- Loan approvals: 2011: 195.8; 2012: 41.5; 2013: 196.8; 2014: 0; 2015: 0; 2016: 0
- Loan disbursements: 2011: 20.5; 2012: 89.3; 2013: 182.5; 2014: 117.0; 2015: 129.2; 2016: 75.03

### Statistical Issues — Assessment of Data Adequacy for Surveillance (As of September, 2016)
- General: Data provision has some shortcomings, but is broadly adequate for surveillance. Most affected areas: national accounts, fiscal accounts, and balance of payments.
- National Accounts:
  - NSO published nominal GDP estimates for 2006–2013 in May 2016 compiled using SNA 2008 after an eight-year hiatus.
  - Real GDP estimates for 2006–2013 are still being verified for accuracy and consistency.
  - NSO revising 2013 preliminary estimates and producing 2014 national account statistics earmarked for release in December 2016.
  - Source data gaps remain, especially for extractive and financial industries; CPI weights are from 2010 HIES but not usable for expenditure estimates of GDP.
  - NSO reform underway with support from ABS and PFTAC.
- Price Statistics:
  - NSO compiles an unpublished quarterly wholesale price index (WPI) and a quarterly CPI.
  - In May 2014 NSO began to publish a new CPI series based on data from the 2009–2010 Household Income Expenditure Survey, replacing a consumption basket from the late 1970s.
- Government Finance Statistics (GFS):
  - GFS data reported to STA in 2016 after a 14-year absence.
  - Data suffers from insufficient coverage and timeliness: central government tax revenue, non-tax revenue, and public expenditure data are deficient; development budget expenditures and utilization of grants and project loans recorded with long lags; few records on trust accounts.
  - Tax revenues collected by extra-budgetary units generally not reflected in central government’s financial information.
  - Interest payment records are accurate but timing issues exist regarding interest on discounted securities.
  - Volume 1 of the 2016 national budget presented in GFSM 2014 format; accompanying 5-year historical time series of GFS data prepared.
  - Authorities participate in Japan Administered Account (JSA)-funded three-year regional GFS capacity-building project since 2013.
- Monetary and Financial Statistics (MFS):
  - Monetary data now produced and reported to STA on a regular basis.
  - Introduction of standardized report form (SRF) for central bank, ODCs, and OFCs; 2013 TA mission introduced general insurance companies into OFC coverage and improved SRF for OFCs.
  - Depository Corporations Survey and Survey of OFCs have data coverage issues.
  - Most monetary statistics in IFS currently aligned with MFSM.
- Financial Sector Surveillance:
  - BPNG compiled selected FSIs for deposit takers to support financial sector assessment.
  - PNG participating in a three-year (FY2014–FY2016) TA project on FSIs funded by Government of Japan; data compilation ongoing and not yet reported to STA.
- External Sector Statistics:
  - Annual BOP data derived from ITRS which is not tightly monitored; marked differences between official trade data and trading partners.
  - Financial accounts data of poor quality due to deficiencies in data collection, notably private external debt and FDI.
  - BPNG relatively under-equipped for the volumes and nature of transactions with nonresidents; little progress implementing mission recommendations with modest improvements in ESS.

### Data Standards, Reporting to STA, and Common Indicator Table (selected)
- PNG began participation in GDDS in 2012.
- Reporting to STA:
  - GFS for 2016 reported for publication in Government Finance Statistics Yearbook and IFS covering only budgetary central government.
  - Monetary data reported monthly to STA for publication in IFS.
  - BOP data for 2010 reported to STA for Balance of Payments Yearbook and IFS.
  - National accounts data for 2006–2013 reported to STA for publication in IFS.
- Common Indicators Required for Surveillance (As of November 2, 2016) — Date of Latest Observation / Date Received / Frequency / Frequency of Reporting / Frequency of Publication (selected):
  - Exchange Rates: 10/31/2016 / 11/1/2016 / D / D / D
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: 07/2016 / 09/18/2016 / W / W / Q
  - Reserve/Base Money: 07/2016 / 09/18/2016 / M / M / Q
  - Broad Money: 07/2016 / 09/18/2016 / M / M / Q
  - Central Bank Balance Sheet: 07/2016 / 09/18/2016 / M / M / Q
  - Consolidated Balance Sheet of the Banking System: 07/2016 / 09/18/2016 / M / M / Q
  - Interest Rates: 10/2016 / 11/1/2016 / W / W / Q
  - Consumer Price Index: 06/2016 / 09/29/2016 / Q / Q / Q
  - Central Government fiscal data: 2015 / 08/24/2016 / A / A / A
  - Stocks of Central Government and Central Government-Guaranteed Debt: 12/2015 / 09/26/2016 / Q / A / A
  - External Current Account Balance: 06/2016 / 09/19/2016 / Q / Q / Q
  - Exports and Imports of Goods and Services: 06/2016 / 09/19/2016 / Q / Q / Q
  - GDP/GNP: 2013 / 03/23/2016 / A / A / A
  - Gross External Debt: 06/2016 / 09/20/2016 / Q / A / A
  - International Investment Position: N/A (lack of capacity prevented authorities from providing the data)

### Debt Sustainability Analysis — Key Conclusion
- The Debt Sustainability Analysis (DSA) indicates that the risk of debt distress in Papua New Guinea (PNG) remains low, based on an assessment of public and publicly-guaranteed (PPG) external debt.
- In line with the DSA for the 2015 Article IV consultation, factoring in public domestic and private external debt, the overall risk of debt distress remains heightened.
- A failure to consolidate the fiscal position — including through obtaining more cost-effective and longer-term financing — would worsen debt dynamics.
- DSA preparation note: This DSA was prepared jointly with the World Bank in accordance with the Debt Sustainability Framework for low-income countries; PNG is rated as a weak performer for policies and institutions for the purposes of the IMF-World Bank low-income country DSA framework.

*Source: Appendix II. Authorities’ Responses to Fund Advice (concluded), staff report and informational annexes, Papua New Guinea, November 11, 2016.*

### 1. Although PNG’s public and external debt burdens remain low relative to peer

### 1. Although PNG’s public and external debt burdens remain low relative to peer countries and the risk of debt distress is low, risks remain.

### Macroeconomic and fiscal context — Key findings
- The ratio of central government debt to GDP remains low, at 30 percent as of end-2015.
- Central government debt has more than doubled between 2012 and 2015.
- Interest payments have doubled between 2012 and 2015 and are expected to triple in 2016.
- Debt servicing costs now exceed national spending on either education or health.
- Liquidity risks remain high, driven by:
  - Expected refinancing of a large public sector loan adding to the liquidity risk associated with external debt.
  - Central government domestic financing becoming increasingly shorter-term.

### Underlying assumptions affecting the outlook
- The medium term growth prospects and current account developments are heavily influenced by the extractive sector and the LNG price outlook.
- A slight upward revision in the longer term growth outlook by 0.4 percent was incorporated following revised historical data that shifted GDP composition; sectoral growth outlook largely unchanged.
- The current account surplus, established in 2014 with commencement of LNG exports, increased in 2015 due to LNG export growth and strong import compression; the surplus is projected to decline as imports recover.
- The possibility of significant capacity expansion in the resource sector is identified as a key upside risk to the baseline outlook.

### External DSA — Baseline and stress scenarios
- Under the baseline scenario, all PPG external debt ratios stay well below the indicative thresholds.
- The baseline is heavily affected by a reported new US$500 million loan from a commercial bank, taken in 2016.
  - Footnote: The loan, reportedly from Credit Suisse, is assumed to have a 5-year term at 7 percent. At present, it is assumed that the loan is continually refinanced through the projection period.
- The historical scenario shows large breaches of thresholds, as in past DSAs; however, the historical scenario is not considered indicative of future risks because the 10-year averages used for underlying macroeconomic assumptions encompass the construction phase for PNG LNG and an extremely elevated current account deficit.
- High levels of private external debt could potentially create balance of payments pressures by competing with the public sector for foreign exchange, but risks are mitigated by many loans being adequately backed by expected cash flows from the LNG project.

### Public DSA — Debt dynamics and liquidity risks
- Public debt dynamics are described as stable and the public debt burden is expected to decline continuously over the projection period.
- Liquidity risks are masked by calculation methods:
  - The debt service-to-revenue ratio is calculated using medium-long term amortization projections.
  - Treasury bills (less than 1 year to maturity) increased as a share of total domestic financing from 45 percent in 2012 to 48 percent in 2015.
  - Using total PPG amortization, and including amortization of Treasury bills, would raise the debt service-to-revenue ratio to over 100 percent.
- The budget remains exposed to unfunded superannuation liabilities estimated at 3½ percent of 2016 GDP.

### Authorities’ views
- The authorities agreed with the DSA findings, noting that the current risk of debt distress is low, but fiscal consolidation is crucial for debt sustainability.
- Authorities acknowledged that further fiscal restraint is needed to keep the debt on a downward path.
- Authorities recognized the importance of more comprehensive data on debt and other liabilities, in particular off-budget and public enterprise debt, in assessing PNG’s overall debt burden.

### Conclusion — Risk assessment
- PNG’s risk of external debt distress remains low.
- The overall risk of public debt distress is heightened, reflecting:
  - Increased stock of domestic debt with a higher share of short-term Treasury bills, even though the stock remains low relative to peers.
  - External debt becoming shorter-term and less concessionary due to the new US$500 million commercial bank loan.

### Box 1 — Macroeconomic assumptions underlying the DSA update (selected items)
- Real GDP growth is projected to average 3.4 percent in the medium/long run (a slight increase above the 3 percent long term average used for the 2015 DSA).
- Inflation is expected to peak at 7.5 percent in 2017, before falling back to 6 percent in the medium/long term. This is an increase of 1 percent above the previous medium/long term projection and reflects the baseline projection of continued nominal depreciation.
- The current account (including grants) turned to surplus in 2014 due to commencement of LNG exports and import compression; it is expected to decline in the near term reflecting in part a weak outlook for commodity exports, and a gradual erosion of the surplus is projected in the medium/long term as imports recover.
- The grant element of new loans has likely reduced given reports of the new US$500 million commercial bank loan reportedly contracted in 2016 to finance the budget; this lowered the grant element of loans in the updated DSA in 2016 and will continue to do so in the projection due to assumed refinancing.
- The primary fiscal balance is estimated to be 2.0 percent of GDP in deficit in 2016. Thereafter the primary deficit is projected to gradually improve to a deficit of around 0.3 percent.

### Selected exact numeric indicators and projections cited in the DSA
- Central government debt to GDP: 30 percent as of end-2015.
- Treasury bills share of total domestic financing: 45 percent in 2012; 48 percent in 2015.
- Unfunded superannuation liabilities: 3½ percent of 2016 GDP.
- New commercial loan: US$500 million (assumed 5-year term at 7 percent; assumed continually refinanced).
- Interest payments: doubled between 2012 and 2015; expected to triple in 2016.
- Primary fiscal balance: 2.0 percent of GDP in deficit in 2016; projected to improve to a deficit of around 0.3 percent thereafter.
- Real GDP growth assumption (medium/long run): 3.4 percent.
- Inflation assumptions: peak 7.5 percent in 2017; 6 percent in medium/long term.

*International Monetary Fund staff summary extracted from the DSA update chapter provided.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1722.pdf_