## External Balance Assessment

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---

### Recent developments and macroeconomic outcomes
- Growth and production:
  - Aggregate growth declined to 2.4 percent in 2016, compared with estimated potential growth of 3.5 percent.
  - Aggregate growth is estimated at 2.2 percent in 2017.
  - LNG and condensate exports rose from zero in 2013 to $2.7 billion in 2017.
- Sectoral drivers:
  - LNG production and exports increased, but generated little direct local employment or additional government revenues; LNG earnings mostly used to repay project-related debt.
  - Other minerals and agricultural sectors (including copper, gold, and coffee) were adversely affected by the drought and weak commodity prices.
  - Post-drought increases in production and exports of minerals and agricultural products and APEC-related spending supported growth in 2017, but effects were largely offset by low business confidence, reduced government spending, FX shortages, and Kina overvaluation.
- External sector and FX:
  - Capital and financial account swung from a surplus of $4.2 billion in 2013 to an estimated deficit of $3 billion in 2017.
  - A portion of outflows reflected construction loan repayments; part of the capital account swing was financed by a $1.7 billion increase in goods and services exports and by reduced imports.
  - Ratio of non-resource sector imports of goods and services fell from an average of 26 percent of GDP in 2009-2011 to around 10 percent in 2015-2017.
  - Gross foreign reserves were US$1.7 billion (around 5 months of imports) as of mid-October, 2017.
  - International reserves depleted by a total of $1.1 billion since 2013.
- Monetary and financial developments:
  - Growth of money and credit aggregates slowed in 2017.
  - Private sector credit growth projected at 4.2 percent (2017), down from 7.2 percent in 2016; non-performing loan ratio remained at over 3 percent.
  - Banks are well-capitalized and hold excess liquidity.
  - Inflation rose to 6.7 percent in 2016; projected to decline significantly in 2017–18 to around 2½ percent as drought effects dissipate and the exchange rate remains stable.
  - The NEER depreciated by 16 percent since end-2014 but little in real terms; since May 2016 the Kina has been stable against the US dollar.
- Fiscal outcomes and public debt:
  - Fiscal deficit widened to 4.6 percent of GDP in 2016 (target had been 3.8 percent).
  - Government targeted narrowing to 2.5 percent of GDP in 2017, but mid-year revenue shortfalls and expenditure over-runs threatened little change from 2016.
  - Fiscal deficits and slow growth pushed government debt-to-GDP ratio over the statutory ceiling of 30 percent; without corrective measures debt-to-GDP could rise above 40 percent.
  - An important part of the budget deficit financed through central bank purchases of government securities and, to some extent, payments arrears.
- Political and policy context:
  - New government formed in early August 2017, coalition headed by Prime Minister O’Neill; Mr. Abel appointed Treasurer and Deputy Prime Minister.
  - September 2017: 100-Day Economic Stimulus Plan announced; 2017 Supplementary Budget presented in late September included large immediate cuts in constituency spending aimed to narrow the deficit to just over 3 percent of GDP.

### Outlook and risks
- Baseline ("passive") scenario on unchanged fiscal and exchange rate policies:
  - Growth projected to remain under 3 percent absent a major new resource project.
  - Inflation projected to decline to around 2½ percent.
  - Government borrowing requirement of over 3 percent of GDP for several years; public debt-to-GDP ratio increasing to 40 percent over the medium term.
  - Debt sustainability analysis indicates a moderate risk of external debt distress and heightened overall risk of public debt distress.
- Risks (Annex I):
  - Downside: significant risk that financing of the fiscal deficit could become extremely difficult, leading to a fiscal and financial crisis with severe fiscal contraction and monetary/exchange policy pressures.
  - Upside: projects to increase LNG export capacity (under negotiation) could begin somewhat sooner than assumed (early 2020s), or other minerals sector developments and commodity price upswings could boost investment and growth if well managed.

### Policy challenges and strategic priorities
- Macro strategy overview:
  - Need to adjust decisively to lower commodity export earnings and lay foundations for stable, inclusive long-term growth.
  - Fiscal consolidation is primary; monetary policy can help mitigate activity impacts and support non-resource sector competitiveness.
- Key fiscal policy challenges:
  - Achieving further fiscal consolidation: recent efforts insufficient; 2017 Supplementary Budget reduced expenditures but additional consolidation needed to reverse debt increases.
  - Mobilizing resources for development objectives: mobilize additional revenues from natural resources to finance infrastructure, education, healthcare, and non-resource sector development.
  - Coping with commodity price cycles: require a fiscal strategy to insulate spending from revenue volatility.
- Monetary and exchange rate policy challenges:
  - Increase exchange rate flexibility: EBA analysis suggests PNG’s external position is moderately weaker than fundamentals imply and the Kina is overvalued; sustained overvaluation and FX restrictions hinder non-resource sector development.
  - Reduce excess financial system liquidity: excess liquidity poses inflation risks during upswings and weakens BPNG policy effectiveness if exchange rate flexibility is increased.

### Fiscal policy priorities and recommendations
- Near term (accelerate fiscal consolidation):
  - Reduce the fiscal deficit from around 3 percent of GDP in 2017 to zero by 2020, including:
    - Streamline the government payroll:
      - Staff recommends a 30 percent reduction in government staffing over 2018–2020, to around 110,000 (from 155,000), focusing on eliminating payroll fraud and strengthening payroll systems and internal controls.
    - Continue to defer grants to provinces and districts:
      - Maintain cuts in the 2017 Supplementary Budget until reforms yield sustainable revenues; restore grants only with stronger procurement rules and accountability.
    - Strengthen revenue collection:
      - Step up tax compliance and collection by strengthening the Internal Revenue Commission (IRC) and consider additional revenue measures proposed by a recent IMF TA mission.
  - Enhance monitoring by the Budget Management Committee to coordinate revenue/expenditure policies, cash management, and address slippages quickly to avoid payments arrears.
- Medium term (develop a new MTFS):
  - Create a Medium-Term Fiscal Strategy to insulate policy from revenue volatility and ensure revenues for key development objectives; include a revenue mobilization framework and an expenditure sustainability framework.
  - Enhance revenue mobilization:
    - Support authorities’ request for IMF assistance in developing and implementing a Medium-Term Revenue Strategy (MTRS) covering tax administration and policy, customs, GST, corporate income tax, and extractive industries taxation; IMF to provide a resident advisor over three years subject to external funding support.
  - Strengthen the expenditure framework:
    - Develop a framework that accounts for sustainability and volatility; staff to work with authorities to develop an operational fiscal rule in coming months.
- Authorities’ stance:
  - Authorities agree fiscal consolidation is needed and have included significant measures in the 2017 Supplementary Budget.
  - Authorities and staff agreed on a twin-track revenue approach: near-term tax compliance focus plus comprehensive strengthening under an MTRS with IMF and donor assistance to support domestic revenue mobilization for Sustainable Development Goals.

### Monetary and exchange rate policy — staff recommendations and authorities’ responses
- Staff view and recommendations:
  - A credible fiscal consolidation plan and MTFS need to go hand-in-hand with greater exchange rate flexibility.
  - Staff estimates a significant exchange rate adjustment is needed to eliminate overvaluation and restore a properly functioning FX market.
  - Recommend gradual adjustment over the medium term to limit inflationary impact and capital flight risk.
  - Gradual adjustment is estimated to keep headline inflation below 6 percent and would boost growth and ease the FX shortage.
  - Based on import and export elasticities for PNG (Nakatani, 2017), a 10 percent depreciation of the Kina in real terms could increase net exports and the supply of FX by US$250 million annually.
  - Strengthen monetary policy transmission by:
    - BPNG clarification of the key objectives of the policy framework to anchor expectations;
    - Active measures to absorb excess liquidity, including moving more government trust funds from the banks to the BPNG; increasing reserve requirements; reducing BPNG holdings of government securities;
    - Active use of interest rates to implement monetary policy and managing the stance and smoothing the exchange rate evolution; review of the operational framework to ensure efficient market-based policy.
- Authorities’ views and responses:
  - Will consider staff recommendations in the context of broader policy objectives and emphasized BPNG operational autonomy.
  - BPNG reservations on increasing exchange rate flexibility:
    - Less confident that a depreciation would stimulate exports and the supply of FX;
    - Concerned about harmful effects on those dependent on imports;
    - Concerned about the impact on overall inflation; therefore do not favor rapid or uncontrolled adjustment.
  - On excess liquidity, BPNG notes high liquidity has not translated into high private sector lending growth or rising inflation, supporting an accommodative stance; sees FX shortage as partly causing excess liquidity; welcomes IMF TA on debt management.

### Scenarios and key projections (Passive vs Alternative/Active)
- Scenario framing:
  - Passive baseline: unchanged fiscal policy and flat exchange rate.
  - Alternative “active” scenario: decline in the fiscal deficit over 2018–20 through spending cuts and revenue mobilization, together with gradual depreciation of the Kina.
- Effects of the active scenario:
  - Temporary reduction in real GDP growth; higher but still moderate inflation; significant narrowing of the fiscal deficit; stronger current account and international reserves positions.
  - Longer-term: reduction in the fiscal deficit and elimination of exchange rate overvaluation raise longer-term growth prospects and reduce downside risks.
  - Passive scenario may be infeasible and could lead to fiscal and financial crisis if deficits cannot be financed. Active scenario has upside risk from confidence effects, notably in agriculture.
- Key projections (Text Table 1: Summary of Passive and Active Policy Scenarios for PNG, 2017-20)
  - Passive Scenario
    - GDP growth rate: 2017 2.2 2018 2.5 2019 2.3 2020 2.9
    - Inflation rate: 2017 5.0 2018 2.6 2019 2.5 2020 2.5
    - Net lending (+)/borrowing (-) (% of GDP): 2017 -3.2 2018 -3.1 2019 -3.6 2020 -3.4
    - Government Revenue (% of GDP): 2017 15.0 2018 14.9 2019 14.9 2020 14.9
    - Government Expenditure (% of GDP): 2017 18.2 2018 18.0 2019 18.4 2020 18.3
    - Government Debt (% of GDP): 2017 35.4 2018 37.0 2019 38.7 2020 40.3
    - Current account (% of GDP): 2017 13.9 2018 14.4 2019 13.8 2020 12.8
    - Gross international reserves (in months of imports): 2017 5.1 2018 5.4 2019 5.8 2020 6.0
  - Alternative Scenario
    - GDP growth rate: 2017 2.2 2018 2.2 2019 1.9 2020 2.5
      - contribution from currency depreciation: 2017 -0.2 2018 0.3 2019 0.4
      - contribution from fiscal consolidation: 2018 -0.5 2019 -0.7 2020 -0.8
      - contribution from higher revenue: 2018 -0.2 2019 -0.3 2020 -0.4
      - contribution from lower spending: 2018 -0.3 2019 -0.4 2020 -0.4
    - Inflation rate: 2017 5.0 2018 3.5 2019 5.4 2020 5.6
    - Net lending (+)/borrowing (-) (% of GDP): 2017 -3.2 2018 -2.1 2019 -1.2 2020 -0.2
    - Government Revenue (% of GDP): 2017 15.0 2018 15.2 2019 15.8 2020 16.4
    - Government Expenditure (% of GDP): 2017 18.2 2018 17.3 2019 17.0 2020 16.6
    - Government Debt (% of GDP): 2017 35.5 2018 36.3 2019 36.0 2020 34.6
    - Current account (% of GDP): 2017 13.9 2018 14.9 2019 14.5 2020 13.6
    - Gross international reserves (in months of imports): 2017 5.1 2018 5.9 2019 6.8 2020 7.6

### Financial sector soundness, inclusion, and supervision
- Banking system:
  - Sound and profitable; three banks (two Australian and one domestic) dominate; maintained high capital adequacy, healthy return on assets, moderate non-performing loan ratios.
  - Banks hold only around half of their assets as loans, rest largely short-term securities and cash.
  - Banks hold government securities that account for nearly one third of their total assets.
- Supervision and macroprudential policy:
  - Need to enhance supervision quality, notably in risk identification and assessment; PFTAC diagnostic mission recommended follow-up.
  - Authorities and staff agree on the need to strengthen macroprudential supervision focusing on data, tools, and institutional arrangements.
  - Ongoing efforts include enabling the Central Bank’s Banking Supervision Department to implement Base II and III principles and shifting to risk-based supervision.
  - New prudential standards released covering corporate governance, capital adequacy and risk management.
- AML/CFT and financial inclusion:
  - PNG exited the FATF “gray” list in June 2016; FASU director and staff appointed; first national assessment of money laundering and terrorist financing risks report expected by end-2017.
  - BPNG engaged in financial inclusion programs; introduced a new TAP facility in April to sell small-denomination government securities to small firms and individuals; uptake limited to date.
  - PNG among the most underbanked countries on several indicators (numbers of branches, ATMs, and loan penetration).

### PNG LNG Project — revenues, fiscal terms, and recommendations
- Revenue composition:
  - Revenues from the LNG sector are composed of royalties, corporate income tax, additional profits tax, development levies, dividends, and various tax concessions aimed for investment incentives.
- Fiscal terms and concessions:
  - 10-year depreciation allowance from 2015 until 2024.
  - Additional capital uplift provisions from 2025 until 2029.
  - Exemption from GST, import duties, and export levies.
  - If the development levy (which is tax deductible) is paid then the royalty becomes creditable for corporate income tax purposes.
  - Calculation of royalties and development levies are based on a net concept: both are calculated as 2 percent of the wellhead value ( $54 million = gross revenues $290 million – operational costs $46.2 million – amortization $75.8 million – capital allowance $114.5 million).
  - Infrastructure tax credit: 100 percent deduction on capital expenditure on infrastructure projects, to a maximum of 2 percent of assessable income.
- Equity and APT:
  - PNG participates through the national oil company, which holds a 16.6 percent stake in PNG LNG.
  - The project enjoys a concessional Additional Profits Tax (APT) with high thresholds and low tax rates by international standards.
  - The 2015 Taxation Review Committee recommended a revamped APT for future projects; changes introduced in the 2017 budget.
- Royalty and levy performance:
  - Average monthly royalty payments have been around $1 million.
  - As of September 2017, K150 million had been received in trust accounts for each of the royalty and development levies.
  - Recommendation for future LNG projects: modify the royalty scheme to use a volume-based levy or a value based on a “field-gate” basis allowing fewer deductions.
- Community payments:
  - In September, the Mineral Resources Development Company started first payment of K15 million to four plant site villages.
  - Distribution of K15 million: 40 percent (K6 million) to LNG plant landowners; 30 percent kept for future generations; 30 percent used for community impact social projects.

### Debt dynamics, DSA findings, and public debt risks
- Key findings:
  - Central government debt to GDP: 33.4 percent as of end-2016.
  - Central government debt has increased recently and interest payments have doubled between 2013 and 2016.
  - Liquidity risks remain high as central government domestic financing has become increasingly shorter-term.
  - Private external debt has declined continuously since the LNG sector started to repay its debt.
  - PPG external debt risk is moderate.
  - Overall risk assessment: risk of external debt distress is moderate; overall risk of public debt distress is high.
- DSA and projections:
  - All PPG external debt ratios stay below indicative thresholds under the baseline scenario; stress tests show a moderate external risk.
  - Public debt is projected to reach 45 percent of GDP over the medium term, deviating above the benchmark.
  - If the primary balance-to-GDP ratio is fixed at the 2016 value, all indicators show a risk of unsustainable debt dynamics.
  - Using total PPG amortization and including Treasury bills would raise the debt service-to-revenue ratio to over 100 percent.
  - Budget exposure to unfunded superannuation liabilities estimated at around K2 billion (3 percent of 2017 GDP).
  - Official debt figures understate the true level of public debt because they do not capture debts of many statutory authorities and state-owned enterprises.
- Policy implication:
  - Need for prudent debt management and further fiscal consolidation.

### Risk Assessment Matrix — selected entries and staff responses
- External risks:
  - Tighter global financial conditions: Relative likelihood: High; Impact if realized: M; Staff advice: focus on cutting government expenditure; allow Kina to depreciate vs. USD.
  - Significant China slowdown and its spillovers: Relative likelihood: Medium; Impact if realized: H; Staff advice: allow Kina to depreciate; additional fiscal adjustment required.
- Domestic risks:
  - Severe difficulty in financing fiscal deficit either externally or domestically: Relative likelihood: High; Impact if realized: H; Staff advice: additional fiscal adjustment required; commit to unwinding central bank financing over 3-year period.
  - Projects to increase LNG (or other minerals) export capacity begin sooner than assumed (early 2020s): Relative likelihood: Medium; Impact if realized: H; Staff advice: continue with fiscal consolidation in line with fiscal rule; eliminate FX restrictions and restore floating exchange rate.
- RAM notes:
  - Relative likelihood categories: “low” <10 percent, “medium” 10–30 percent, “high” 30–50 percent.
  - RAM reflects staff views as of discussions with authorities; risks may interact and materialize jointly.

### Authorities’ responses to Fund advice — summarized
- Monetary, Financial and Exchange Rate Policies:
  - Authorities increased issuance of government securities and BPNG FX intervention to diffuse some excess liquidity; BPNG intended to increase intervention in the FX market by US$100 million in 2017.
  - CRR kept at 10 percent since September 2014; BPNG considers options to tighten monetary policy if necessary.
  - BPNG skeptical of depreciation’s effect on FX supply and concerned about inflation and import-dependent households.
  - Authorities progressing with AML/CFT measures; FASU appointed; national assessment report expected by end-2017.
- Fiscal Policy:
  - 2017 budget aimed to cut the deficit to 2.5 percent of GDP; Supplementary Budget introduced in September to address shortfalls.
  - Debt-to-GDP target changed from under 30 percent to a range of 30 to 35 percent.
  - Measures to improve revenue and spending quality include compulsory Taxpayer Identification Number registration, remittance rules for non-tax revenue agencies, freezes on recruitment, payroll management strengthening, and amalgamation of agencies.
- Structural Reform and Statistics:
  - Authorities maintain policy priorities: Tuition fee free education, free primary healthcare, transport infrastructure, and law and order.
  - Plans to publish a 5-year medium term development plan in mid-2018.
  - Notable improvements in national accounts and fiscal data since 2014; NSO plans to release new GDP estimates for 2015 in December 2017.
  - Authorities seek technical assistance on SWF establishment and PFM improvements.

### Staff appraisal and recommendations — summary
- Diagnosis:
  - 2015-16 slowdown driven by falls in export commodity prices, completion of PNG LNG, and drought; 2017 activity remained subdued.
  - Slow growth, generous tax treatment of LNG, drought, and weak tax administration contributed to declining tax revenues, substantial fiscal deficit, and increasing debt-to-GDP ratio. Large current account surplus coexists with large financial account outflows and FX shortage.
- Main recommendations:
  - Accelerate fiscal consolidation to reverse rising public debt and reduce reliance on central bank financing.
  - Streamline public employment and payroll costs and improve tax compliance.
  - Develop and implement a Medium-Term Revenue Strategy (MTRS) with IMF and donor support and a medium-term expenditure strategy to insulate spending from commodity revenue volatility.
  - Allow the Kina to depreciate gradually to eliminate over-valuation, end the FX shortage, and promote external competitiveness; accompany with clarification of monetary policy framework, measures to eliminate excess liquidity, and strengthening of market-based operational framework.
  - Do not recommend IMF approval of retention of exchange restrictions if they are not temporary and lack a timetable for elimination.
  - Strengthen financial supervision and continue PFM and statistical improvements.
- Timing:
  - Next Article IV consultation with PNG proposed on the standard 12-month cycle.

*Source: Papua New Guinea — International Monetary Fund, "External Balance Assessment" (cr17411).*

### 1. External Balance Assessment __________________________________________________________________ 17

### 1. External Balance Assessment

### Recent developments and macroeconomic outcomes
- Growth and production:
  - Aggregate growth declined to 2.4 percent in 2016, compared with estimated potential growth of 3.5 percent.
  - Aggregate growth is estimated at 2.2 percent in 2017.
  - LNG and condensate exports rose from zero in 2013 to $2.7 billion in 2017.
- Sectoral drivers:
  - LNG production and exports increased, but generated little direct local employment or additional government revenues; LNG earnings mostly used to repay project-related debt.
  - Other minerals and agricultural sectors (including copper, gold, and coffee) were adversely affected by the drought and weak commodity prices.
  - Post-drought increases in production and exports of minerals and agricultural products and APEC-related spending supported growth in 2017, but effects were largely offset by low business confidence, reduced government spending, FX shortages, and Kina overvaluation.
- External sector and FX:
  - Capital and financial account swung from a surplus of $4.2 billion in 2013 to an estimated deficit of $3 billion in 2017.
  - A portion of outflows reflected construction loan repayments; part of the capital account swing was financed by a $1.7 billion increase in goods and services exports and by reduced imports.
  - Ratio of non-resource sector imports of goods and services fell from an average of 26 percent of GDP in 2009-2011 to around 10 percent in 2015-2017.
  - Gross foreign reserves were US$1.7 billion (around 5 months of imports) as of mid-October, 2017.
  - International reserves depleted by a total of $1.1 billion since 2013.
- Monetary and financial developments:
  - Growth of money and credit aggregates slowed in 2017.
  - Private sector credit growth projected at 4.2 percent (2017), down from 7.2 percent in 2016; non-performing loan ratio remained at over 3 percent.
  - Banks are well-capitalized and hold excess liquidity.
  - Inflation rose to 6.7 percent in 2016; projected to decline significantly in 2017–18 to around 2½ percent as drought effects dissipate and the exchange rate remains stable.
  - The NEER depreciated by 16 percent since end-2014 but little in real terms; since May 2016 the Kina has been stable against the US dollar.
- Fiscal outcomes and public debt:
  - Fiscal deficit widened to 4.6 percent of GDP in 2016 (target had been 3.8 percent).
  - Government targeted narrowing to 2.5 percent of GDP in 2017, but mid-year revenue shortfalls and expenditure over-runs threatened little change from 2016.
  - Fiscal deficits and slow growth pushed government debt-to-GDP ratio over the statutory ceiling of 30 percent; without corrective measures debt-to-GDP could rise above 40 percent.
  - An important part of the budget deficit financed through central bank purchases of government securities and, to some extent, payments arrears.
- Political and policy context:
  - New government formed in early August 2017, coalition headed by Prime Minister O’Neill; Mr. Abel appointed Treasurer and Deputy Prime Minister.
  - September 2017: 100-Day Economic Stimulus Plan announced; 2017 Supplementary Budget presented in late September included large immediate cuts in constituency spending aimed to narrow the deficit to just over 3 percent of GDP.

### Outlook and risks
- Baseline ("passive") scenario on unchanged fiscal and exchange rate policies:
  - Growth projected to remain under 3 percent absent a major new resource project.
  - Inflation projected to decline to around 2½ percent.
  - Government borrowing requirement of over 3 percent of GDP for several years; public debt-to-GDP ratio increasing to 40 percent over the medium term.
  - Debt sustainability analysis indicates a moderate risk of external debt distress and heightened overall risk of public debt distress.
- Risks (Annex I):
  - Downside: significant risk that financing of the fiscal deficit could become extremely difficult, leading to a fiscal and financial crisis with severe fiscal contraction and monetary/exchange policy pressures.
  - Upside: projects to increase LNG export capacity (under negotiation) could begin somewhat sooner than assumed (early 2020s), or other minerals sector developments and commodity price upswings could boost investment and growth if well managed.

### Policy challenges and strategic priorities
- Macro strategy overview:
  - Need to adjust decisively to lower commodity export earnings and lay foundations for stable, inclusive long-term growth.
  - Fiscal consolidation is primary; monetary policy can help mitigate activity impacts and support non-resource sector competitiveness.
- Key fiscal policy challenges:
  - Achieving further fiscal consolidation: recent efforts insufficient; 2017 Supplementary Budget reduced expenditures but additional consolidation needed to reverse debt increases.
  - Mobilizing resources for development objectives: mobilize additional revenues from natural resources to finance infrastructure, education, healthcare, and non-resource sector development.
  - Coping with commodity price cycles: require a fiscal strategy to insulate spending from revenue volatility.
- Monetary and exchange rate policy challenges:
  - Increase exchange rate flexibility: EBA analysis suggests PNG’s external position is moderately weaker than fundamentals imply and the Kina is overvalued; sustained overvaluation and FX restrictions hinder non-resource sector development.
  - Reduce excess financial system liquidity: excess liquidity poses inflation risks during upswings and weakens BPNG policy effectiveness if exchange rate flexibility is increased.

### Fiscal policy priorities and recommendations
- Near term (accelerate fiscal consolidation):
  - Reduce the fiscal deficit from around 3 percent of GDP in 2017 to zero by 2020, including:
    - Streamline the government payroll:
      - Staff recommends a 30 percent reduction in government staffing over 2018–2020, to around 110,000 (from 155,000), focusing on eliminating payroll fraud and strengthening payroll systems and internal controls.
    - Continue to defer grants to provinces and districts:
      - Maintain cuts in the 2017 Supplementary Budget until reforms yield sustainable revenues; restore grants only with stronger procurement rules and accountability.
    - Strengthen revenue collection:
      - Step up tax compliance and collection by strengthening the Internal Revenue Commission (IRC) and consider additional revenue measures proposed by a recent IMF TA mission.
  - Enhance monitoring by the Budget Management Committee to coordinate revenue/expenditure policies, cash management, and address slippages quickly to avoid payments arrears.
- Medium term (develop a new MTFS):
  - Create a Medium-Term Fiscal Strategy to insulate policy from revenue volatility and ensure revenues for key development objectives; include a revenue mobilization framework and an expenditure sustainability framework.
  - Enhance revenue mobilization:
    - Support authorities’ request for IMF assistance in developing and implementing a Medium-Term Revenue Strategy (MTRS) covering tax administration and policy, customs, GST, corporate income tax, and extractive industries taxation; IMF to provide a resident advisor over three years subject to external funding support.
  - Strengthen the expenditure framework:
    - Develop a framework that accounts for sustainability and volatility; staff to work with authorities to develop an operational fiscal rule in coming months.
- Authorities’ stance:
  - Authorities agree fiscal consolidation is needed and have included significant measures in the 2017 Supplementary Budget.
  - Authorities and staff agreed on a twin-track revenue approach: near-term tax compliance focus plus comprehensive strengthening under an MTRS with IMF and donor assistance to support domestic revenue mobilization for Sustainable Development Goals.

*Source: Papua New Guinea — International Monetary Fund, "External Balance Assessment" (cr17411).*

### 19. The authorities and staff were also in general agreement on requirements for a MTFS.

### cr17411 - 19. The authorities and staff were also in general agreement on requirements for a MTFS.

### Medium-Term Fiscal Framework (MTFS) and fiscal credibility
- Development of a MTFS is a priority; authorities and staff expressed interest in continued cooperation.
- Authorities noted the need for political will to build a reputation for maintaining a credible fiscal framework.
- The Supplementary Budget changed the debt-to-GDP target from under 30 percent to between 30 and 35 percent.

### Monetary policy priorities and exchange rate policy
- Main objective: increase exchange rate flexibility and promote external competitiveness.
- Staff view:
  - A credible fiscal consolidation plan and MTFS need to go hand-in-hand with greater exchange rate flexibility.
  - Staff estimates a significant exchange rate adjustment is needed to eliminate overvaluation and restore a properly functioning FX market.
  - A rapid adjustment would have a large impact on inflation and could trigger capital flight; recommend gradual adjustment over the medium term.
  - Gradual adjustment is estimated to keep headline inflation below 6 percent and would boost growth and ease the FX shortage.
  - Based on import and export elasticities for PNG (Nakatani, 2017), a 10 percent depreciation of the Kina in real terms could increase net exports and the supply of FX by US$250 million annually.
- Strengthening monetary policy transmission — staff recommends accompanying greater exchange rate flexibility with:
  - BPNG clarification of the key objectives of the policy framework to anchor expectations;
  - Active measures to absorb excess liquidity, including:
    - moving more government trust funds from the banks to the BPNG (some of this has been done, but many accounts remain with banks);
    - increasing reserve requirements;
    - reducing BPNG holdings of government securities;
  - Active use of interest rates to implement monetary policy and managing the stance and smoothing the exchange rate evolution; review of the operational framework to ensure efficient market-based policy.
- Authorities’ views:
  - Will consider staff recommendations in the context of broader policy objectives and emphasized BPNG operational autonomy.
  - BPNG reservations on increasing exchange rate flexibility:
    - Less confident that a depreciation would stimulate exports and the supply of FX;
    - Concerned about harmful effects on those dependent on imports;
    - Concerned about the impact on overall inflation; therefore do not favor rapid or uncontrolled adjustment.
  - On excess liquidity, BPNG notes high liquidity has not translated into high private sector lending growth or rising inflation, supporting an accommodative stance; sees FX shortage as partly causing excess liquidity; welcomes IMF TA on debt management.

### Implications of policy adjustments for the outlook (passive vs active scenarios)
- Passive baseline: unchanged fiscal policy and flat exchange rate.
- Alternative “active” scenario: decline in the fiscal deficit over 2018–20 through spending cuts and revenue mobilization, together with gradual depreciation of the Kina.
- Effects of the active scenario: temporary reduction in real GDP growth; higher but still moderate inflation; significant narrowing of the fiscal deficit; stronger current account and international reserves positions. Projections exclude possible LNG development over 2018-20.
- Longer-term: reduction in the fiscal deficit and elimination of exchange rate overvaluation raise longer-term growth prospects and reduce downside risks. Passive scenario may be infeasible and could lead to fiscal and financial crisis if deficits cannot be financed. Active scenario has upside risk from confidence effects, notably in agriculture.

- Key projections (Text Table 1: Summary of Passive and Active Policy Scenarios for PNG, 2017-20)
  - Passive Scenario
    - GDP growth rate: 2017 2.2 2018 2.5 2019 2.3 2020 2.9
    - Inflation rate: 2017 5.0 2018 2.6 2019 2.5 2020 2.5
    - Net lending (+)/borrowing (-) (% of GDP): 2017 -3.2 2018 -3.1 2019 -3.6 2020 -3.4
    - Government Revenue (% of GDP): 2017 15.0 2018 14.9 2019 14.9 2020 14.9
    - Government Expenditure (% of GDP): 2017 18.2 2018 18.0 2019 18.4 2020 18.3
    - Government Debt (% of GDP): 2017 35.4 2018 37.0 2019 38.7 2020 40.3
    - Current account (% of GDP): 2017 13.9 2018 14.4 2019 13.8 2020 12.8
    - Gross international reserves (in months of imports): 2017 5.1 2018 5.4 2019 5.8 2020 6.0
  - Alternative Scenario
    - GDP growth rate: 2017 2.2 2018 2.2 2019 1.9 2020 2.5
      - contribution from currency depreciation: 2017 -0.2 2018 0.3 2019 0.4
      - contribution from fiscal consolidation: 2018 -0.5 2019 -0.7 2020 -0.8
      - contribution from higher revenue: 2018 -0.2 2019 -0.3 2020 -0.4
      - contribution from lower spending: 2018 -0.3 2019 -0.4 2020 -0.4
    - Inflation rate: 2017 5.0 2018 3.5 2019 5.4 2020 5.6
    - Net lending (+)/borrowing (-) (% of GDP): 2017 -3.2 2018 -2.1 2019 -1.2 2020 -0.2
    - Government Revenue (% of GDP): 2017 15.0 2018 15.2 2019 15.8 2020 16.4
    - Government Expenditure (% of GDP): 2017 18.2 2018 17.3 2019 17.0 2020 16.6
    - Government Debt (% of GDP): 2017 35.5 2018 36.3 2019 36.0 2020 34.6
    - Current account (% of GDP): 2017 13.9 2018 14.9 2019 14.5 2020 13.6
    - Gross international reserves (in months of imports): 2017 5.1 2018 5.9 2019 6.8 2020 7.6

### Financial sector issues and inclusion
- Banking system: sound and profitable; three banks (two Australian and one domestic) dominate; maintained high capital adequacy, healthy return on assets, moderate non-performing loan ratios.
- Need to enhance supervision quality, notably in risk identification and assessment; PFTAC diagnostic mission recommended follow-up.
- AML/CFT: PNG exited the FATF “gray” list in June 2016; authorities appointed a Financial Analysis and Supervision Unit (FASU) director and staff; anticipate a first national assessment of money laundering and terrorist financing risks report by end-2017.
- Financial inclusion:
  - Banks hold only around half of their assets as loans, rest largely short-term securities and cash.
  - PNG among the most underbanked countries on several indicators (numbers of branches, ATMs, and loan penetration).
  - BPNG engaged in financial inclusion programs; introduced a new TAP facility in April to sell small-denomination government securities to small firms and individuals to broaden savings options (uptake limited to date).

### Reforms for inclusive growth
- Strategy elements:
  - Ensure country benefits more from exploitation of natural wealth (focus on better deals for future LNG and minerals projects; use revenues to develop non-resource sector).
  - Prioritize public spending to enhance growth, inclusiveness, and fairness: improve transportation and communications networks; commit to stable, long-term funding of education, health care, and law and order.
  - Strengthen PFM systems, notably procurement, budget execution, monitoring, and reporting (PFTAC assistance).
- Main impediments to private sector development:
  - Macroeconomic policies: FX shortages and macroeconomic policy uncertainty; weak cross-border trading.
  - Structural impediments: law and order, contract enforcement, insolvency resolution, corruption, security, inefficient bureaucracy, lack of basic infrastructure outside main cities.

### Statistics and data issues
- Improvements acknowledged in national accounts and fiscal data since 2014 with PFTAC and IMF assistance.
- BOP data remain an issue; July 2017 STA launched a JSA-funded project eligible for TA in external sector statistics.
- Weaknesses remain: data completeness, timeliness, and accuracy; debt numbers incomplete and unreliable because of data gaps; arrears reported but not included in fiscal data; gaps in disposition of LNG earnings reflected in large gaps in external financial accounts.
- Authorities committed to improving statistics and indicated willingness to seek further TA and support.

### Staff appraisal and recommendations
- 2015-16 slowdown from falls in export commodity prices, completion of PNG LNG, and drought; 2017 activity remained subdued.
- Slow growth, generous tax treatment of LNG, drought, and weak tax administration contributed to declining tax revenues, substantial fiscal deficit, and increasing debt-to-GDP ratio. Inflation boosted to over 6 percent by drought but beginning to ease. Large current account surplus coexists with large financial account outflows and FX shortage.
- Risks if policies unchanged: several more years of economic stagnation, growth under 3 percent, growing risk of fiscal and financial crisis if financing of deficits becomes difficult.
- Fiscal consolidation progress: 2017 Supplementary Budget reduced expenditures, but additional effort needed to align spending with realistic revenue assessment and reverse debt-to-GDP increases. Emphasis on streamlining public employment and payroll costs and improving tax compliance.
- Need to mobilize additional revenues for infrastructure, education, and healthcare; development of a MTRS is commended and to be supported with TA; a medium-term expenditure strategy needed to insulate spending from commodity revenue volatility.
- Exchange rate policy: staff recommend allowing the Kina to depreciate to eliminate over-valuation, end the FX shortage, and promote external competitiveness; recommend gradual approach to depreciation and increasing flexibility; accompany with clarification of monetary policy framework, measures to eliminate excess liquidity, and strengthening of market-based operational framework.
- Staff does not recommend Fund approval of retention of exchange restrictions arising from FX prioritization, rationing of FX, tax clearance certificate requirement, and MCPs if they are not temporary and lack a timetable for elimination.
- Financial supervision framework needs strengthening.
- Staff supports broad lines of government development strategy: (i) revenue measures to capture resource wealth; (ii) prioritize public spending on basic education and health care and infrastructure; (iii) avoid sustained over-valuation of the Kina.
- Macroeconomic statistics: improving but further progress needed.
- Proposed timing: next Article IV consultation with PNG on the standard 12-month cycle.

*Source: IMF staff report (cr17411).*

### Box 2. The PNG LNG Project

### Box 2. The PNG LNG Project

### Overview
- Revenues from the LNG sector are composed of royalties, corporate income tax, additional profits tax, development levies, dividends, and various tax concessions aimed for investment incentives.
- Government revenue from the LNG sector has been very limited due to the generous fiscal terms of the agreement.
- The fiscal regime should strike a balance between securing a substantial share of the value of these resources for the people of PNG, while also providing incentives for investment in PNG.

### Tax concessions and fiscal terms
- 10-year depreciation allowance from 2015 until 2024.
- Additional capital uplift provisions from 2025 until 2029.
- Exemption from GST, import duties, and export levies.
- If the development levy (which is tax deductible) is paid then the royalty becomes creditable for corporate income tax purposes (i.e., it becomes an advance payment of future corporate income tax).
- Calculation of royalties and development levies are based on a net concept: both are calculated as 2 percent of the wellhead value ( $54 million = gross revenues $290 million – operational costs $46.2 million – amortization $75.8 million – capital allowance $114.5 million).
- Infrastructure tax credit, through which petroleum firms can charge a 100 percent deduction on capital expenditure on infrastructure projects, to a maximum of 2 percent of assessable income.

### Equity participation and Additional Profits Tax (APT)
- PNG participates through the national oil company, which holds a 16.6 percent stake in PNG LNG.
- The project enjoys a concessional additional profits tax (APT) which has high thresholds and low tax rates by international standards.
- The 2015 Taxation Review Committee (TRC) recommended that for future projects, a revamped APT be applied with a single threshold and a higher tax rate.
- The TRC also recommended reducing the government equity participation in future projects.
- These changes were introduced in the 2017 budget.

### Royalty and development levy performance and recommendations
- The current royalty and development levy scheme has yielded quite limited benefits; future agreements should apply specific levies based on volume or ad-valorem levies.
- Average monthly royalty payments have been around $1 million.
- As of September 2017, K150 million had been received in trust accounts for each of the royalty and development levies.
- The levies are based on “wellhead” value, allowing generous deduction of various costs in the calculation, significantly reducing the value of the royalties, especially in the early years of the project.
- This approach partly defeats the normal purpose of royalties, which is to ensure that the government receives some benefits from the project from day one.
- Recommendation for future LNG projects: modify the royalty scheme to use a volume-based levy or a value based on a “field-gate” basis allowing fewer deductions.

### Community payments from Mineral Resources Development Company
- In September, the Mineral Resources Development Company started first payment of K15 million to four plant site villages (Boera, Porebada, Papa and Lealea) where they finished clan-vetting process.
- Out of K15 million:
  - 40 percent (K6 million) is paid to LNG plant landowners as per Section 176 of the Oil and Gas Act,
  - 30 percent is kept for future generations,
  - 30 percent is used for community impact social projects.

*Box 2. The PNG LNG Project (cr17411).*

### Annex I.  Risk Assessment Matrix

### Annex I.  Risk Assessment Matrix

### External risks
- Tighter global financial conditions  
  - Relative likelihood: High  
  - Impact if realized: M  
  - Direction/implication: ↓ Decline in likelihood of external financing of fiscal deficit, putting more pressure on domestic financing sources  
  - Staff advice on policy response:
    - Focus on cutting government expenditure
    - Allow Kina to depreciate vs. USD

- Significant China slowdown and its spillovers  
  - Relative likelihood: Medium  
  - Impact if realized: H  
  - Direction/implication: ↓ Declines in major commodity export prices. Adverse BOP impact; moderate budget impact  
  - Staff advice on policy response:
    - Allow Kina to depreciate
    - Additional fiscal adjustment required

### Domestic risks
- Severe difficulty in financing fiscal deficit either externally or domestically  
  - Relative likelihood: High  
  - Impact if realized: H  
  - Direction/implication: ↓ Could lead either to sharper consolidation than expected, with adverse growth impact, or to increased reliance on central bank financing  
  - Staff advice on policy response:
    - Additional fiscal adjustment required
    - Commit to unwinding central bank financing over 3-year period

- Projects to increase LNG (or other minerals) export capacity begin sooner than assumed (early 2020s)  
  - Relative likelihood: Medium  
  - Impact if realized: H  
  - Direction/implication: ↑ Favorable impact on GDP, external balance and fiscal position. Could induce government to end consolidation  
  - Staff advice on policy response:
    - Continue with fiscal consolidation in line with fiscal rule
    - Eliminate FX restrictions and restore floating exchange rate

### Risk Assessment Matrix notes
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).  
- The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent).  
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Nonmutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

*Source: cr17411 - Annex I. Risk Assessment Matrix*

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

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

### Monetary, Financial and Exchange Rate Policies
- Fund recommendation: Remove excess liquidity to improve monetary policy effectiveness and reduce downside pressure on the kina exchange rate.
  - Authorities’ response:
    - Increased issuance of government securities and the BPNG’s intervention in FX market assisted in diffusing some of the excess liquidity.
    - As per the 100-Day Economic Stimulus Plan, the BPNG intended to increase intervention in the FX market by US$100 million in 2017.
    - The CRR has kept at 10 percent since September 2014; the BPNG considers options to tighten monetary policy if necessary.
- Fund recommendation: Allow greater exchange rate flexibility to clear the FX market.
  - Authorities’ response:
    - Although excess demand for foreign currency has persisted, the official interbank exchange rate has been stable since May 2016.
    - BPNG is concerned with the inflation impact of depreciation, and is skeptical of the impact on FX supply or demand.
- Fund recommendation: Continue to implement AML/CFT legislation.
  - Authorities’ response:
    - Authorities are taking steps to put in place a robust AML/CTF regime.
    - FASU director and staff were appointed, and a first national assessment of money laundering and terrorist financing risks report is expected to be finalized by end-2017.

### Fiscal Policy
- Fund recommendation: Adopt a fiscal policy stance consistent with putting public debt in line with the government’s targets and ensuring debt sustainability.
  - Authorities’ response:
    - The 2017 budget aimed to cut the deficit to 2.5 percent of GDP.
    - A Supplementary Budget was introduced in September to address the revenue shortfalls and expenditure over-runs.
    - The debt-to-GDP target was changed from under 30 percent to a range of 30 to 35 percent, targeting an average non-resource primary balance of zero over the medium term.
- Fund recommendation: Improve the quality of spending. Strengthen revenue collection through rationalizing tax exemptions and concessions and other measures recommended by the Tax Review Committee.
  - Authorities’ response:
    - The 100-Day Economic Stimulus Plan and the 2017 Supplementary Budget show continuing efforts to improve tax compliance and effectiveness of tax administration.
    - Intentions to review a range of excise charges and fees, introduce compulsory Taxpayer Identification Number registration, and implement regulations to compel the remittance of 90 percent of collected revenue to consolidated revenue fund by non-tax revenue agencies of government.
    - Corrective measures on expenditure include: amalgamation of departments and agencies, freezes on recruitment, constraints on the high personnel emoluments costs, strengthening payroll management, and compulsory National Identity for public servants.
- Fund recommendation: Safeguard the integrity of the SWF for it to play a key role in managing PNG’s resource revenues.
  - Authorities’ response:
    - The government has sought external technical assistance on the establishment of the SWF Administrative Secretariat at the BPNG.
    - The World Bank fielded a scoping mission from their RAMP, Financial Advisory and Banking Department in early 2017.

### Structural Reform
- 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:
    - Tuition fee free education, free primary healthcare, transport infrastructure, and law and order remain policy priorities of the Government.
    - The Government plans to publish a 5-year medium term development plan in mid-2018 incorporating the UN Sustainable Development Goals and Government’s Alotau Accord 2.
- Fund recommendation: Strengthen PFM by implementing further reforms identified in the PEFA assessment and SOE reform to enhance transparency and governance.
  - Authorities’ response:
    - The Government intends to review a number of Acts and Bills such as the National Procurement Authority Bill and table this with audited accounts of SOEs in Parliament, as well as ensure that there are boards for public bodies.

### Statistics
- Fund recommendation: Improve macroeconomic statistics and move forward with the publication of new GDP estimates.
  - Authorities’ response:
    - The authorities have made notable improvements in national accounts and fiscal data since 2014 and continue to make progress with the TAs.
    - The NSO plans to release new GDP estimates for 2015 in December 2017.

*Source: Annex II. Authorities’ Responses to Fund Advice (cr17411).*

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

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

### Key findings
- Central government debt to GDP: 33.4 percent as of end-2016.
- Central government debt has increased recently and interest payments have doubled between 2013 and 2016.
- Liquidity risks remain high as central government domestic financing has become increasingly shorter-term.
- Private external debt has declined continuously since the LNG sector started to repay its debt.
- PPG external debt risk is moderate.
- Overall risk assessment: risk of external debt distress is moderate; overall risk of public debt distress is high.

### Underlying assumptions
- PNG’s growth prospects and current account developments will be heavily influenced by its extractive sector and the commodity price outlook.
- The long-term growth outlook has been revised down slightly by 0.3 percent, reflecting recent weak economic fundamentals.
- The current account surplus reflects steady LNG export growth and strong import compression; the current account surplus is projected to decline, as imports recover.
- Primary fiscal balance projections:
  - Primary fiscal deficit is estimated to be around 0.7 percent of GDP in 2017.
  - Primary balance is projected to gradually improve to a surplus of around 1.3 percent.
- Issuing of a sovereign bond and future rolling over of a Credit Suisse loan were eliminated following decisions made by the government.
- Downside risks: recent weak commodity prices.
- Upside risk: possibility of significant capacity expansion in the resource sector.

### External DSA (public and publicly guaranteed (PPG) external debt)
- All PPG external debt ratios stay below indicative thresholds under the baseline scenario.
- Stress tests show a moderate external risk.
- Baseline scenario is heavily affected by a reported new loan from a commercial bank, taken in 2016 and 2017.
- Historical scenario produces large breaches in all indicators; however, this scenario is not considered indicative of future risks because 10-year averages encompass the PNG LNG construction phase and an extremely elevated current account deficit.
- The most extreme shock scenario (shocks to export growth) shows a marginal breach in the ratio of PPG external debt to exports, indicating moderate risk.
- An additional probability approach confirmed moderate external risk, showing breaches of several indicators (debt-to-GDP ratio, debt-to-exports ratio, and debt-to-revenue ratio) in the most extreme shock scenario.
- The relatively weak non-resource sector, partly due to the shortage of foreign exchange, increased vulnerability to external shocks.
- Upside import risk: imports may recover faster than the baseline if a new resource project starts, as historical PNG LNG construction phase shock indicates.

### Public DSA
- Public debt is projected to reach 45 percent of GDP over the medium term, deviating above the benchmark.
- All scenarios show public debt will be above the benchmark on public debt to GDP and increasing over time.
- If the primary balance-to-GDP ratio is fixed at the 2016 value, all indicators show a risk of unsustainable debt dynamics, underscoring the need for further fiscal consolidation.
- Drivers of adverse debt dynamics include the increasing average real interest rate and cost over time.
- Liquidity risks are masked by calculation methods:
  - Debt service-to-revenue ratio is calculated using medium- to 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 53 percent in 2016.
  - Using total PPG amortization and including amortization of Treasury bills would raise the debt service-to-revenue ratio to over 100 percent.
- Budget exposure to unfunded superannuation liabilities estimated at around K2 billion (3 percent of 2017 GDP).
- Official debt figures understate the true level of public debt because they include only domestic central government debt and external public debt and do not capture debts of many statutory authorities and state-owned enterprises.
- Policy implication: need for prudent debt management and further fiscal consolidation.

### Authorities’ views
- The authorities initiated their first own DSA analysis in 2017 and agreed that further fiscal consolidation is crucial for debt sustainability.
- Following the joint IMF-World Bank TA on a Medium-Term Debt Management Strategy conducted in 2016, the authorities started their own DSA exercise for the first time in 2017.
- Authorities acknowledged the importance of more comprehensive data on debt and other liabilities, particularly off-budget and public enterprise debt.

### Conclusion
- PNG’s risk of external debt distress is moderate.
- The overall risk of public debt distress is high, reflecting the increased stock of domestic debt with a higher share of short-term Treasury bills.
- Additional future external financing without being backed by expected foreign exchange inflows might increase the risk of distress.

### Box 1 — Macroeconomic assumptions underlying the DSA update
- Compared to the 2016 DSA, macroeconomic assumptions are largely unchanged in terms of the overall story, except elimination of rollover of the Credit Suisse loan and cancellation of sovereign bond issuance.
- Inflation rates are expected to converge to core inflation, given current stable exchange rates.
- The current account is projected to be in surplus, mainly due to the downward revision in imports.
- Real GDP growth projection: Real GDP growth is projected to average 3.1 percent in the medium/long run, a slight decrease from the 3.4 percent long term average growth rate used for the 2016 DSA.
- Inflation projection: Inflation is expected to be about 2 percent in 2017 reflecting worsening terms-of-trade, before going back to

*PAPUA NEW GUINEA — INTERNATIONAL MONETARY FUND*

### 2.4 percent in the medium term. This decrease of inflation from the previous medium/long term projection

### cr17411 - 2.4 percent in the medium term. This decrease of inflation from the previous medium/long term projection

### Macroeconomic outlook
- Real growth projected at 2.4 percent in 2018, up from 2.2 percent in 2017.
- Inflation projected at 6.9 percent in 2018, up from 5.9 percent in 2017.
- Authorities’ medium-term projections: real growth will average 2.4 percent; inflation expected to average 5.7 percent over the medium term.
- Growth projection assumptions: subdued commodity prices and exclusion of all potential major resource projects (Elk-Antelope project, Stanley gas project, expansion of the PNG LNG project, Papua LNG project, petrochemical projects, Frieda copper mine and Wafi-Golpu gold mine).
- Downside risks to inflation: exogenous supply and demand shocks or further depreciation of the currency.
- Conservative outlook intended to ensure macroeconomic policies are achievable over the projection horizon (2017-2020).

### External account and balance of payments
- The current account (including grants) turned to surplus in 2014 due to the commencement of LNG exports.
- Recent strong current account also supported by import compression caused by the shortage of foreign exchange.
- Medium/long-term projection: gradual erosion of the current account surplus as imports recover.
- External debt indicators and projections presented for 2017-2037 (see tables and figures in source for detailed year-by-year values).

### Fiscal policy and public finances
- Primary fiscal deficit estimated to be around 0.7 percent of GDP in 2017; projected to gradually improve to a surplus of around 1.3 percent thereafter.
- Authorities passed a 100-day Plan and the 2017 Supplementary Budget in September to narrow the fiscal deficit.
- Measures on wage bill control: commencement of physical audit into the payroll; freeze on new recruitments; ceasing use of the parallel payroll system; migration of all government employees onto the centralized government payroll; national identification card; identification of offices and agencies for amalgamation in 2018.
- Fiscal Responsibility Act amended: single target public debt-to-GDP ratio ceiling of 30 percent replaced with a public debt-to-GDP range of 30-35 percent; targeting an average annual non-resource primary fiscal balance of zero over the medium term.
- New Medium Term Fiscal Strategy (MTFS) launched to promote revenue mobilization and spending reduction.
- 2018 Budget (first under MTFS) lifts capital spending and reprioritizes limited public spending to higher value priorities.
- Revenue measures and Medium-Term Revenue Strategy (MTRS): financed special task forces to increase tax collections and compliance; amending non-tax revenue regulations to compel 90 percent of remittances to consolidated revenue; stopped all credit tax for projects until further notice; compulsory registration of business bank accounts and tax identification numbers with Investment Promotion Authority; 2018 Budget approved new tariff and excise rates, legislative amendments and administrative initiatives.

### Debt assumptions and financing
- Credit Suisse loan is assumed to be a bridge loan; future rollover of this loan (included in past DSA) was eliminated.
- Sovereign bond issuance has been put on hold by the government and is not assumed in this DSA.
- Identified fiscal figures in source tables (examples, selected values):
  - Primary fiscal deficit: 0.7 percent of GDP in 2017.
  - Public sector debt levels and projections provided in Table 3 (2017-2037) with year-by-year percentages.
  - PV of public sector debt and PV of PPG external debt shown across projections (see tables for exact numeric trajectories).
- Memorandum items and financing needs (from tables): Total gross financing need (Billions of U.S. dollars) series and other detailed debt-service and PV ratios are provided in the source tables.

### Monetary policy and liquidity management
- Authorities maintain a neutral monetary policy stance with inflation considered manageable; will adjust policy as necessary while closely monitoring inflation trends.
- Liquidity remains high but has not translated into high lending to the private sector.
- Liquidity management tools used: open market operations issuing Central Bank Bills (CBB); maintaining cash reserve ratio at 10 percent since 2014.
- New Tap Facility for Treasury bills and bonds introduced in April 2017 to assist liquidity withdrawal; eligible investors are those not able to participate in the primary auctions.
- CBB Tap Facility defined as a short-term financial instrument issued by the Bank of PNG for the purpose of liquidity management.

### Key policy priorities and reforms
- Restore macroeconomic stability while implementing reforms to foster inclusive medium-term growth.
- Contain public debt to prudent levels and improve public finance management governance.
- Mobilize revenue via MTRS and strengthen revenue institutions.
- Protect critical development spending on education, health, infrastructure, and law and order during protracted economic cycles.
- Promote structural reforms to support inclusive growth and investments in non-resource sectors.

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

### 1.5 percent less than the primary auctions yields. Furthermore, as at end July 2017, noting the

### cr17411 - 1.5 percent less than the primary auctions yields. Furthermore, as at end July 2017, noting the

### Monetary operations and fiscal-financial interactions
- Central Bank issued CBB to withdraw the new money created under the slack arrangement; a small net amount remained to diffuse as at end July 2017.
- The practice of large Central Bank holdings of government securities under the slack arrangement is anticipated to cease given authorities commitment to credible fiscal consolidation in the medium term.
- Authorities intend to issue a 3-year bond to finance structural reforms with some financing used to mitigate the foreign exchange imbalances.

### Financial sector soundness and risks
- PNG’s financial sector is described as sound and stable.
- Commercial banks:
  - Continue to record positive balance sheets against a low number of non-performing loans.
  - Have low credit growth, which is expected to pick up with the recovery in the economy.
  - Hold government securities that account for nearly one third of their total assets.
- Correspondent banking relationships were lost on a few occasions over the last five years; affected entities established low tier banking relationships out of Europe.
- Authorities and staff agree on the need to strengthen macroprudential supervision of the Central Bank, focusing on three areas:
  1. Establishing relevant data for macroprudential analysis.
  2. Ensuring availability of various macroprudential tools.
  3. Building the institutional and governance arrangements of the macroprudential authority.
- Ongoing efforts include enabling the Central Bank’s Banking Supervision Department (which covers Savings and Loans Societies) to implement Base II and III principles.
- Authorities are shifting to a risk based supervision regime for:
  - The banking industry.
  - The superannuation and life insurance sectors.
- New prudential standards have been released covering corporate governance, capital adequacy and risk management for banking, savings and loans, superannuation and life insurance sectors.
- Anti–money laundering/combating the financing of terrorism (AML/CTF) measures:
  - Appointment of a Financial Analysis and Supervision Unit (FASU) director and staff.
  - Anticipated first national assessment of money laundering and terrorist financing risks report by end 2017.

### Exchange rate regime and external buffers
- Authorities support a slow depreciation of the local currency using the existing exchange rate framework.
- The currency has depreciated by 16 percent in nominal terms since mid-2014.
- Since May 2016 the currency has been stable against the US dollar.
- Central Bank intervention has been limited.
- Gross foreign reserves were USD1.7 billion (around 5 months of imports) as of mid-October 2017.
- Broader policy context:
  - Fiscal policy is bearing the brunt of adjustment with accommodative monetary policy to help mitigate the impact on the economy.
  - International multilateral agencies have indicated commitment to provide concessional financing.

### Structural reforms and inclusive growth
- Authorities are committed to promoting inclusive economic growth and boosting investments in the non-resources sectors as a pre-condition for diversified broad-based economic growth.
- Legislative amendments introduced to create a growth-friendly environment for private sector growth include amendments to:
  - Lands & Physical Planning Act
  - Investment Promotion Act
  - Mining Act and the Mineral Resources Authority
  - Agricultural Administration Adjustment Act
  - Agriculture Investment Act
  - Biosecurity Act
- Support for small to medium enterprises (SME’s):
  - Training on financial literacy and entrepreneurial skills.
  - Facilitating access to financial initiatives.
  - Resulted in a significant increase in new personal bank accounts and expanded financial education coverage, including women.
- Authorities are investing in key infrastructure projects, including hospitals, the highlands highway, power plants, and agriculture.
- Social commitments:
  - Continued provision of Free Education and Free Primary Health Care to ensure equal opportunities in education and basic health care.

*Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17411.pdf*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17411.pdf_