## 1. Public Debt and Its Drivers ## Source details **Canonical URL:** [1. Public Debt and Its Drivers](https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025084.pdf) ## Other formats - [Markdown version](/-/media/files/publications/selected-issues-papers/2025/english/sipea2025084.pdf.md) - [Structured JSON version](/-/media/files/publications/selected-issues-papers/2025/english/sipea2025084.pdf.json) --- ### Key findings on recent debt dynamics and drivers - Public debt rose from 40.6 percent of GDP in 2019 to nearly 55 percent of GDP more recently. - Fiscal deficits averaged 4.2 percent of GDP in 2012-2019. - Identified drivers of public debt increases: - Sustained drop in revenue in 2012-2019, reflecting in part lower commodity prices. - Weak growth and significant fiscal relaxation during Covid-19. - Kina depreciation. - Resource sector concentration (as of 2023): - Resource sector accounts for 25 percent of output, 24 percent of fiscal revenues, and 87 percent of total exports. - Risk profile and vulnerabilities: - PNG is now more susceptible to resource sector shocks, with pro-cyclical fiscal policy linked to commodity price cycles. - Volatility of resource revenues poses risks to debt sustainability. - Public debt assessed as sustainable but at a high risk of debt distress under the LIC-DSF, with weak debt-carrying capacity. ### Composition and evolution of public debt - Composition shifts: - Share of domestic debt declined from around 80 percent of total public debt in 2015 to 50 percent in 2023, and to 44 percent more recently. - Creditor composition shifted away from commercial loans toward official multilateral and bilateral financing. - Implication: - Greater exposure to external concessional financing has contributed to improved debt sustainability indicators in the medium term. ### Existing fiscal framework and shortcomings - Legal and target inconsistencies: - FRA 2006 placed a ceiling of 30 percent of GDP on public debt. - Debt ceiling changes: raised to 45 percent of GDP in 2019, to 60 percent of GDP in 2020, and to 57.5 percent of GDP in 2023; plans to reduce back to below 40 percent of GDP from 2033 onwards (FRA 2023). - FRA 2017 amendment stipulated an implicit debt anchor between 30 and 35 percent of GDP (revised multiple times). - Operational rule gaps: - Non-resource primary balance rule exists but has not been linked to the implicit debt anchor and was not implemented until 2024 and 2025 budgets. - Sovereign wealth fund legislation (2015) established stabilization and development funds that remain dormant. - Development planning tensions: - MTDP IV specifies investment needs with a total expenditure envelope of K51 billion (equivalent to 8.4 percent of estimated GDP in 2024) between 2025 and 2029, of which K30 billion is financed by the central government — potentially in tension with rapid debt reduction objectives. - Conclusion: - Frequent revisions of the statutory debt limit and ambiguity between the 13-year plan, the FRA, and operational rules undermine credibility and the framework’s ability to mitigate public debt risks. ### Proposed medium-term fiscal anchor and operational rule - Recommended anchor: - A public debt anchor is more appropriate for PNG than a net wealth anchor given uncertainty in long-term resource revenue estimates and reserve estimates. - Proposed medium-term debt anchor: between 30 and 40 percent of GDP to ensure the statutory debt limit of 60 percent is not breached under most scenarios. - Recommended operational rule: - Use the primary balance as an operational policy instrument to facilitate convergence of public debt to its anchor and keep it at that level over the longer term. - Complementary measures: - Advance Public Financial Management (PFM) reforms. - Mobilize revenue in accordance with the Medium-Term Revenue Strategy (MTRS). - Enhance expenditure and commitment controls to bolster credibility of the fiscal framework. - Monitoring: - For resource-rich context, monitor developments of natural resources and assess implications for long-term public finance sustainability. ### Criteria for selecting operational fiscal rules - Five criteria for “good” operational rules in resource-rich developing countries: - Maintaining fiscal sustainability: ensure long-term debt sustainability. - Smoothening the economic cycle: allow automatic stabilizers and discretionary countercyclical policy. - Simplicity to monitor and communicate: easy verification and public understanding. - Neutrality on expenditure composition: avoid incentives to shift spending away from development needs. - Incentive to mobilize revenue: provide long-term constraints that encourage revenue mobilization. - Note: All criteria may not be achievable simultaneously with a single rule; multiple rules may be needed but risk overlap and inconsistency. ### Candidate operational rules and trade-offs - Nominal budget balance rule: - Pros: Directly linked to debt dynamics; simple to communicate and monitor. - Cons: Does not adjust for the economic cycle; silent on expenditure composition; may force procyclical consolidation. - Structural balance rule: - Pros: Adjusts for output gap and commodity gap; better economic stabilization. - Cons: Difficult to compute and monitor, especially separating cyclical versus structural commodity price movements; silent on composition of adjustment. - Expenditure rules: - Pros: Easy to monitor and enforce; can support macroeconomic stabilization if limits defined in levels or growth rates; targeting current spending can protect capital spending. - Cons: May reduce public investment if not designed to protect capital spending. - Revenue rules: - Pros: Can boost revenue collection and require saving of windfalls during commodity booms. - Cons: Do not constrain borrowing or spending and therefore do not ensure fiscal sustainability alone. ### Calibration, credibility, and institutional reforms (summary) - Anchor calibration: - Debt anchor between 30 and 40 percent of GDP is proposed to align with FRA medium-term objectives and to avoid breaching the 60 percent statutory debt limit in most scenarios. - Operationalization: - Primary balance rule recommended as operational instrument to guide debt convergence to the anchor. - Institutional reforms to enhance credibility: - Strengthen PFM systems. - Activate and operationalize sovereign wealth fund elements (stabilization and development funds). - Implement MTRS revenue measures. - Improve expenditure and commitment controls to constrain procyclical spending and protect development investment priorities. --- ### This paper proposes a primary balance rule to achieve PNG’s medium-term debt anchor ### Rationale for a primary balance rule - Primary balance rule priorities: - Ensure debt sustainability by constraining the fiscal aggregate that primarily influences debt dynamics in PNG. - Easy to monitor and control given PNG’s low capacity and gaps in national accounts data that complicate structural balance rules. - Easier to communicate to the public and more closely related to the authorities’ commitment to a balanced budget in 2027 compared to the current non-resource primary balance rule, aiding public awareness and credibility-building over time. - Empirical note: - Jamaica adopted in 2012 a fiscal rule of overall balance anchored by a debt ceiling of 60 percent of GDP; Jamaica reduced debt-to-GDP from 144 percent of GDP to 72 percent in 2023. ### Debt limit: determination and findings - Purpose: - A debt ceiling is the maximum public debt level that prevents debt distress and should not be exceeded in almost all circumstances; the debt limit serves as a reference point for calibrating the debt anchor and is set below the ceiling. - Two approaches used to determine PNG’s maximum debt limit: - Prudential approach: - Maximum debt limit = highest primary balance divided by the interest-growth differential under stress. - PNG’s highest primary balance (three-year moving average) since the GFC: 2.3 percent of GDP in 2011. - PNG’s largest interest-growth differential: 4.2 percent in 2020. - Resulting prudential debt limit: 54 percent of GDP. - Growth-friendly debt approach: - Assesses level beyond which further debt undermines growth; literature notes adverse effects above 60 percent of GDP and aggravated beyond 90 percent of GDP for emerging countries. - Combined assessment and recommendation: - A debt limit of 60 percent of GDP is deemed appropriate and broadly consistent with the authorities’ FRA. - Comparative note: 44 countries adopt a debt ceiling of 60 percent of GDP worldwide. - Practical suggestion: To avoid frequent modification of the FRA, authorities could maintain the current debt ceiling of 57.5 percent of GDP, which is close to the proposed 60 percent of GDP. ### Calibrating the fiscal anchor and scenarios - Safe buffer concept: - A buffer below the debt limit ensures debt remains below the limit under large negative shocks and provides time for corrective measures; buffer determined by historical shocks, medium-term projections, and policymakers’ tolerance of the probability of breaching the limit. - Historical shocks calibration: - Based on macroeconomic variables from the WEO database and simulations using a student-T distribution and the standard debt dynamic equation and fiscal reaction function. - Table 2 calibrated anchors (from IMF staff calculations): - Tolerance level (percent probability): 0 → Anchor 32 - Tolerance level (percent probability): 10 → Anchor 38 - Tolerance level (percent probability): 15 → Anchor 39 - Scenario probabilities considered: - The paper considers probabilities that debt will breach the 60 percent of GDP limit of 0, 10, and 20 percent over the medium term. - Interpretation and recommendation: - Calibrated debt anchor range: 32 to 39 percent of GDP depending on tolerance level. - With a tolerance level of 10 percent, the calibrated debt anchor is 38 percent of GDP (implying a 90 percent probability that debt will remain below 60 percent of GDP in the medium term). - Prudential recommendation: A prudent debt anchor estimated between 30 and 40 percent of GDP. Maintaining public debt around the anchor allows with at least 85 percent probability that PNG can withstand typical adverse macroeconomic shocks without breaching the maximum debt limit in the medium term. - For illustrative purposes the paper uses the midpoint of 35 percent of GDP as the calibrated debt anchor. - Cross-reference: - The DSF-LIC framework suggests a maximum PV of total debt for PNG of 35 percent of GDP; the debt limit in this paper is a more stringent limit. ### Calibrating a deficit rule and transition path to the anchor - Objective: - Calibrate a path for primary balances to guide public debt to the anchor of 35 percent of GDP by 2032. - Transition path design: - Include a transition period before the primary balance reaches its steady state (debt-stabilizing) level to balance gradual consolidation and political feasibility. - Proposed path consistent with DSA: - Reach a primary balance of 2.5 percent of GDP by 2027 (in line with the 13-year plan). - Maintain that primary balance for another three years to ensure public debt declines to 40 percent of GDP by 2030. - Then gradually ease fiscal policy towards the steady-state deficit to lower debt towards its anchor by 2032. - Underlying assumption: - Primary balance consistent with WEO until 2030, with a primary surplus of 2.5 percent of GDP from 2027 until debt reaches its anchor in 2030. - The primary balance rule is a floor; windfall resource revenues should be saved to avoid procyclical policies and allow faster convergence to the debt anchor. - Steady-state/debt-stabilizing calibration: - Debt-stabilizing primary balance formula: b* = λ d*, where b* is the debt-stabilizing primary balance, d* is the debt anchor, and λ is the growth-adjusted interest rate. - Once public debt reaches the anchor of 40 percent of GDP in 2030, the target primary balance shall be gradually reduced to -0.7 percent of GDP, which would stabilize public debt at around 35 percent of GDP in the longer term while providing more fiscal space for development needs. - Assessment of pace: - A more gradual consolidation path relative to the authorities’ 13-year plan is considered appropriate as it enhances credibility and reduces the drag from fiscal tightening; more gradual convergence helps establish a track record and lower the risk premium on government bonds. - Financing mix recommendations: - Domestic financing: issue longer-term Treasury bonds to decrease the PV of public debt and reduce rollover risks. - External financing: consider increasing external concessional borrowing while prudently managing exchange rate risks. ### Other considerations: expenditure rule, escape clause, sovereign wealth fund - Expenditure rule to save procyclical resource revenues: - Consider a complementary nominal growth cap on overall spending to support stabilization and improve transparency relative to real-term caps. - Capping overall spending helps prevent creative accounting (e.g., reclassifying goods and services as capital spending in PIP). - Implementation requires building capacity to monitor expenditure and track domestic arrears; seen as a medium-term priority. - Suggested quantitative guidance: - Under current projections, a ceiling of about 6 percent on overall nominal expenditure growth could supplement the primary deficit rule and facilitate saving of additional revenues. - This 6 percent ceiling would ensure that the primary balance complies with the fiscal rule at -0.7 percent of GDP in the steady state. - Comparative statistic: average expenditure growth rate over the past decade was 8.6 percent. - Operational detail: If commodity prices underperform, the expenditure rule will not be binding because the primary balance rule will mechanically ensure compliance; the expenditure rule becomes binding in the event of a positive revenue surprise. - Escape clause design principles: - A well-designed escape clause provides flexibility to cope with shocks while preserving the credibility of the framework by formalizing deviations rather than abandoning rules. - Typical elements to specify in formal regulation: (i) description of shocks accommodated, (ii) period for deviation, (iii) maximum magnitude of deviation, (iv) pathway to return to rules, (v) institutional responsibility for triggering the clause, (vi) institutional responsibility for monitoring implementation. - Examples: resource-rich countries define ‘economic shock’ as sudden and unexpected changes in prices of key resource exports. - Sovereign wealth fund and use of resource windfalls: - Consider saving excess commodity revenues into a sovereign wealth fund to avoid procyclicality and ensure prudent use. - Caveats for using windfalls for investment: - Procyclical resource revenue is an uncertain source for capital expenditures. - IMF (2014) shows only half of increases in public investment translated into productive capital in EMDEs during 1980-2012. - Risks: weak public investment management, capacity constraints, macro vulnerabilities, potential wage-inflation spiral, inflationary pressures, and real exchange rate appreciation harming non-resource exporters. - Recommendation: Use resource revenue windfalls prudently, consistent with capacity limits and guided by sound governance practices. ### Supporting the MTFF with PFM reforms - Fiscal rules should sit within a broader Medium-Term Fiscal Framework (MTFF) containing core elements: - A medium-term fiscal strategy. - Medium-term fiscal projections. - An assessment of fiscal risks. - An effective MTFF should also define key roles and responsibilities of major stakeholders, including entities often outside government such as Parliament, the Supreme Audit Institution, and, in some cases, an independent Fiscal Council. --- ### MTFF linkage to the budget process, existing strengths, and capacity gaps ### MTFF linkage to the budget process - MTFFs must have a direct relationship to government plans for expenditure, revenue, deficit, and debt. - Expenditure is the most directly controllable fiscal component; expenditure plans in the annual budget should be directly derived from the MTFF. - Typical good practice: make at least the first year of the MTFF’s expenditure projection the binding aggregate ceiling for the forthcoming budget year. - Key MTFF outputs (e.g. the fiscal strategy, fiscal projections) must be produced in time to input into the budget process. ### PNG: existing strengths in fiscal and budget documents - Government has set out a 13 year “budget repair” process. - Stand-alone medium-term fiscal strategies produced (latest version 2017-2022). - Annual budget documents: - Summarize fiscal strategy goals. - Outline global and national macroeconomic trends. - Present three-year forecasts of key fiscal aggregates. - Compare proposed fiscal plan to fiscal anchors and rules to which government has committed. - Include a short discussion of key macroeconomic and fiscal risks. - Briefly compare previous years’ expenditure estimates to mid-year outturn forecasts and supplementary budgets. - An annual mid-year economic and fiscal outlook provides mid-year and end-year forecast updates of key fiscal aggregates and a narrative summary of key revenue and expenditure developments. - PEFA assessment from 2020 noted good scores in macroeconomic forecasting and fiscal strategy. ### Gaps: weak linkage, reconciliation, and fiscal risk coverage - No clear reconciliation, explanation, or discussion of differences between successive vintages of fiscal forecasts and actual outturn in fiscal and budget documentation. - No detailed discussion of current progress against the overall 13-year budget repair strategy and/or supporting five-year medium-term fiscal strategies. - Question over the role of the published MTFF in guiding expenditure plans; discrepancies in budget documents suggest a disjuncture between fiscal policy and the actual budget. - Example discrepancies: - 2023: fiscal policy discussion total expenditure and net lending = K25,567 million; later chapters of 2023 budget document total appropriation = K39,155m. - 2024: fiscal policy discussion figure = K27,376 million; later chapters figure = K47,742 million. - Discussion of fiscal risks is somewhat limited. ### Fiscal data and reporting challenges - 2020 PEFA assessment noted financial statements from many government agencies, statutory authorities, and provincial authorities are frequently out of date. - Overall government accounts for several previous years are still to be audited. - Government does not have a full list of public entities correctly classified into appropriate sectors for fiscal and budgetary reporting. - IMF technical assistance highlighted challenges in budget execution, cash management, and expenditure control processes that hinder tracking and controlling financial flows. - The stock of alleged arrears remains subject to government verification and may be fiscally significant. ### Institutional capacity needs and MTFF development - PNG should invest in additional institutional capacity to develop its MTFF and better support implementation of fiscal rules. - Annual fiscal and budgetary cycle allows gradual year-on-year improvement if government invests resources in key areas. - Strengthening basic processes (notably production of reliable fiscal reports) is necessary before adopting more explicit and binding fiscal rules. - Without functioning basic processes, operationalizing well-designed fiscal rules will be difficult. ### Calibrated fiscal framework proposals and policy implications - Calibrated proposals: - Consider a debt anchor of between 30 and 40 percent of GDP. - Propose a primary balance rule to achieve the debt anchor with a transition period to 2032. - After convergence in 2032, a gradual fiscal relaxation is assumed until a debt stabilizing primary deficit of 0.7 percent of GDP is reached. - Parallel priorities: - Invest in strengthening institutional capacity and improving the reliability of fiscal data to implement rules and manage resource revenue fluctuations. - Support fiscal sustainability and more inclusive growth. ### Additional design considerations - Over the longer term, consider a complementary expenditure rule to encourage saving of excess resource revenues to: - Avoid procyclical fiscal policy. - Avoid significant inflationary pressures. - Mitigate adverse effects of a Dutch disease. - Design well-crafted escape clauses to provide fiscal policy flexibility to respond to severe economic shocks while maintaining fiscal discipline. - Careful consideration of the structure and governance of a sovereign wealth fund is required to manage resource revenues and promote intergenerational equity. *Source: sipea2025084 - 1. Public Debt and Its Drivers. May 28, 2025.* ### 1. Public Debt and Its Drivers ___________________________________________________________ 2 ### 1. Public Debt and Its Drivers ### Key findings on recent debt dynamics and drivers - Public debt rose from 40.6 percent of GDP in 2019 to nearly 55 percent of GDP more recently. - Fiscal deficits averaged 4.2 percent of GDP in 2012-2019. - Drivers of public debt increases identified: - Sustained drop in revenue in 2012-2019, reflecting in part lower commodity prices. - Weak growth and significant fiscal relaxation during Covid-19. - Kina depreciation. - Resource sector concentration (as of 2023): - Resource sector accounts for 25 percent of output, 24 percent of fiscal revenues, and 87 percent of total exports. - Risk profile and vulnerabilities: - PNG is now more susceptible to resource sector shocks, with pro-cyclical fiscal policy linked to commodity price cycles. - Volatility of resource revenues poses risks to debt sustainability. - Public debt assessed as sustainable but at a high risk of debt distress under the LIC-DSF, with weak debt-carrying capacity. ### Composition and evolution of public debt - Composition shifts: - Share of domestic debt declined from around 80 percent of total public debt in 2015 to 50 percent in 2023, and to 44 percent more recently. - Creditor composition shifted away from commercial loans toward official multilateral and bilateral financing. - Implication: - Greater exposure to external concessional financing has contributed to improved debt sustainability indicators in the medium term. ### Existing fiscal framework and shortcomings - Legal and target inconsistencies: - FRA 2006 placed a ceiling of 30 percent of GDP on public debt. - Debt ceiling changes: raised to 45 percent of GDP in 2019, to 60 percent of GDP in 2020, and to 57.5 percent of GDP in 2023; plans to reduce back to below 40 percent of GDP from 2033 onwards (FRA 2023). - FRA 2017 amendment stipulated an implicit debt anchor between 30 and 35 percent of GDP (revised multiple times). - Operational rule gaps: - Non-resource primary balance rule exists but has not been linked to the implicit debt anchor and was not implemented until 2024 and 2025 budgets. - Sovereign wealth fund legislation (2015) established stabilization and development funds that remain dormant. - Development planning tensions: - MTDP IV specifies investment needs with a total expenditure envelope of K51 billion (equivalent to 8.4 percent of estimated GDP in 2024) between 2025 and 2029, of which K30 billion is financed by the central government — potentially in tension with rapid debt reduction objectives. - Conclusion: - Frequent revisions of the statutory debt limit and ambiguity between the 13-year plan, the FRA, and operational rules undermine credibility and the framework’s ability to mitigate public debt risks. ### Proposed medium-term fiscal anchor and operational rule - Recommended anchor: - A public debt anchor is more appropriate for PNG than a net wealth anchor given uncertainty in long-term resource revenue estimates and reserve estimates. - Proposed medium-term debt anchor: between 30 and 40 percent of GDP to ensure the statutory debt limit of 60 percent is not breached under most scenarios. - Recommended operational rule: - Use the primary balance as an operational policy instrument to facilitate convergence of public debt to its anchor and keep it at that level over the longer term. - Complementary measures: - Advance Public Financial Management (PFM) reforms. - Mobilize revenue in accordance with the Medium-Term Revenue Strategy (MTRS). - Enhance expenditure and commitment controls to bolster credibility of the fiscal framework. - Monitoring: - For resource-rich context, monitor developments of natural resources and assess implications for long-term public finance sustainability. ### Criteria for selecting operational fiscal rules - Five criteria for “good” operational rules in resource-rich developing countries: - Maintaining fiscal sustainability: ensure long-term debt sustainability. - Smoothening the economic cycle: allow automatic stabilizers and discretionary countercyclical policy. - Simplicity to monitor and communicate: easy verification and public understanding. - Neutrality on expenditure composition: avoid incentives to shift spending away from development needs. - Incentive to mobilize revenue: provide long-term constraints that encourage revenue mobilization. - Note: All criteria may not be achievable simultaneously with a single rule; multiple rules may be needed but risk overlap and inconsistency. ### Candidate operational rules and trade-offs - Nominal budget balance rule: - Pros: Directly linked to debt dynamics; simple to communicate and monitor. - Cons: Does not adjust for the economic cycle; silent on expenditure composition; may force procyclical consolidation. - Structural balance rule: - Pros: Adjusts for output gap and commodity gap; better economic stabilization. - Cons: Difficult to compute and monitor, especially separating cyclical versus structural commodity price movements; silent on composition of adjustment. - Expenditure rules: - Pros: Easy to monitor and enforce; can support macroeconomic stabilization if limits defined in levels or growth rates; targeting current spending can protect capital spending. - Cons: May reduce public investment if not designed to protect capital spending. - Revenue rules: - Pros: Can boost revenue collection and require saving of windfalls during commodity booms. - Cons: Do not constrain borrowing or spending and therefore do not ensure fiscal sustainability alone. ### Calibration, credibility, and institutional reforms (summary points) - Anchor calibration: - Debt anchor between 30 and 40 percent of GDP is proposed to align with FRA medium-term objectives and to avoid breaching the 60 percent statutory debt limit in most scenarios. - Operationalization: - Primary balance rule recommended as operational instrument to guide debt convergence to the anchor. - Institutional reforms to enhance credibility: - Strengthen PFM systems. - Activate and operationalize sovereign wealth fund elements (stabilization and development funds). - Implement MTRS revenue measures. - Improve expenditure and commitment controls to constrain procyclical spending and protect development investment priorities. *Source: sipea2025084 - 1. Public Debt and Its Drivers. May 28, 2025.* ### 18. This paper proposes a primary balance rule to achieve PNG’s medium-term debt ### 18. This paper proposes a primary balance rule to achieve PNG’s medium-term debt anchor. ### Rationale for a primary balance rule - Primary balance rule priorities: - Ensure debt sustainability by constraining the fiscal aggregate that primarily influences debt dynamics in PNG. - Easy to monitor and control given PNG’s low capacity and gaps in national accounts data that complicate structural balance rules. - Easier to communicate to the public and more closely related to the authorities’ commitment to a balanced budget in 2027 compared to the current non-resource primary balance rule, aiding public awareness and credibility-building over time. - Empirical note: A recent successful case cited is Jamaica, which adopted in 2012 a fiscal rule of overall balance anchored by a debt ceiling of 60 percent of GDP; Jamaica reduced debt-to-GDP from 144 percent of GDP to 72 percent in 2023. ### Debt limit: determination and findings - Purpose: A debt ceiling is the maximum public debt level that prevents debt distress and should not be exceeded in almost all circumstances; the debt limit serves as a reference point for calibrating the debt anchor and is set below the ceiling. - Two approaches used to determine PNG’s maximum debt limit: - Prudential approach: maximum debt limit = highest primary balance divided by the interest-growth differential under stress. - PNG’s highest primary balance (three-year moving average) since the GFC: 2.3 percent of GDP in 2011. - PNG’s largest interest-growth differential: 4.2 percent in 2020. - Resulting prudential debt limit: 54 percent of GDP. - Growth-friendly debt approach: assesses level beyond which further debt undermines growth (literature cited: Reinhart et al. (2015) notes adverse effects above 60 percent of GDP and aggravated beyond 90 percent of GDP for emerging countries). - Combined assessment and recommendation: - A debt limit of 60 percent of GDP is deemed appropriate and broadly consistent with the authorities’ FRA. - Comparative note: 44 countries adopt a debt ceiling of 60 percent of GDP worldwide. - Practical suggestion: To avoid frequent modification of the FRA, authorities could maintain the current debt ceiling of 57.5 percent of GDP, which is close to the proposed 60 percent of GDP. ### Calibrating the fiscal anchor and scenarios - Safe buffer concept: a buffer below the debt limit ensures debt remains below the limit under large negative shocks and provides time for corrective measures; buffer determined by historical shocks, medium-term projections, and policymakers’ tolerance of the probability of breaching the limit. - Historical shocks calibration: based on macroeconomic variables from the WEO database and simulations using a student-T distribution and the standard debt dynamic equation and fiscal reaction function. - Table 2 calibrated anchors (from IMF staff calculations): - Tolerance level (percent probability): 0 → Anchor 32 - Tolerance level (percent probability): 10 → Anchor 38 - Tolerance level (percent probability): 15 → Anchor 39 - Textual scenario statement: - The paper considers probabilities that debt will breach the 60 percent of GDP limit of 0, 10, and 20 percent over the medium term (paragraph 25). - Interpretation: - Calibrated debt anchor range: 32 to 39 percent of GDP depending on tolerance level. - Example: With a tolerance level of 10 percent, the calibrated debt anchor is 38 percent of GDP (implying a 90 percent probability that debt will remain below 60 percent of GDP in the medium term). - Prudential recommendation: A prudent debt anchor estimated between 30 and 40 percent of GDP. Maintaining public debt around the anchor allows with at least 85 percent probability that PNG can withstand typical adverse macroeconomic shocks without breaching the maximum debt limit in the medium term. - For illustrative purposes the paper uses the midpoint of 35 percent of GDP as the calibrated debt anchor. - Cross-reference: The DSF-LIC framework suggests a maximum PV of total debt for PNG of 35 percent of GDP; the debt limit in this paper is a more stringent limit. ### Calibrating a deficit rule and transition path to the anchor - Objective: Calibrate a path for primary balances to guide public debt to the anchor of 35 percent of GDP by 2032. - Transition path design: - Include a transition period before the primary balance reaches its steady state (debt-stabilizing) level to balance gradual consolidation and political feasibility. - Proposed path consistent with DSA: reach a primary balance of 2.5 percent of GDP by 2027 (in line with the 13-year plan), maintain that primary balance for another three years to ensure public debt declines to 40 percent of GDP by 2030, then gradually ease fiscal policy towards the steady-state deficit to lower debt towards its anchor by 2032. - Underlying assumption: primary balance consistent with WEO until 2030, with a primary surplus of 2.5 percent of GDP from 2027 until debt reaches its anchor in 2030. - The primary balance rule is a floor; windfall resource revenues should be saved to avoid procyclical policies and allow faster convergence to the debt anchor. - Steady-state/debt-stabilizing calibration: - Debt-stabilizing primary balance formula: b* = λ d*, where b* is the debt-stabilizing primary balance, d* is the debt anchor, and λ is the growth-adjusted interest rate. - Once public debt reaches the anchor of 40 percent of GDP in 2030, the target primary balance shall be gradually reduced to -0.7 percent of GDP, which would stabilize public debt at around 35 percent of GDP in the longer term while providing more fiscal space for development needs. - Assessment of pace: - A more gradual consolidation path relative to the authorities’ 13-year plan is considered appropriate as it enhances credibility and reduces the drag from fiscal tightening; more gradual convergence helps establish a track record and lower the risk premium on government bonds. - Financing mix recommendations: - For domestic financing: issue longer-term Treasury bonds to decrease the PV of public debt and reduce rollover risks. - For external financing: consider increasing external concessional borrowing while prudently managing exchange rate risks. ### Other considerations: expenditure rule, escape clause, sovereign wealth fund - Expenditure rule to save procyclical resource revenues: - Consider a complementary nominal growth cap on overall spending to support stabilization and improve transparency relative to real-term caps. - Capping overall spending helps prevent creative accounting (e.g., reclassifying goods and services as capital spending in PIP). - Implementation requires building capacity to monitor expenditure and track domestic arrears; seen as a medium-term priority. - Suggested quantitative guidance: - Under current projections, a ceiling of about 6 percent on overall nominal expenditure growth could supplement the primary deficit rule and facilitate saving of additional revenues. - This 6 percent ceiling would ensure that the primary balance complies with the fiscal rule at -0.7 percent of GDP in the steady state. - Comparative statistic: average expenditure growth rate over the past decade was 8.6 percent. - Operational detail: If commodity prices underperform, the expenditure rule will not be binding because the primary balance rule will mechanically ensure compliance; the expenditure rule becomes binding in the event of a positive revenue surprise. - Escape clause design principles: - A well-designed escape clause provides flexibility to cope with shocks while preserving the credibility of the framework by formalizing deviations rather than abandoning rules. - Typical elements to specify in formal regulation: (i) description of shocks accommodated, (ii) period for deviation, (iii) maximum magnitude of deviation, (iv) pathway to return to rules, (v) institutional responsibility for triggering the clause, (vi) institutional responsibility for monitoring implementation. - Examples: resource-rich countries define ‘economic shock’ as sudden and unexpected changes in prices of key resource exports. - Sovereign wealth fund and use of resource windfalls: - Consider saving excess commodity revenues into a sovereign wealth fund to avoid procyclicality and ensure prudent use. - Caveats for using windfalls for investment: - Procyclical resource revenue is an uncertain source for capital expenditures. - IMF (2014) shows only half of increases in public investment translated into productive capital in EMDEs during 1980-2012. - Risks: weak public investment management, capacity constraints, macro vulnerabilities, potential wage-inflation spiral, inflationary pressures, and real exchange rate appreciation harming non-resource exporters. - Recommendation: Use resource revenue windfalls prudently, consistent with capacity limits and guided by sound governance practices. ### Supporting the MTFF with PFM reforms - Fiscal rules should sit within a broader Medium-Term Fiscal Framework (MTFF) containing core elements: - A medium-term fiscal strategy. - Medium-term fiscal projections. - An assessment of fiscal risks. - An effective MTFF should also define key roles and responsibilities of major stakeholders, including entities often outside government such as Parliament, the Supreme Audit Institution, and, in some cases, an independent Fiscal Council. *Source: sipea2025084 - This paper proposes a primary balance rule to achieve PNG’s medium-term debt anchor.* ### 38. An effective MTFF – and its fiscal rules – must link directly to the budget process. For ### 38. An effective MTFF – and its fiscal rules – must link directly to the budget process. For ### MTFF linkage to the budget process - MTFFs must have a direct relationship to government plans for expenditure, revenue, deficit, and debt. - Expenditure is the most directly controllable fiscal component; expenditure plans in the annual budget should be directly derived from the MTFF. - Typical good practice: make at least the first year of the MTFF’s expenditure projection the binding aggregate ceiling for the forthcoming budget year. - Key MTFF outputs (e.g. the fiscal strategy, fiscal projections) must be produced in time to input into the budget process. - If an MTFF does not inform budget detail, it risks becoming an academic exercise rather than a policy lever. ### PNG: existing strengths in fiscal and budget documents - Government has set out a 13 year “budget repair” process. - Stand-alone medium-term fiscal strategies produced (latest version 2017-2022). - Annual budget documents: - Summarize fiscal strategy goals. - Outline global and national macroeconomic trends. - Present three-year forecasts of key fiscal aggregates. - Compare proposed fiscal plan to fiscal anchors and rules to which government has committed. - Include a short discussion of key macroeconomic and fiscal risks. - Briefly compare previous years’ expenditure estimates to mid-year outturn forecasts and supplementary budgets. - An annual mid-year economic and fiscal outlook provides mid-year and end-year forecast updates of key fiscal aggregates and a narrative summary of key revenue and expenditure developments. - PEFA assessment from 2020 noted good scores in macroeconomic forecasting and fiscal strategy. ### Gaps: weak linkage, reconciliation, and fiscal risk coverage - No clear reconciliation, explanation, or discussion of differences between successive vintages of fiscal forecasts and actual outturn in fiscal and budget documentation. - No detailed discussion of current progress against the overall 13-year budget repair strategy and/or supporting five-year medium-term fiscal strategies. - Question over the role of the published MTFF in guiding expenditure plans; discrepancies in budget documents suggest a disjuncture between fiscal policy and the actual budget. - Example discrepancies: - 2023: fiscal policy discussion total expenditure and net lending = K25,567 million; later chapters of 2023 budget document total appropriation = K39,155m. - 2024: fiscal policy discussion figure = K27,376 million; later chapters figure = K47,742 million. - Discussion of fiscal risks is somewhat limited. ### Fiscal data and reporting challenges - 2020 PEFA assessment noted financial statements from many government agencies, statutory authorities, and provincial authorities are frequently out of date. - Overall government accounts for several previous years are still to be audited. - Government does not have a full list of public entities correctly classified into appropriate sectors for fiscal and budgetary reporting. - IMF technical assistance highlighted challenges in budget execution, cash management, and expenditure control processes that hinder tracking and controlling financial flows. - The stock of alleged arrears remains subject to government verification and may be fiscally significant. ### Institutional capacity needs and MTFF development - PNG should invest in additional institutional capacity to develop its MTFF and better support implementation of fiscal rules. - Annual fiscal and budgetary cycle allows gradual year-on-year improvement if government invests resources in key areas. - Strengthening basic processes (notably production of reliable fiscal reports) is necessary before adopting more explicit and binding fiscal rules. - Without functioning basic processes, operationalizing well-designed fiscal rules will be difficult. ### Calibrated fiscal framework proposals and policy implications - The paper calibrates a debt anchor and a primary balance rule to enhance the existing framework: - Consider a debt anchor of between 30 and 40 percent of GDP. - Propose a primary balance rule to achieve the debt anchor. - The proposed primary balance rule includes a transition period of several years to facilitate convergence of public debt to its anchor in 2032. - After convergence in 2032, a gradual fiscal relaxation is assumed until a debt stabilizing primary deficit of 0.7 percent of GDP is reached. - Parallel priorities: - Invest in strengthening institutional capacity and improving the reliability of fiscal data to implement rules and manage resource revenue fluctuations. - Support fiscal sustainability and more inclusive growth. ### Additional design considerations for the fiscal framework - Over the longer term, consider a complementary expenditure rule to encourage saving of excess resource revenues to: - Avoid procyclical fiscal policy. - Avoid significant inflationary pressures. - Mitigate adverse effects of a Dutch disease. - Design well-crafted escape clauses to provide fiscal policy flexibility to respond to severe economic shocks while maintaining fiscal discipline. - Careful consideration of the structure and governance of a sovereign wealth fund is required to manage resource revenues and promote intergenerational equity. ### Boxed guidance extracted from source boxes - Basic components of an MTFF: - Medium-term projections for key macroeconomic variables and main fiscal aggregates (revenue, expenditure, debt, and deficit). - A fiscal strategy stating government’s fiscal objectives and targets over a 3-to-5-year period. - A comprehensive assessment of fiscal risks and their potential impact on government finances. - Design choices: coverage, time horizon, frequency of revision, fixed or rolling frameworks, binding or indicative expenditure limits, nominal or real terms, and institutional assignments. - MTFFs must be integral to fiscal and budgetary decision making; without direct impact on revenue, expenditure, deficits, and debt decisions, MTFFs can remain a paper exercise. - Fiscal rule escape clauses in small island states (examples of approaches to suspension or deviation in specific circumstances). *Source: Excerpt from sipea2025084, IMF selected issues paper.* --- _Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025084.pdf_