## 1. Update on the Mineral Sector

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---

### Context
- PNG’s economy entered a transitional growth period as new liquefied natural gas (LNG) production and exports commenced; the LNG project was completed ahead of schedule in May 2014.
- Spillovers from the LNG project to the rest of the economy are limited; structural weaknesses impede broad-based growth in the non-resource sector, including: inadequate infrastructure, high energy costs, lack of skilled workers, limited access to credit, poor security, and regulatory weaknesses.
- Policy buffers have shrunk after sharp fiscal expansions over the past three years:
  - foreign reserves: 4 months of prospective imports at end-September.
  - introduction in early June 2014 of a trading band around the official exchange rate and the requirement for banks to use the band may have worsened excess demand in the FX market.

### Outlook and Risks
- Growth and inflation projections:
  - Real GDP growth: 5.8 percent in 2014.
  - Real GDP growth: around 19.5 percent in 2015 (with production reaching full capacity).
  - Non-resource sector growth: 0.5 percent in 2014; 4 percent in 2015.
  - Headline inflation: projected to exceed 5 percent in 2014; moderate slightly over the medium term.
- External position:
  - Current account: expected to narrow substantially in 2014 and turn to a surplus in 2015 due to increasing LNG exports.
- Key risks (tilted to the downside):
  - Near term: global economic weakness, weaker commodity prices, limited fiscal room for stimulus due to debt sustainability needs.
  - Exchange rate policy: effective appreciation heightens risks to growth and external position by potentially harming non-resource exports.
  - Longer term: development of LNG in Australia and shale gas elsewhere could reduce gas prices, export earnings, and government revenue; lower LNG and mineral prices and higher funding costs could affect FDI.
  - Upside risks: potential second LNG project and further mineral resource development.

---

### Fiscal Policy and Resource Revenue Management

### Findings
- Fiscal expansion has significantly reduced fiscal space despite new LNG revenue.
  - Staff baseline: overall fiscal deficit expected to be 7.2 percent of GDP in 2014 (slight improvement from 8.0 percent of GDP in 2013).
  - Gross central government debt expected to exceed the 35 percent cap for 2014 and the 30 percent cap for 2015 and beyond.
  - Overall public debt amounts to about 51 percent of GDP once arrears to a superannuation fund and other liabilities are taken into account.
  - Debt-to-GDP ratio understates PNG’s debt burden due to large net income outflows (about 10 percent of GDP).

### Recommended fiscal targeting and path
- Continue to anchor fiscal policy with the current debt target but use the non-resource primary balance (NRPB) as the underlying fiscal target.
- Achieving the 30 percent debt target in 2015 would imply:
  - an NRPB deficit of about 3.6 percent of non-resource GDP in 2014 (equivalent to an overall deficit of 1.0 percent of GDP),
  - with a gradual reduction to 2.5 percent of GDP by 2019.
- If prudent policy is pursued over the longer term, PNG could eventually build up net financial wealth of about 20 percent of NRGDP by 2050.

### Adjustment composition and PFM
- Bulk of fiscal adjustment should come from expenditure restraint; limited near- to medium-term scope to increase revenue (including from LNG due to accelerated depreciation arrangements).
- Slow growth of development expenditure would facilitate adjustment and ease capacity constraints.
- Cease practice of transferring unused funds from poorly implemented projects into project trust accounts toward year-end.
- Shift focus toward improving expenditure quality: postpone non-essential expenditures in light of expected revenue shortfall (0.9 percent of GDP) and spike in long-term government borrowing costs.
- Reprioritize projects to align planned infrastructure investments with implementation capacity.
- Prioritize frontline health and education services and maintenance of existing assets and other critical recurrent expenditure.
- Continue operationalizing the Integrated Financial Management System (IFMS); integrate recurrent and development budgets; improve cash management and medium-term budgeting; reduce use of multiple trust accounts; strengthen debt management.
- For government-contracted loans (including via SOEs), observe established procedures and publish terms and conditions to ensure fiscal transparency and debt sustainability.

### Resource revenue governance and revenue measures
- Bring the proposed sovereign wealth fund (SWF) into operation as soon as practical; the organic law passed in early 2012 followed the Santiago Principles.
- Channel resource revenue through the government’s budget to the greatest extent possible while ensuring transparency and governance for the proposed Kumul Trust.
- Move from EITI candidacy toward full EITI membership.
- Tax review (with IMF TA) offers opportunity to improve efficiency and fairness of the tax system.
- Scope to limit income tax holidays for new mining projects; urgency of conducting mining industry audits to eliminate potential revenue leakages.
- Ongoing IMF TA focuses on tax progressivity and government equity participation in extractive industries.

### Authorities’ views
- Authorities agreed fiscal consolidation is needed and remain committed to achieving legislated debt targets.
- Authorities welcomed the NRPB as the fiscal target and acknowledged need for clear communication.
- Agreed that capital expenditure implementation needs improvement and that priority recurrent expenditures should be protected; will consider postponement of some lower-priority projects in 2014.

---

### Monetary, Exchange Rate and Financial Sector Issues

### Monetary stance and liquidity
- Monetary policy remains accommodative due to weak non-resource activity and benign inflation, but policy transmission is weak because of excess liquidity.
- BPNG raised the cash reserve requirement (CRR) on banks from 9 percent to 10 percent in September 2014.
- Bank of PNG policy rate, the Kina Facility Rate (KFR), unchanged at 6¼ percent since March 2013.
- Despite a decline in banks’ lending rates, growth of credit to the private sector slowed and turned negative (y/y) in July 2014.

### Staff recommendations to reduce excess liquidity
- Move government deposits and trust accounts from commercial banks to the BPNG.
- Ensure purchases of government paper by the BPNG at primary auctions are completely sterilized.
- Target broad money growth through open market operations by issuing additional Central Bank Bills (CBBs) and further raising the CRR if inflation pressures intensify.

### Exchange rate measures and effects
- FX market disorderly early in 2014 with banks quoting widely diverging rates from the official interbank rate in customer transactions.
- In early June 2014, BPNG imposed a 150 basis points band on FX buy-sell spreads around the official rate and required banks to use the band, leading to a de facto kina appreciation of around 17 percent.
- Subsequent official rate depreciation at 5-10 basis points per week (6-12 percent per annum) since the band’s introduction; pace insufficient to reduce excess FX demand meaningfully.
- The band incentivizes exporters to delay FX sales and encourages importers to demand more FX; continued FX sales by BPNG could jeopardize foreign reserve position if interventions are persistent or large.

### Staff’s proposed exchange rate and intervention approach
- Allow the kina to move more quickly to a market-clearing level.
- Conduct FX interventions via transparent, competitive auctions rather than outright sales, using auction results as a first approximation of the market-clearing interbank rate.
- As market conditions improve, make BPNG interventions two-sided and aimed only at smoothing short-term volatility.
- Remove the trading band once competition and transparency in the FX retail market increase.
- Communicate policy intentions clearly to the market.
- Staff is assessing the trading band and tax clearance certificate regime for consistency with PNG’s obligations under Article VIII of the IMF Articles of Agreement.

### External competitiveness
- Exchange rate assessment suggests the kina is moderately undervalued and expected to strengthen over the medium term because of expected LNG earnings.
- Major challenge: improve competitiveness and productivity in the non-resource sector (including agriculture) to offset possible Dutch disease effects, noting PNG’s comparatively high minimum wages.

### Policy recommendations (monetary, FX, financial)
- Reduce banking system excess liquidity by:
  - Moving government deposits and trust accounts to the BPNG.
  - Sterilizing BPNG purchases of government paper at primary auctions.
  - Issuing additional CBBs and consider further CRR increases if needed.
- Reform FX operations by:
  - Allowing faster exchange rate adjustment toward market-clearing levels.
  - Conducting transparent, competitive FX auctions for interventions and using interventions only to smooth volatility.
  - Removing the trading band once retail FX market competition and transparency improve.
- Strengthen financial sector and policy coordination:
  - Improve monetary–fiscal coordination.
  - Lengthen maturity of domestic debt carefully to reduce rollover risks while considering long-term borrowing costs.

---

### Banking System Stability and Performance

### Key findings
- Banks continue to be profitable and non-performing loans ratios are low.
- Banks’ high liquidity ratios—with more than half of their assets held in government securities or cash—partly reflect structurally low levels of lending.
- Loan-to-deposit ratio has been consistently below 50 percent, among the lowest in the Pacific Island region.
- Banks’ direct exposure to the property sector is limited.
- Indirect exposure is confined to small liquidity risk arising from potential withdrawals of deposits by superannuation funds, which have invested heavily in the property sector.
- Recent price declines in the high-end property market have had limited impact on superannuation funds, which have also reduced their exposure to the market.

### Liquidity, monetary policy effectiveness, and exchange rate operations
- Excess liquidity accumulated due to unsterilized purchases of foreign exchange by the BPNG over the past decade.
- Around half of financial system assets are held in liquid Treasury bills and CBBs, while less than half are represented by loans.
- Excess liquidity effects:
  - Added demand for short-dated CBBs and Treasury bills, lowering short-term market interest rates and driving a wedge between these rates and the KFR policy rate.
  - Impaired monetary policy transmission; excess liquidity would need to be withdrawn before the interest rate channel could regain effectiveness.
  - Large excess kina reserves raise the risk of a sharp depreciation through the sale of liquid kina assets when risk aversion is on.

### Tools and steps for liquidity withdrawal
- BPNG can withdraw liquidity through CBB issuance and increases in the CRR.
- Transfer of government deposits to the BPNG is an important step; these deposits were around K630 million at end-September 2013, which exceeds the amount of excess reserves held by banks at end-2013.
- Transfer of government deposits would also improve government cash management and reduce fragmentation from multiple trust accounts.

### Banking sector indicators (selected)
- Capital to risk-weighted assets: 2014 (Est.): 28.7.
- Nonperforming loans to total loans: 2014 (Est.): 1.6.
- Provision for losses to NPL: 2014 (Est.): 220.2.
- Return on assets: 2014 (Est.): 2.7.
- Loan-to-deposit ratio: 2014 (Est.): 52.8.
- Loan-to-deposit ratio has historically been: 2010: 49.9; 2011: 46.3; 2012: 46.9; 2013: 50.3.

---

### External Sector, Reserves, and Exchange Rate Assessment

### Exchange rate and recent movements
- Between January 2013 and July 2014:
  - Kina depreciated by 9 percent in nominal effective exchange rate (NEER) terms.
  - Kina depreciated by 14 percent against the U.S. dollar.
  - Kina depreciated by 4 percent against the Australian dollar.
  - Kina depreciated by 7 percent in real effective exchange rate (REER) terms.
- CGER assessment results show a wide range of 0-21 percent in undervaluation from different approaches.
  - Exchange Rate Assessment baseline excerpts:
    - PPP approach: 0.3
    - ES approach: -20.6
    - MB approach: 5.6-6.2
    - ERER approach: -8.1

### Reserves adequacy
- Reserve metric approach suggests PNG’s current reserve holdings are slightly below the adequate level (estimated to be close to 5 month of imports).
- Optimal reserve approach indicates current holdings are well above the optimal level (about 2.5 months of imports for the fixed regime).
- IMF staff: "more weight should be placed on the result from the reserve metric approach."
- Reserve-metric specifications (based on Nkunde Mwase’s IMF Working Paper (WP/12/205)):
  - Metric for the floating regime: 4.7 months of imports.
  - Metric for the fixed regime: 4.9 months of imports.
- Over the medium term, the level of foreign reserves is expected to increase once LNG production reaches full capacity.

### Selected reserves and external figures
- Gross official reserves (end-year, millions of U.S. dollars): 2014 (proj.): 2,624; 2015 (proj.): 3,755.
- Gross official reserves (in months of goods and services imports, c.i.f.): 2014 (proj.): 4.0; 2015 (proj.): 5.5.
- Gross official international reserves (in months of goods and services imports, alternate figures in table): 2014 2.6 (4.0 months); 2015 3.8 (5.5 months).

---

### Public Debt, Debt Sustainability, and Stress Tests

### Fiscal and debt projections (selected)
- Central government operations (percent of GDP):
  - Total revenue and grants: 2014: 30.1; 2015 (Proj.): 25.3.
  - Total expenditure: 2014: 37.3; 2015 (Proj.): 27.8.
  - Net lending(+)/borrowing(-) [Overall balance]: 2014: -7.2; 2015 (Proj.): -2.5.
  - Nonresource net lending(+)/borrowing(-): 2014: -8.9; 2015 (Proj.): -5.8.
  - Gross government debt (percent of GDP): 2014: 37.0; 2015 (Proj.): 31.0.
- Table 2 (levels, selected 2014 projections in millions of kina):
  - Revenue and grants (2014 proj.): 11,974.
  - Expenditure (2014 proj.): 14,848.
  - Net acquisition of nonfinancial assets (2014 proj., old classification): 3,161.

### Stress-test findings and scenarios
- Protracted breach of the PV of debt-to-GDP ratio under the historical and extreme exports shock scenarios.
- Breach of the PV of public external debt-to-exports ratio under the extreme exports shock scenario.
- All these scenarios would be tantamount to a major delay or complete failure of the LNG project.
- “LNG shock” scenario: LNG production assumed to be 50 percent lower than the baseline over the medium term; under this scenario the PV of debt-to-GDP ratio would fall more slowly but debt burden would remain sustainable.
- A failure to consolidate the fiscal position would result in an unsustainable debt burden.
- Risks from contingent liabilities:
  - Superannuation arrears, estimated to be about 6½ percent of GDP at end-2013.
  - Public enterprise liabilities, estimated to be about 7½ of GDP (data incomplete).
- Customized scenario "All other liabilities included" assumes full amount of superannuation arrears and 100 percent of SOEs debt realized and added to the debt stock.

### Authorities’ views
- Authorities agreed with the DSA findings, noting current risk of debt distress is low, but fiscal consolidation is crucial.
- Authorities committed to achieving legislated debt targets and recognized importance of more comprehensive data on debt and other liabilities.

### Conclusion and policy implications
- Papua New Guinea’s PPG external debt remains at low risk of debt stress.
- Overall risk of public debt distress has increased given rising stock of public domestic debt.
- Contingent and non-contingent liabilities significantly increase the public debt burden.
- Policy recommendations:
  - Adhere to existing debt targets.
  - Focus on improving spending quality to make the most out of a restrained resource envelope.

---

### Structural Reforms, Statistics, and Staff Appraisal

### Structural reform priorities
- Accelerate structural reforms to improve business environment and job creation.
- Address top impediments: inadequate infrastructure, poor security, lack of skilled workers.
- Government priorities: investment in infrastructure, health, education, and law and order.
- Improve returns on public investment via capacity development, careful evaluation and planning, and improved expenditure mix.
- Attract foreign know-how and capital by easing investor concerns about restrictions on foreign ownership.
- Minimum wage: last increase in 2008; staff noted large increases could harm employment and should be gradual in line with productivity.
- Encourage SOE reform: clarify corporate objectives and community service obligations and accelerate reforms to improve service delivery and economic efficiency.
- Agriculture and rural development: protect farm crops and property from theft; expand agricultural extension services; focus on roads within budget envelope; innovations in financial inclusion for farmers.

### Statistics, data, and capacity building
- Progress made in macroeconomic statistics: 2011 census data, household income and expenditure survey, rebased CPI series.
- Challenges remain in timely compilation of national accounts, CPI, and balance of payments; need decisive response to institutional weaknesses in the National Statistics Office (NSO).
- Staff welcomed authorities’ initiatives to reform the NSO and recommended IMF TA support.
- Authorities committed to reforming the NSO and expect a review to produce an action plan to be implemented over a three-year period.

### Staff appraisal: policy guidance and priorities
- LNG production set to boost overall GDP growth in 2014-15, while non-resource sector growth remains slow.
- Prudent macroeconomic policies essential to maintain debt sustainability and external and financial stability during transition.
- Fiscal policy: steadfast fiscal consolidation needed following strong expenditure growth; expenditure restraint key to meeting debt targets and aligning spending with absorptive capacity.
- PFM and expenditure prioritization: implement high-impact projects, improve delivery of frontline health and education services, and ensure sufficient allocation of critical recurrent expenditure.
- Sovereign wealth fund: should be put into operation as soon as practical; retain essential features of original SWF design and channel resource revenues through the budget to the greatest extent possible.
- Exchange rate and monetary policy: greater exchange rate flexibility needed; allow exchange rate to be more market-determined through competitive FX auctions; mop up excess liquidity in banking system to reduce excess demand for FX and improve monetary policy transmission.
- Structural reforms: deepen reforms to improve infrastructure, security, health and education, attract more FDI, revive agriculture, strengthen SME sector, and accelerate SOE reforms.
- Statistics: determined action needed to improve macroeconomic statistics; increased IMF TA expected to assist reform efforts.
- Consultation cycle: next Article IV consultation proposed on the standard 12-month cycle.

---

*Source: _cr14325 - IMF staff report (PDF), excerpts from chapters and appendices provided.*

### 1. Update on the Mineral Sector _________________________________________________________________ 14

### 1. Update on the Mineral Sector

### Context
- PNG’s economy has entered a transitional growth period as new liquefied natural gas (LNG) production and exports commence; the LNG project was completed ahead of schedule in May 2014.
- Spillovers from the LNG project to the rest of the economy are limited; structural weaknesses impede broad-based growth in the non-resource sector, including:
  - inadequate infrastructure, high energy costs, lack of skilled workers, limited access to credit, poor security, and regulatory weaknesses.
- Policy buffers have shrunk after sharp fiscal expansions over the past three years:
  - foreign reserves: 4 months of prospective imports at end-September.
  - introduction in early June 2014 of a trading band around the official exchange rate and the requirement for banks to use the band may have worsened excess demand in the FX market.

### Outlook and Risks
- Growth and inflation projections:
  - Real GDP growth: 5.8 percent in 2014.
  - Real GDP growth: around 19.5 percent in 2015 (with production reaching full capacity).
  - Non-resource sector growth: 0.5 percent in 2014; 4 percent in 2015.
  - Headline inflation: projected to exceed 5 percent in 2014; moderate slightly over the medium term.
- External position:
  - Current account: expected to narrow substantially in 2014 and turn to a surplus in 2015 due to increasing LNG exports.
- Key risks (tilted to the downside; see Appendix 1):
  - Near term: global economic weakness, weaker commodity prices, limited fiscal room for stimulus due to debt sustainability needs.
  - Exchange rate policy: effective appreciation heightens risks to growth and external position by potentially harming non-resource exports.
  - Longer term: development of LNG in Australia and shale gas elsewhere could reduce gas prices, export earnings, and government revenue; lower LNG and mineral prices and higher funding costs could affect FDI.
  - Upside risks: potential second LNG project and further mineral resource development.

### Fiscal Policy and Resource Revenue Management
Findings
- Fiscal expansion has significantly reduced fiscal space despite new LNG revenue.
  - Staff baseline: overall fiscal deficit expected to be 7.2 percent of GDP in 2014 (slight improvement from 8.0 percent of GDP in 2013).
  - Gross central government debt expected to exceed the 35 percent cap for 2014 and the 30 percent cap for 2015 and beyond.
  - Overall public debt amounts to about 51 percent of GDP once arrears to a superannuation fund and other liabilities are taken into account.
  - Debt-to-GDP ratio understates PNG’s debt burden due to large net income outflows (about 10 percent of GDP).
- Recommended fiscal targeting and path:
  - Continue to anchor fiscal policy with the current debt target but use the non-resource primary balance (NRPB) as the underlying fiscal target.
  - Achieving the 30 percent debt target in 2015 would imply an NRPB deficit of about 3.6 percent of non-resource GDP in 2014 (equivalent to an overall deficit of 1.0 percent of GDP), with a gradual reduction to 2.5 percent of GDP by 2019.
  - If prudent policy is pursued over the longer term, PNG could eventually build up net financial wealth of about 20 percent of NRGDP by 2050.
- Adjustment composition:
  - Bulk of fiscal adjustment should come from expenditure restraint; limited near- to medium-term scope to increase revenue (including from LNG due to accelerated depreciation arrangements).
  - Slowing growth of development expenditure would facilitate adjustment and ease capacity constraints.
  - Cease practice of transferring unused funds from poorly implemented projects into project trust accounts toward year-end.
- Expenditure quality and public financial management (PFM):
  - Shift policy focus toward improving expenditure quality: postpone non-essential expenditures in light of expected revenue shortfall (0.9 percent of GDP) and spike in long-term government borrowing costs.
  - Reprioritize projects to align planned infrastructure investments with implementation capacity.
  - Prioritize frontline health and education services and maintenance of existing assets and other critical recurrent expenditure.
  - Continue operationalizing the Integrated Financial Management System (IFMS), integrate recurrent and development budgets, improve cash management and medium-term budgeting, reduce use of multiple trust accounts, and strengthen debt management.
  - For government-contracted loans (including via SOEs), observe established procedures and publish terms and conditions to ensure fiscal transparency and debt sustainability.
- Resource revenue governance:
  - Bring the proposed sovereign wealth fund (SWF) into operation as soon as practical; the organic law passed in early 2012 followed the Santiago Principles.
  - Channel resource revenue through the government’s budget to the greatest extent possible while ensuring transparency and governance for the proposed Kumul Trust.
  - Move from EITI candidacy toward full EITI membership to better safeguard public resources.
- Revenue-side measures:
  - Tax review (with IMF TA) offers opportunity to improve efficiency and fairness of the tax system.
  - Scope to limit income tax holidays for new mining projects; urgency of conducting mining industry audits to eliminate potential revenue leakages.
  - Ongoing IMF TA focuses on tax progressivity and government equity participation in extractive industries.

Authorities’ views on fiscal policy
- Authorities agreed fiscal consolidation is needed and remain committed to achieving legislated debt targets, acknowledging the need for a medium-term perspective given spending pressures.
- Authorities welcomed the NRPB as the fiscal target and acknowledged need for clear communication.
- Agreed that capital expenditure implementation needs improvement and that priority recurrent expenditures should be protected; will consider postponement of some lower-priority projects in 2014.

### Monetary, Exchange Rate and Financial Sector Issues
Findings
- Monetary stance and liquidity:
  - Monetary policy remains accommodative due to weak non-resource activity and benign inflation, but policy transmission is weak because of excess liquidity.
  - Bank of PNG (BPNG) raised the cash reserve requirement (CRR) on banks from 9 percent to 10 percent in September 2014.
  - BPNG has kept its policy rate, the Kina Facility Rate (KFR), unchanged at 6¼ percent since March 2013.
  - Despite a decline in banks’ lending rates, growth of credit to the private sector slowed and turned negative (y/y) in July 2014.
- Staff recommendations to reduce excess liquidity and strengthen transmission:
  - Move government deposits and trust accounts from commercial banks to the BPNG.
  - Ensure purchases of government paper by the BPNG at primary auctions are completely sterilized.
  - Target broad money growth through open market operations by issuing additional Central Bank Bills (CBBs) and further raising the CRR if inflation pressures intensify.
- Exchange rate measures and effects:
  - FX market became disorderly early in 2014 with banks quoting widely diverging rates from the official interbank rate in customer transactions.
  - In early June 2014, BPNG imposed a 150 basis points band on FX buy-sell spreads around the official rate and required banks to use the band, leading to a de facto kina appreciation of around 17 percent.
  - Staff welcomed the subsequent 5-10 basis points depreciation per week (6-12 percent per annum) since the band’s introduction but noted the pace is insufficient to reduce excess FX demand meaningfully.
  - The band incentivizes exporters to delay FX sales and encourages importers to demand more FX; continued FX sales by BPNG could jeopardize foreign reserve position if interventions are persistent or large.
- Staff’s proposed exchange rate and intervention approach:
  - Allow the kina to move more quickly to a market-clearing level.
  - Conduct FX interventions via transparent, competitive auctions rather than outright sales, using auction results as a first approximation of the market-clearing interbank rate.
  - As market conditions improve, make BPNG interventions two-sided and aimed only at smoothing short-term volatility.
  - Remove the trading band once competition and transparency in the FX retail market increase to avoid excessive spreads.
  - Communicate policy intentions clearly to the market.
  - Staff is assessing the trading band and tax clearance certificate regime for consistency with PNG’s obligations under Article VIII of the IMF Articles of Agreement.
- External competitiveness:
  - Exchange rate assessment suggests the kina is moderately undervalued and expected to strengthen over the medium term because of expected LNG earnings.
  - Major challenge: improve competitiveness and productivity in the non-resource sector (including agriculture) to offset possible Dutch disease effects, noting PNG’s comparatively high minimum wages.

Policy recommendations (monetary, FX, financial)
- Reduce banking system excess liquidity by:
  - Moving government deposits and trust accounts to the BPNG.
  - Sterilizing BPNG purchases of government paper at primary auctions.
  - Issuing additional CBBs and consider further CRR increases if needed.
- Reform FX operations by:
  - Allowing faster exchange rate adjustment toward market-clearing levels.
  - Conducting transparent, competitive FX auctions for interventions and using interventions only to smooth volatility.
  - Removing the trading band once retail FX market competition and transparency improve.
- Strengthen financial sector and policy coordination:
  - Improve monetary–fiscal coordination.
  - Lengthen maturity of domestic debt carefully to reduce rollover risks while considering long-term borrowing costs.

*Source: _cr14325 - 1. Update on the Mineral Sector; IMF staff report (PDF).*

### 19. The banking system remains stable, underpinned by strong capital adequacy and

### 19. The banking system remains stable, underpinned by strong capital adequacy and

### Banking system stability and performance
- Banks continue to be profitable and non-performing loans ratios are low.
- Banks’ high liquidity ratios—with more than half of their assets held in government securities or cash—partly reflect the structurally low levels of lending.
- The loan-to-deposit ratio has been consistently below 50 percent, among the lowest in the Pacific Island region.
- Banks’ direct exposure to the property sector is limited.
- Indirect exposure is confined to small liquidity risk arising from potential withdrawals of deposits by superannuation funds, which have invested heavily in the property sector.
- Recent price declines in the high-end property market have had limited impact on superannuation funds, which have also reduced their exposure to the market.

### Liquidity, monetary policy effectiveness, and exchange rate operations
- Excess liquidity has accumulated in the financial system as a result of unsterilized purchases of foreign exchange by the BPNG over the past decade.
- During the period of record-high commodity prices, sizeable export tax receipts were paid to the government in US dollars; these FX receipts were converted to kina by the BPNG, and the portion of kina revenue deposited with commercial banks added to banking system reserves as the BPNG did not completely sterilize this added liquidity.
- Around half of financial system assets are held in liquid Treasury bills and CBBs, while less than half is represented by loans.
- Banks attribute this asset composition to lack of lending opportunities due to structural constraints including lack of collateral and limited contract enforceability.
- Excess liquidity effects:
  - Added demand for short-dated CBBs and Treasury bills, lowering short-term market interest rates and driving a wedge between these rates and the KFR policy rate.
  - Impaired monetary policy transmission; excess liquidity would need to be withdrawn before the interest rate channel could regain effectiveness.
  - Large excess kina reserves raise the risk of a sharp depreciation through the sale of liquid kina assets when risk aversion is on.
- Tools and steps for liquidity withdrawal:
  - BPNG can withdraw liquidity through CBB issuance and increases in the CRR.
  - Transfer of government deposits to the BPNG is an important step; these deposits were around K630 million at end-September 2013, which exceeds the amount of excess reserves held by banks at end-2013.
  - Transfer of government deposits would also improve government cash management and reduce fragmentation from multiple trust accounts.

### Exchange rate trading band and FX market developments
- Between 2010 and 2012, FX supply was abundant due to inflows associated with the PNG LNG project and strong commodity prices, leading to rapid appreciation of the kina.
- The upswing reversed in 2013 as FDI inflows declined and commodity prices fell and the kina started to depreciate.
- Despite pressures, the official (interbank) rate was held constant from October 2013 to early June 2014; BPNG’s net FX sales in the interbank market were insufficient to meet demand of authorized dealers.
- On June 4, 2014 the BPNG imposed a 150 basis point trading band on FX buy-sell spreads of authorized dealers around the official rate, forcing market exchange rates into line with the official rate and causing a 17 percent de facto appreciation of the kina vis-a-vis the U.S. dollar at the time.
- Since the introduction of the band:
  - The official rate has depreciated at a rate of 5-10 basis points per week (6-12 percent per annum).
  - BPNG has continued to intervene through FX sales.
  - Some exporters report reduced revenues in kina terms and initial discouragement of FX sales by exporters.
  - Importers and other FX users report increased difficulties in obtaining adequate amounts of FX at prevailing exchange rates.
  - Banks expressed concerns that the trading band has reduced FX liquidity and added to delays in filling customer orders for FX.

### External sector and exchange rate assessment (selected quantitative outcomes)
- Between January 2013 and July 2014:
  - Kina depreciated by 9 percent in nominal effective exchange rate (NEER) terms.
  - Kina depreciated by 14 percent against the U.S. dollar.
  - Kina depreciated by 4 percent against the Australian dollar.
  - Kina depreciated by 7 percent in real effective exchange rate (REER) terms.
- CGER assessment results show a wide range of 0-21 percent in undervaluation from different approaches.
- Exchange Rate Assessment: Baseline Results (in percent), REER/Overvaluation table excerpts preserved as presented:
  - PPP approach: 0.3
  - ES approach: -20.6
  - MB approach: 5.6-6.2
  - ERER approach: -8.1

### AML/CFT and FATF listing
- Papua New Guinea was placed on the Financial Action Task Force’s (FATF) ‘gray list’ in early 2014.
- Authorities have made a high-level political commitment to address AML/CFT regulatory and operational deficiencies.
- Authorities have developed an AML/CFT National Strategic Plan aimed at addressing the action items within an agreed timeframe with the FATF, with assistance from Australia and the Asian Development Bank.

### Structural reforms for inclusive growth and sectoral priorities
- An acceleration of structural reforms is needed to improve the environment for business development and job creation.
- Surveys indicate inadequate infrastructure, poor security, and lack of skilled workers are among the top impediments to business development in PNG.
- Government priorities include investment in infrastructure, health, education, and law and order.
- Recommendations for improving returns on public investment:
  - Capacity development.
  - Careful evaluation and planning for investments.
  - Improved expenditure mix to achieve better development outcomes.
- To create more jobs and diversify the non-resource sector, PNG should aim to attract more foreign know-how and capital by easing investor concerns about restrictions on foreign ownership.
- Minimum wage considerations:
  - Staff noted the last increase in minimum wages was in 2008.
  - Staff noted that recent large increases could have a negative impact on employment and that future increases should take place in a gradual manner in line with productivity improvements.
- Progress noted in increasing competition in public utilities and telecommunications resulting in greater service coverage and lower prices.
- Staff encouraged authorities to clarify corporate objectives for SOEs, notably pertaining to community services obligations (these obligations are related to service delivery on a non-commercial basis and require government subsidies to recover costs).
- Agriculture and rural development:
  - Greater efforts required to develop the agricultural sector for the benefit of the majority of the population.
  - Continued strong focus on roads within the budget envelope due to importance for market access.
  - Need to protect farm crops and property from theft and expand agricultural extension services.
  - Innovations in financial inclusion such as rural credit unions/cooperatives targeting farmers in remote areas are being pursued.
  - Rural women’s groups commended for capacity development and social protection at grassroots levels.
- Authorities’ views:
  - Authorities agreed with the need to develop the non-resource sector as set out in Vision 2050.
  - Infrastructure development for agriculture and rural areas is a key part of the Medium-Term Development Plan but constrained by limited implementation capacity and resource availability.
  - Reform of poorly performing SOEs is a key priority for improving service delivery and economic efficiency.

### Statistics, data, and capacity building
- Progress has been made in the production of macroeconomic statistics, but fundamental reforms are needed for further improvements.
- Staff welcomed recent data releases, including the 2011 census data, the household income and expenditure survey, and the rebased CPI series.
- PNG continues to face challenges in timely compilation of accurate macroeconomic statistics, especially data on national accounts, the CPI, and balance of payments.
- Strengthening capacity will require a decisive response to institutional weaknesses in the National Statistics Office (NSO).
- Staff welcomed authorities’ recent initiatives to reform the NSO and recommended IMF TA in support.
- Authorities committed to statistical improvement and look forward to collaborating with development partners, including the IMF and Australia, to develop statistical capacity and conduct a review of the NSO, which is expected to produce an action plan in coming months to be implemented over a three-year period.

### Staff appraisal: policy guidance and priorities
- PNG’s economy is undergoing an important transition with commencement of LNG production set to boost overall GDP growth in 2014-15, while the non-resource sector growth remains slow.
- Prudent macroeconomic policies are essential to maintaining debt sustainability and external and financial stability during the transition.
- Fiscal policy:
  - Following strong government expenditure growth over the past three years, steadfast fiscal consolidation is needed to ensure debt sustainability.
  - With modest LNG revenue expected over the medium term, expenditure restraint will be key to meeting existing government debt targets and aligning spending with absorptive capacity and improving spending quality.
- Public financial management and expenditure prioritization:
  - Better expenditure prioritization and PFM will be crucial for improving development outcomes.
  - High priority should be given to implementing high-impact projects and improving delivery of frontline health and education services, including sufficient allocation of critical recurrent expenditure.
  - Greater efforts needed in improving management of trust accounts, cash flows, and public debt, notably transparency in contracting government and SOE loans.
- Sovereign wealth fund:
  - The sovereign wealth fund should be put into operation as soon as practical.
  - Authorities’ intention to retain essential features of original SWF design is welcome, notably strong commitment to ensuring resource revenues are channeled through the budget to the greatest extent possible.
- Exchange rate and monetary policy recommendations:
  - Greater exchange rate flexibility is needed to safeguard external buffers and eliminate imbalances in the foreign exchange market.
  - BPNG should allow the exchange rate to be more market-determined and move quickly to a market-clearing rate through competitive FX auctions.
  - Over the medium term, PNG’s external position is expected to strengthen on account of its macroeconomic fundamentals.
  - To improve monetary policy effectiveness, BPNG should mop up excess liquidity more fully in the banking system to help reduce excess demand for FX and improve monetary policy transmission.
- Structural reforms:
  - Accelerate and deepen reforms to improve infrastructure, security, health and education outcomes, attract more FDI, and accelerate SOE reforms to reduce business costs, create more jobs, and improve service delivery.
  - Revive agriculture and strengthen the SME sector supported by innovations in financial inclusion.
- Statistics:
  - Determined action is needed to improve macroeconomic statistics.
  - Authorities’ commitment to reforming the NSO is a strong step, with increased IMF TA expected to assist reform efforts and improve capacity.
- Consultation cycle:
  - It is proposed that the next Article IV consultation with PNG will be held on the standard 12-month cycle.

*Source: IMF staff report excerpt (chapter/section provided).*

### Box 4. Papua New Guinea: External Sector Assessment (Concluded)

### Box 4. Papua New Guinea: External Sector Assessment (Concluded)

### Reserve metric approach vs. optimal reserve approach
- The reserve metric approach suggests that PNG’s current reserve holdings are slightly below the adequate level (estimated to be close to 5 month of imports).
- The optimal reserve approach indicates that the current holdings are well above the optimal level (about 2.5 months of imports for the fixed regime).

### Key caveat
- The latter result depends critically on the long-term opportunity cost of holding reserves, which is currently estimated to be

*Source: _cr14325 - Box 4. Papua New Guinea: External Sector Assessment (Concluded)*

### 8.7 percent, more weight should be placed on the

### _cr14325 - 8.7 percent, more weight should be placed on the

### Reserves adequacy and reserve-metric findings
- IMF staff estimates and projections indicate that "more weight should be placed on the result from the reserve metric approach."
- Over the medium term, the level of foreign reserves is expected to increase once LNG production reaches full capacity.
- Reserve-metric specifications (based on Nkunde Mwase’s IMF Working Paper (WP/12/205)):
  - Metric for the floating regime: 4.7 months of imports.
  - Metric for the fixed regime: 4.9 months of imports.
- Note: reserve requirements are reduced because the mining sector traditionally meets much of its own FX needs, rather than drawing on official reserves.
- End-2014 (projection) context is presented in figures showing optimal level of reserves (months of imports) for Flexible and Fixed regimes.

### Macro performance: growth, sectoral contributions, and inflation
- Economic growth is projected to pick up with the start of LNG production in May 2014.
- Non-resource industries are expected to be less buoyant as the LNG-related construction boom has ended.
- Commodity prices: after declining over the year, commodity prices are stabilizing.
- Inflation trends:
  - Inflation has inched up recently.
  - Upward pressures from higher prices for food and services and from increased fiscal spending.
  - Food price dynamics: generally stable food prices have contributed to low inflation, notwithstanding recent increases.
- Key real-sector projections and figures (from Table 5 and related charts):
  - Real GDP (percentage change): 2010: 7.7; 2011: 10.7; 2012: 8.1; 2013: 5.5; 2014: 5.8; 2015: 19.6; 2016: 3.3; 2017: 3.4; 2018: 3.5; 2019: 3.5.
  - Resource growth (percentage change): 2010: -2.0; 2011: -11.8; 2012: -7.4; 2013: 7.2; 2014: 90.6; 2015: 150.5; 2016: -0.7; 2017: -0.6; 2018: -0.6; 2019: -0.6.
  - Nonresource growth (percentage change): 2010: 8.7; 2011: 12.8; 2012: 9.2; 2013: 5.4; 2014: 0.5; 2015: 4.0; 2016–2019: 4.5 (each year).
  - CPI (period average): 2010: 6.0; 2011: 4.4; 2012: 4.5; 2013: 5.0; 2014: 5.3; 2015: 5.0; 2016–2019: 5.0 (each year).
  - CPI (end-period): 2010: 4.9; 2011: 4.4; 2012: 5.8; 2013: 2.9; 2014: 6.3; 2015: 5.0; 2016–2019: 5.0 (each year).

### Fiscal performance, balance, and public debt
- The overall fiscal deficit continued to increase in 2013 and is expected to remain high in 2014.
- Compared with the previous decade, the recent fiscal balance has deteriorated distinctly, though government debt remains relatively low compared with many other Pacific Island countries.
- Fiscal stance has loosened, while overall government revenue is set to decline in 2014 despite some increases to mineral revenues.
- Trust accounts: role of the trust accounts has declined, mostly since 2009.
- Central government operations (Table 2, select figures in percent of GDP):
  - Total revenue and grants: 2010: 31.3; 2011: 30.4; 2012: 29.2; 2013: 28.2; 2014: 30.1; 2015 (Proj.): 25.3.
  - Total expenditure: 2010: 28.2; 2011: 28.7; 2012: 32.4; 2013: 36.1; 2014: 37.3; 2015 (Proj.): 27.8.
  - Net lending(+)/borrowing(-) [Overall balance] (percent of GDP): 2010: 3.1; 2011: 1.7; 2012: -3.2; 2013: -8.0; 2014: -7.2; 2015 (Proj.): -2.5.
  - Nonresource net lending(+)/borrowing(-) [Nonresource overall balance] (percent of GDP): 2010: -3.6; 2011: -5.7; 2012: -6.6; 2013: -9.9; 2014: -8.9; 2015 (Proj.): -5.8.
  - Gross government debt (percent of GDP): 2010: 25.6; 2011: 23.0; 2012: 26.7; 2013: 34.0; 2014: 37.0; 2015 (Proj.): 31.0.
- Table 2 (levels, selected 2014 projections in millions of kina):
  - Revenue and grants (2014 proj.): 11,974.
  - Expenditure (2014 proj.): 14,848.
  - Net acquisition of nonfinancial assets (2014 proj., old classification): 3,161.

### Monetary policy, liquidity, and external position
- Monetary policy stance has been loosened as inflation fell.
- Real interest rates have fallen over the past year despite limited declines in nominal rates.
- Broad money and private sector credit growth have fallen recently as the resource boom faltered.
- Ample liquidity remains given insufficient sterilization; central bank sterilization indicators show central bank bills and sterilization ratios in figures.
- Exchange rates have depreciated rapidly since 2013 as capital inflows associated with the LNG project passed the peak and the terms of trade worsened.
- Current account outlook:
  - Current account deficit should narrow sharply as project-related imports fall and LNG exports increase.
  - Official reserves have declined sharply but are expected to stabilize in the year assuming limited intervention going forward.
- Monetary and reserves key figures:
  - Reserve money (end-period, millions of kina): 2010: 2,016; 2011: 3,259; 2012: 3,834; 2013: 3,853; 2014 (proj.): 4,816; 2015 (proj.): 6,020.
  - Gross official reserves (end-year, millions of U.S. dollars; Table 3): 2010: 3,092; 2011: 4,323; 2012: 4,001; 2013: 2,814; 2014 (proj.): 2,624; 2015 (proj.): 3,755.
  - Gross official reserves (in months of goods and services imports, c.i.f.): 2010: 3.7; 2011: 4.1; 2012: 5.0; 2013: 4.2; 2014 (proj.): 4.0; 2015 (proj.): 5.5.

### Banking sector soundness and performance
- Banking sector dominated by three banks; they remain quite profitable with low NPLs and high capital adequacy.
- Provisioning remains high.
- Loan-to-deposit ratio has stayed low, reflecting deposit-based funding structure and excess liquidity.
- Superannuation funds: earnings improved a little after a big drop in 2011.
- Financial soundness indicators (Table 7, 2014 estimates where available):
  - Capital to risk-weighted assets: 2010: 28.3; 2011: 26.9; 2012: 28.0; 2013: 27.9; 2014 (Est.): 28.7.
  - Nonperforming loans to total loans: 2010: 1.7; 2011: 2.0; 2012: 2.0; 2013: 1.2; 2014 (Est.): 1.6.
  - Provision for losses to NPL: 2010: 173.6; 2011: 158.2; 2012: 170.9; 2013: 288.0; 2014 (Est.): 220.2.
  - Return on assets: 2010: 2.2; 2011: 2.2; 2012: 2.3; 2013: 2.4; 2014 (Est.): 2.7.
  - Loan-to-deposit ratio: 2010: 49.9; 2011: 46.3; 2012: 46.9; 2013: 50.3; 2014 (Est.): 52.8.

### Cross-country context and structural observations
- Papua New Guinea is among the lowest income countries in the region with a large share of subsistence farming and an underdeveloped tourism industry.
- It does not depend much on foreign aid relative to peers.
- Trade account is more balanced than peer countries.
- Government recurrent spending is moderate in regional comparison, though there is scope for improving the business climate.
- Selected country stats:
  - Nominal GDP (2013): US$15.4 billion.
  - Population (2013): 7.3 million.
  - GDP per capita (2013): US$2,098.
  - Quota (SDR): 131.6 million.

### Medium-term and balance-of-payments scenario highlights
- Medium-term projections (Table 5, select items):
  - Total revenue and grants (percent of GDP): 2014: 30.1; 2015 (Proj.): 25.3; 2016–2019: 24.6, 24.4, 24.2, 24.7 (respectively).
  - Total expenditure (percent of GDP): 2014: 37.3; 2015 (Proj.): 27.8; 2016–2019: 26.7, 25.8, 25.6, 26.0 (respectively).
  - Primary balance (percent of GDP): 2010: 4.4; 2011: 3.1; 2012: -1.8; 2013: -6.6; 2014: -5.4; 2015 (Proj.): -0.5; 2016–2019: -0.1, 0.8, 1.2, 1.3.
- Balance of payments (Table 3 and Table 5, selected flow-levels in millions of U.S. dollars):
  - Current account balance: 2010: -2,091; 2011: -3,040; 2012: -8,244; 2013: -4,750; 2014 (Est.): -1,827; 2015 (Proj.): 2,749.
  - Exports, f.o.b.: 2014 (Est.): 6,259; 2015 (Proj.): 12,358.
  - Imports, c.i.f.: 2014 (Est.): -4,394; 2015 (Proj.): -4,691.
  - Overall balance (including exceptional financing): 2014 (Est.): -190; 2015 (Proj.): 1,131.
- Assumed commodity prices used in projections (Table 5, selected):
  - Gold (U.S. dollars per ounce): 2014: 1,290; 2015 (Proj.): 1,286; 2016 (Proj.): 1,295; 2017 (Proj.): 1,320; 2018 (Proj.): 1,351; 2019 (Proj.): 1,394.
  - Copper (U.S. dollars per ton): 2014: 6,986; 2015 (Proj.): 7,052; 2016 (Proj.): 7,043; 2017 (Proj.): 7,021; 2018 (Proj.): 6,991; 2019 (Proj.): 6,967.
  - Oil (U.S. dollars per barrel): 2014: 99; 2015 (Proj.): 79; 2016 (Proj.): 104; 2017 (Proj.): 105; 2018 (Proj.): 104; 2019 (Proj.): 99.

### External vulnerability and financial indicators
- Indicators of external vulnerability (Table 6, select items):
  - Gross public debt (percent of GDP): 2010: 25.6; 2011: 23.0; 2012: 26.7; 2013: 34.0.
  - Broad money (percentage change, 12-month basis): 2010: 10.2; 2011: 17.8; 2012: 10.9; 2013: 6.7.
  - Private sector credit (percentage change, 12-month basis): 2010: 18.1; 2011: 7.9; 2012: 12.1; 2013: 17.5.
  - Current account balance (percent of GDP): 2010: -21.5; 2011: -23.6; 2012: -53.6; 2013: -30.8.
  - Gross official reserves (in months of nonresource imports, c.i.f.): 2010: 9.6; 2011: 10.4; 2012: 11.6; 2013: 7.6.
  - Exchange rate (kina per U.S. dollar; period average): 2010: 2.6; 2011: 2.1; 2012: 2.1; 2013: 2.4.
- Financial ratings (long-term foreign currency government debt rating):
  - Moody's: Ba2 (2010–2013).
  - Standard & Poor's: B+ (2010–2013).

### Millennium Development Goals status (Table 8)
- Goal 1: Eradicate extreme poverty and hunger — Global targets: Off track; Papua New Guinea’s National Targets: On track.
- Goal 2: Achieve universal primary education — Global targets: Off track; National Targets: Mixed.
- Goal 3: Promote gender equality and empower women — Global targets: Off track; National Targets: Mixed.
- Goal 4: Reduce child mortality — Global targets: Off track; National Targets: On track.
- Goal 5: Improve maternal health — Global targets: Off track; National Targets: Off track.
- Goal 6: Combat HIV/AIDS, malaria and other diseases — Global targets: Off track; National Targets: Off track.
- Goal 7: Ensure environmental sustainability — Global targets: Off track; National Targets: Off track.
- Goal 8: Develop a global partnership for development — Global targets: Off track; National Targets: Not a national target.

*Source: IMF staff estimates and projections; Papua New Guinea authorities; IMF staff calculations and projections.*

### Appendix I. Papua New Guinea: Risk Assessment Matrix

### Appendix I. Papua New Guinea: Risk Assessment Matrix

### Summary of Risks, Likelihoods, Impacts, and Policy Recommendations
- Risk likelihood classification (staff’s subjective assessment):
  - "low" is meant to indicate a probability below 10 percent,
  - "medium" a probability between 10 and 30 percent,
  - "high" a probability of 30 percent or more.

- 1. Protracted period of slower growth in advanced and emerging economies
  - Source of risks: Prolonged slow growth in advanced economies and emerging markets would reduce exports and GDP growth and weaken investor sentiment; could result in a large drop in world commodity prices.
  - Overall level of concern: High
  - Likelihood of severe realization in the next one–three years: High
  - Expected impact if realized: High — A sharp decline in export earnings would worsen the trade balance; reduce fiscal revenue and weaken the reserves buffer; FDI inflows would also be adversely affected.
  - Policy recommendations:
    - Introduce temporary fiscal and monetary stimulus;
    - Allow the kina to depreciate to boost non-resource exports;
    - Accelerate structural reforms to improve competitiveness.

- 2. Sustained decline in energy prices
  - Source of risks: The large number of new LNG and shale gas projects coming on stream in Australia and North America, coupled with weak global demand, would depress global gas prices.
  - Overall level of concern: Medium
  - Likelihood of severe realization in the next one–three years: High
  - Expected impact if realized: High — Lower LNG prices would reduce fiscal revenue, export proceeds, and foreign reserves; development of future LNG projects would become less likely.
  - Policy recommendations:
    - Allow the kina to depreciate and accelerate structural reforms to boost non-resource exports;
    - Tighten the fiscal stance to buttress the external position;
    - Reprioritize spending to support export-oriented infrastructure.

- 3. Property market correction
  - Source of risks: Property prices in Port Moresby and Lae would fall further with the completion of the LNG project and the emergence of excess capacity.
  - Overall level of concern: Low/Medium
  - Likelihood of severe realization in the next one–three years: Medium
  - Expected impact if realized: Medium — Authorized superannuation funds and local banks that have invested in or lent to the property sector could be adversely affected.
  - Policy recommendations:
    - Accelerate clearance of superannuation arrears;
    - Write down losses in the funds;
    - Ensure banks’ capital adequacy.

- 4. Political instability and worsening security
  - Source of risks: Political tensions could rise, leading to broader instability, which could worsen law and order problems.
  - Overall level of concern: Medium
  - Likelihood of severe realization in the next one–three years: Medium
  - Expected impact if realized: Medium/High — Rent-seeking behavior could intensify and more nonproductive expenditures could arise; confidence and investment could falter.
  - Policy recommendations:
    - Resist monetary accommodation of a fiscal expansion;
    - Focus any increased spending on improving security, but with greater fiscal transparency.

- 5. Natural disasters
  - Source of risks: PNG is prone to earthquakes, flooding, volcanic eruptions, and cyclones.
  - Overall level of concern: Low/Medium
  - Likelihood of severe realization in the next one–three years: Medium
  - Expected impact if realized: Medium/High — Given PNG’s poor infrastructure and weak capacity, the economic impact could be significant.
  - Policy recommendations:
    - Ensure fiscal buffers are adequate to support affected groups;
    - Spend more on preparation and prevention;
    - Encourage take-up of disaster insurance.

*Source: Appendix I. Papua New Guinea: Risk Assessment Matrix (IMF staff).*

### 4.      Papua New Guinea is vulnerable to certain extreme shocks despite the currently low

### 4.      Papua New Guinea is vulnerable to certain extreme shocks despite the currently low

### Summary of stress-test findings and scenarios
- There is a protracted breach of the PV of debt-to-GDP ratio under the historical and extreme exports shock scenarios.
- There is a breach of the PV of public external debt-to-exports ratio under the extreme exports shock scenario.
- All these scenarios would be tantamount to a major delay or complete failure of the LNG project.
- Historical scenario: when the current account deficit is fixed at the ten-year average of 2004–13, the simulation effectively keeps imports at levels elevated by the LNG project and rules out the expected large increases in LNG exports going forward.
  - Given that LNG production has already commenced, such an outcome is considered very unlikely.
- “LNG shock” scenario: LNG production assumed to be 50 percent lower than the baseline over the medium term.
  - Under this scenario the PV of debt-to-GDP ratio would fall more slowly over time but the debt burden would remain sustainable.
- Stress tests based on recent current account deficits and volatility tend to overstate the risk of debt distress because large current account deficits in recent years were exceptional due to large imports required for LNG construction.

### Public debt dynamics and risks
- Under the baseline (government follows through with fiscal consolidation as committed under its Medium-Term Fiscal Strategy), the public debt burden is expected to decline continuously over the projection period.
- A shock reducing LNG production by 50 percent over the medium term would:
  - Slow the decline of the debt burden;
  - Keep the debt burden at a higher level;
  - Still leave debt dynamics sustainable.
- A failure to consolidate the fiscal position would result in an unsustainable debt burden.
- Risks also arise from:
  - Superannuation arrears, estimated to be about 6½ percent of GDP at end-2013.
  - Public enterprise liabilities, estimated to be about 7½ of GDP (data on public enterprise liabilities are incomplete and not up to date).
- When these liabilities and contingent liabilities are taken into account, there would be a noticeable increase in the public debt burden over the medium term (shown in the customized scenario “All other liabilities included” for the public DSA).
  - This scenario assumes that the full amount of superannuation arrears is added to the debt stock, and 100 percent of SOEs debt is realized to become actual liabilities and added to the debt stock.
  - The SOEs debt stock is assumed to grow in line with nominal GDP.

### Authorities’ views
- The authorities agreed with the DSA findings, noting that the current risk of debt distress is low, but fiscal consolidation is crucial for debt sustainability.
- The authorities remain committed to achieving the legislated debt targets.
- The authorities recognized the importance of more comprehensive data on debt and other liabilities, in particular off-budget and public enterprise debt, in assessing PNG’s overall debt burdens.

### Conclusion and policy implications
- Papua New Guinea’s PPG external debt remains at low risk of debt stress.
- The overall risk of public debt distress has increased, given the rising stock of public domestic debt in recent years.
- Contingent and non-contingent liabilities significantly increase the public debt burden.
- A failure to consolidate the fiscal position would result in unsustainable debt dynamics.
- Policy recommendations:
  - Adhere to existing debt targets.
  - Focus on improving spending quality to make the most out of a restrained resource envelope in meeting the country’s development needs.

*IMF staff summary as presented in the source content.*

### Box 1. Macroeconomic Assumptions Underlying the DSA Update

### Box 1. Macroeconomic Assumptions Underlying the DSA Update

### Overview and context
- Macroeconomic assumptions for this DSA are generally more conservative than those for the previous DSA.  
- Projections of GDP growth and inflation are somewhat lower than those for the 2013 DSA, as are projections of the long-term external current account balance.  
- This largely reflects a less favorable outlook for the resource sector owing to forecasts of lower commodity prices and volumes.  
- LNG production is assumed to provide a boost to medium-term growth and external balances.

### Real activity and inflation
- Real GDP growth is projected at 7 percent on average over the medium term (reflecting the boost of LNG production), and to slow to 3 percent in the long run.  
- Inflation is expected to stabilize at about 5 percent over the medium and long term.

### External current account and grants
- The current account (including grants) will remain in deficit until 2014, primarily reflecting the strong import growth related to the construction phase of the LNG project.  
- The current account is expected to turn into a surplus in 2015 as LNG production and exports increase and imports related to the LNG project wind down.  
- The surplus is projected to be 6 percent of GDP on average during 2015–25.  
- The grant element of loans (excluding the UBS loan) is expected to decline gradually. As per capita income rises, the share of external financing provided on concessional terms is expected to decline over the projection period.

### Fiscal projections and primary balance
- The primary fiscal balance is estimated to be in deficit of 5.4 percent of GDP in 2014.  
- During the current medium-term fiscal strategy period (2013–2017), a continuous primary deficit of 2.4 percent of GDP on average is expected.  
- The primary fiscal balance is projected to turn into surplus in 2021, averaging 0.5 percent of GDP during 2021–34.

*Source: Box 1. Macroeconomic Assumptions Underlying the DSA Update (excerpt).*

### introduction of the standardized report form (SRF) for the central bank, other depository corporations

### introduction of the standardized report form (SRF) for the central bank, other depository corporations

### Monetary statistics and SRF introduction
- Introduction of the standardized report form (SRF) for the central bank, other depository corporations (ODCs), and the other financial corporations (OFCs).
- The 2013 mission introduced general insurance companies in the institutional coverage of OFCs and an improved SRF for OFCs.
- Most of the monetary statistics published in International Financial Statistics (IFS) are currently aligned with the Monetary and Financial Statistics Manual (MFSM).

### Financial sector surveillance (FSIs)
- The BPNG has compiled selected FSIs for deposit takers to support the financial sector assessment.
- Papua New Guinea is participating in a three-year (FY2014–FY2016) TA project on FSIs for selected AFR and APD countries funded by the Government of Japan.
- PNG is expected to submit FSI data and metadata to STA for posting on the IMF’s FSI website well before the end of the project.

### External sector statistics (ESS) and balance of payments (BOP)
- Annual balance of payments data are derived from the International Transactions Reporting System (ITRS), which is not tightly monitored despite the BPNG reporting requirements.
- Marked differences exist between official data on exports and imports of goods and those reported by trading partners.
- Financial accounts data are of poor quality because of major deficiencies in data collection, especially in private external debt and foreign direct investment.
- Quarterly data are also published by the BPNG.
- Progress has been made in implementing recommendations from PFTAC’s BOP missions in June 2008 and November 2009.
- PNG benefited from the JSA Project on improvement of ESS: two TA missions to improve BOP and IIP statistics in May-June 2013 and February 2014; missions made recommendations to improve ESS compilation framework.
- BPNG is largely under-equipped in capacity and collection framework vis-à-vis the volumes and nature of transactions and positions with nonresidents.
- Little progress has been made regarding implementation of the missions’ recommendations; overall improvements in the quality of ESS have been very modest.

### Data standards and reporting to STA
- Papua New Guinea began to participate in the General Data Dissemination System (GDDS) in 2012.
- Reporting history to STA:
  - GFS for publication in Government Finance Statistics Yearbook and IFS for 1999–2002, covering only the budgetary central government.
  - Monetary data are reported to STA for publication in IFS on a regular monthly basis.
  - BOP data for 2010 were reported to STA for publication in Balance of Payments Yearbook and IFS.
  - National accounts data for 2004 were reported to STA for publication in IFS.

### Table of Common Indicators Required for Surveillance (As of September 17, 2014) — key items and frequencies
- Exchange Rates: Date of Latest Observation 09/17/14; Date Received 09/17/14; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation 09/10/14; Date Received 09/10/14; Frequency of Data W; Frequency of Reporting W; Frequency of Publication Q.
- Reserve/Base Money: Date of Latest Observation 07/14; Date Received 09/11/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication Q.
- Broad Money: Date of Latest Observation 07/14; Date Received 09/11/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication Q.
- Central Bank Balance Sheet: Date of Latest Observation 07/14; Date Received 09/11/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication Q.
- Consolidated Balance Sheet of the Banking System: Date of Latest Observation 07/14; Date Received 09/11/14; Frequency of Data M; Frequency of Reporting M; Frequency of Publication Q.
- Interest Rates: Date of Latest Observation 09/10/14; Date Received 09/10/14; Frequency of Data W; Frequency of Reporting W; Frequency of Publication Q.
- Consumer Price Index: Date of Latest Observation 06/14; Date Received 08/29/14; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q.
- Revenue, Expenditure, Balance and Composition of Financing — Central Government: Date of Latest Observation 2013; Date Received 07/31/14; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of Latest Observation 03/14; Date Received 08/13/14; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q.
- External Current Account Balance: Date of Latest Observation 03/14; Date Received 08/13/14; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q.
- Exports and Imports of Goods and Services: Date of Latest Observation 03/14; Date Received 08/13/14; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q.
- GDP/GNP: Date of Latest Observation 2013; Date Received 07/31/14; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- Gross External Debt: Date of Latest Observation 03/14; Date Received 08/13/14; Frequency of Data Q; Frequency of Reporting A; Frequency of Publication A.
- International Investment Position: N/A across Date of Latest Observation, Date Received, Frequency of Data, Frequency of Reporting, Frequency of Publication.
- Note footnotes: 1) D, W, M, Q, A, I, N/A definitions; 2) includes reserve assets pledged...; 3) both market-based and officially-determined interest rates; 4) financing definitions; 5) general government composition; 6) including currency and maturity composition; 7) includes external gross financial asset and liability positions vis-à-vis nonresidents; 8) Lack of capacity prevented the authorities from providing the data.

### Budget update (Government of Papua New Guinea submissions November 18 and 19, 2014)
- On November 18, 2014, Government tabled the 2015 National Budget and a 2014 supplementary budget.
- Projected fiscal deficit in 2014: 5.9 percent of GDP, expected to be 1.3 percentage points of GDP lower than the staff’s projection (Table 1).
- Government revenues buoyed by higher-than-expected growth from new LNG production.
- Debt-to-GDP ratio projected to breach slightly the 35 percent of GDP ceiling in 2014, but would be lower than staff’s projection.
- Proposed 2015 budget: overall deficit at 4.4 percent of GDP, compared with 2.5 percent of GDP in the staff report.
- Debt-to-GDP ratio projected to decline to 27.8 percent in 2015 (lower than staff report’s projection of 31 percent), with off-budget receipts from sale of landowners’ equity in the LNG project to be used to retire debt.
- Government’s Medium-Term Fiscal Strategy aims to reduce government debt to below 30 percent of GDP over the medium term.
- Government envisages further fiscal consolidation beyond 2015: deficit target of 2.5 percent of GDP for 2016 and a balanced budget for 2017-19.
- Proposed 2015 budget does not change the staff assessment as reported in the staff report.

### Selected budget indicators (Table 1) — key series (percent of GDP unless otherwise shown)
- GDP growth series (percentage change): 2012 8.1; 2013 5.5; 2014 5.8; 2015 8.4? (table formatting indicates series: "GDP8.15.55.88.419.615.53.35.03.42.3" — source text layout preserved; see "Selected Economic and Financial Indicators" table below for official series).
- Non-resource (percentage change): "Non-resource9.25.40.51.44.04.04.53.94.53.7" (preserved as in source).
- CPI Inflation (annual average): 4.5 5.0 5.3 5.9 5.0 5.5 5.0 5.0 5.0 5.0 (preserved as in source line "CPI Inflation4.55.05.35.95.05.55.05.05.05.0")
- Total Revenue (percent of GDP): "29.228.230.131.125.327.224.624.724.424.4" (preserved as in source).
- Expenditure (percent of GDP): "32.436.137.337.027.831.626.727.225.824.4" (preserved as in source).
- Deficit (overall, percent of GDP): "-3.2-8.0-7.2-5.9-2.5-4.4-2.1-2.5-1.40.0" (preserved as in source).
- Debt (percent of GDP): "26.734.637.035.531.027.831.528.031.126.6" (preserved as in source).
- Table 1 header indicates selected budget indicators for 2012–2017 and staff report vs. 2015 Budget columns; source text preserved verbatim.

### IMF Press Release highlights and Executive Board Assessment (Press Release No. 14/547; December 2, 2014)
- IMF Executive Board concluded the 2014 Article IV consultation with Papua New Guinea on November 21, 2014 and endorsed the staff appraisal without a meeting on lapse-of-time basis.
- Key macro context:
  - PNG experiencing important transition with major near-term macro-financial challenges and opportunities.
  - Government embarked on large fiscal expansion starting in 2013 to accelerate development and cushion the non-resource economy, reducing fiscal space and increasing government debt likely to exceed legislated targets by end 2014.
  - LNG production and exports starting: resource sector growth projected to surge in 2015, but spillovers to rest of economy may be limited.
  - Inflation moderated from construction-boom peaks; likely to remain reasonably low given global commodity price outlook.
  - External current account deficit fell significantly since 2013; expected to narrow further in 2014 and turn into a surplus in 2015 with LNG exports.
  - Depreciation pressure on the kina since mid-2013 due to lower commodity prices, weaker mining output, and reduction in LNG project-related capital inflows.
  - Early June 2014 BPNG measure required authorized dealers to conduct transactions within a trading band of 150 basis points around the official (interbank) exchange rate; caused large de facto currency appreciation; since then the Kina has been depreciating at the rate of 5-10 basis points per week.
- Risks:
  - Downside tilt: weaker global growth, lower LNG prices from global LNG and shale gas developments, implications for government revenue and FDI; domestically, lower growth could weigh on property valuations.
  - Upside potential: second LNG project and new mining operations.
- Policy recommendations (Executive Board and staff appraisal):
  - Foremost: fiscal consolidation anchored by government’s existing debt targets to maintain macro-financial stability.
  - Better expenditure prioritization to improve development outcomes; align spending with absorptive capacity and improve spending quality.
  - Strengthen public financial management (PFM): improve management of trust accounts, cash flows, and public debt; increase transparency in contracting government and State Owned Enterprises (SOE) loans.
  - Sovereign wealth fund (SWF) should be put into operation as soon as practical; authorities’ intention to retain essential features of original SWF design is welcome, with commitment to channel resource revenues through the budget to the greatest extent possible.
  - Greater exchange rate flexibility: BPNG should allow exchange rate to be more market-determined and move quickly to a market-clearing rate through competitive foreign exchange auctions.
  - Mop up excess liquidity in the banking system more fully to reduce excess demand for foreign exchange and improve monetary policy transmission.
  - Accelerate and deepen structural reforms: improve infrastructure, security, health and education outcomes, attract more FDI, accelerate SOE reforms, revive agriculture, strengthen SME sector, and support financial inclusion innovations.
  - Improve macroeconomic statistics: reform National Statistics Office (NSO) and use increased IMF technical assistance to improve capacity.

### Selected Economic and Financial Indicators, 2010–15 (key figures preserved)
- Nominal GDP (2013): US$15.4 billion 1/
- Population (2013): 7.3 million
- GDP per capita (2013): US$2,098
- Quota: SDR 131.6 million

Selected series (2010–2015; Est./Proj. where indicated)
- Real GDP growth: 2010 7.7; 2011 10.7; 2012 8.1; 2013 5.5; 2014 5.8; 2015 19.6 (Est./Proj. heading preserved).
- Resource (percentage change): 2010 -2.0; 2011 -11.8; 2012 -7.4; 2013 7.2; 2014 90.6; 2015 150.5.
- Nonresource (percentage change): 2010 8.7; 2011 12.8; 2012 9.2; 2013 5.4; 2014 0.5; 2015 4.0.
- CPI (annual average): 2010 6.0; 2011 4.4; 2012 4.5; 2013 5.0; 2014 5.3; 2015 5.0.
- CPI (end-period): 2010 4.9; 2011 4.4; 2012 5.8; 2013 2.9; 2014 6.3; 2015 5.0.
- Central government operations (percent of GDP):
  - Revenue and grants: 2010 31.3; 2011 30.4; 2012 29.2; 2013 28.2; 2014 30.1; 2015 25.3.
  - Expenditure and net lending: 2010 28.2; 2011 28.7; 2012 32.4; 2013 36.1; 2014 37.3; 2015 27.8.
  - Net lending(+)/borrowing(-) [Overall balance] (Revenue - expenditure): 2010 3.1; 2011 1.7; 2012 -3.2; 2013 -8.0; 2014 -7.2; 2015 -2.5.
  - Nonresource net lending(+)/borrowing(-): 2010 -3.6; 2011 -5.7; 2012 -6.6; 2013 -9.9; 2014 -8.9; 2015 -5.8.
- Money and credit (percentage change): Domestic credit 2010 4.9; 2011 -5.2; 2012 37.7; 2013 40.9; credit to the private sector 2010 18.1; 2011 7.9; 2012 12.1; 2013 17.5; broad money 2010 10.2; 2011 17.8; 2012 10.9; 2013 6.7; Interest rate (182-day Treasury bills; period average) 2010 5.2; 2011 4.3; 2012 5.8; 2013 5.0.
- Balance of payments (in billions of U.S. dollars): Exports, f.o.b. 2010 5.9; 2011 6.9; 2012 6.3; 2013 5.6; 2014 6.3; 2015 12.4. Of which: Nonresource 2010 4.4; 2011 4.9; 2012 4.5; 2013 4.1; 2014 4.3; 2015 10.1. Imports, c.i.f. 2010 -4.3; 2011 -6.3; 2012 -7.7; 2013 -5.5; 2014 -4.4; 2015 -4.7. Current account (including grants) 2010 -2.1; 2011 -3.0; 2012 -8.2; 2013 -4.7; 2014 -1.8; 2015 2.7. (In percent of GDP) -21.5 -23.6 -53.6 -30.8 -11.4 13.5.
- Gross official international reserves (in months of goods and services imports): 2010 3.1 (3.7 months); 2011 4.3 (4.1 months); 2012 4.0 (5.0 months); 2013 2.8 (4.2 months); 2014 2.6 (4.0 months); 2015 3.8 (5.5 months).
- Government debt (percent of GDP): Government gross debt 2010 25.6; 2011 23.0; 2012 26.7; 2013 34.0; 2014 37.0; 2015 31.0.
- External debt-to-GDP ratio (percent) 3/: 2010 10.7; 2011 8.3; 2012 7.3; 2013 8.1; 2014 9.0; 2015 7.8.
- External debt-service ratio (percent of exports) 3/: 2010 1.5; 2011 1.3; 2012 1.5; 2013 1.5; 2014 1.8; 2015 0.7.
- Exchange rates: US$/kina (end-period) 2010 0.3785; 2011 0.4665; 2012 0.4755; 2013 0.4130.
- Nominal GDP (in billions of kina): 2010 26.4; 2011 30.5; 2012 32.1; 2013 34.6; 2014 39.8; 2015 52.2.
- Sources: Department of Treasury; Bank of Papua New Guinea; and IMF staff estimates and projections.
- Footnotes preserved verbatim from source: 1/ Based on period average exchange rate. 2/ Resource sector includes production of mineral, petroleum, and gas and directly related activities such as mining and quarrying, but excludes indirectly related activities such as transportation and construction. 3/ Public external debt includes external debt of the central government, the central bank, and statutory authorities.

*Source: _cr14325 - introduction of the standardized report form (SRF) for the central bank, other depository corporations (ODCs), and the other financial corporations (OFCs).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14325.pdf_