## _cr15318

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---

### Key issues and context
- Context: PNG has abundant resources including agriculture, cultural diversity, fisheries, forestry, minerals, and petroleum/LNG; growth has been volatile and LNG production boosted overall GDP growth in 2014-15.
- Main challenge: Severe revenue shortfalls from lower global commodity prices and temporary suspension of a large mining operation require a comprehensive policy response.
- Policy agenda priorities:
  - Measured but ambitious medium-term fiscal consolidation to keep debt-to-GDP on a downward trajectory while safeguarding social outlays.
  - Measures to reduce excess liquidity to increase monetary policy effectiveness and dampen downward pressures on the kina.
  - Greater exchange rate flexibility to restore market-clearing FX conditions.
  - Structural reforms to boost inclusive non-resource growth: investment in health and education, improvement in infrastructure and law and order, increased agricultural productivity, financial development and inclusion, and strengthening of public financial management (PFM).

### Recent developments
- Exchange rate and monetary actions:
  - In early June 2014, the Bank of Papua New Guinea (BPNG) introduced measures to require authorized dealers to transact with their customers within a trading band of 150 basis points around the official (interbank) exchange rate; this move caused a large de facto currency appreciation. Since then, the kina has depreciated vis-à-vis the U.S. dollar.
- Growth and inflation (selected):
  - Real GDP growth: 2011: 10.7; 2012: 8.1; 2013: 5.5; 2014: 8.5; 2015 (Est.): 9.0; 2016 (Proj.): 3.1.
  - Nonresource growth: 2011: 12.8; 2012: 9.2; 2013: 5.4; 2014: 0.7; 2015 (Est.): 1.5; 2016 (Proj.): 3.8.
  - CPI (annual average): 2011: 4.4; 2012: 4.5; 2013: 5.0; 2014: 5.3; 2015 (Proj.): 6.0; 2016 (Proj.): 6.0.
- External sector and reserves:
  - Gross international reserves projected around $2 billion in 2015 (equivalent to 3 months of total goods and nonfactor services imports); reserves remain below staff’s assessment of adequacy.
  - Current account (including grants) in percent of GDP: 2011: -23.6; 2012: -53.6; 2013: -31.8; 2014: -4.2; 2015 (Proj.): 4.6; 2016 (Proj.): 3.8.
- Fiscal developments:
  - MYEFO projected a K 2.5 billion revenue shortfall in 2015 (equivalent to 5.5 percent of GDP) compared to the K 1.3 billion shortfall expected in the budget.
  - Central government operations (percent of GDP): Revenue and grants: 2011: 30.4; 2012: 29.2; 2013: 28.2; 2014: 27.3; 2015 (Proj.): 24.7; 2016 (Proj.): 25.7. Expenditure and net lending: 2011: 28.7; 2012: 32.4; 2013: 36.1; 2014: 34.5; 2015 (Proj.): 32.3; 2016 (Proj.): 31.2.
  - Net lending(+)/borrowing(-) [Overall balance]: 2011: 1.7; 2012: -3.2; 2013: -8.0; 2014: -7.2; 2015 (Proj.): -7.6; 2016 (Proj.): -5.5.
  - Government gross debt (percent of GDP): 2011: 23.0; 2012: 26.7; 2013: 34.0; 2014: 35.6; 2015 (Proj.): 39.4; 2016 (Proj.): 41.1.
- Financial sector and inclusion:
  - No generalized credit boom; overall credit growth moderate and broadly in line with nominal GDP since 2010.
  - PNG’s ratio of domestic private credit to GDP is well below the average for comparators; low levels of financial development and access persist despite progress with mobile banking.
- Selected country indicators (2014 unless noted):
  - Nominal GDP (2014): US$16.8 billion.
  - Population (2014): 7.5 million.
  - GDP per capita (2014): US$2,232.
  - Quota: SDR 131.6 million.
  - US$/kina (end-period): 2011: 0.4665; 2012: 0.4755; 2013: 0.4130; 2014: 0.3938.

### Outlook
- Growth and inflation projections:
  - Real GDP growth expected to expand strongly by about 9 percent in 2015 reflecting LNG production.
  - Non-resource GDP projected to grow by 1½ percent in 2015 and by about 3½ percent in 2016.
  - Medium-term growth expected to converge to about 3 percent; 2018 growth projected to slow to 1½ percent and stabilize at 3 percent over the longer term.
  - Inflation expected to stabilize around 5 percent over the medium term.
  - Current account expected to turn into a surplus in 2015 as the LNG plant has its first full year of operation.
- Reserves and external financing:
  - Gross international reserves projected to remain at around $2 billion in 2015 and strengthen modestly over the medium term.

### Risks
- Downside risks:
  - Fiscal consolidation necessitated by weaker-than-anticipated revenue performance will dampen non-resource growth in the short run.
  - A weak global economy could further dampen external demand and commodity prices.
  - LNG developments in Australia and shale gas developments globally could continue to put downward pressure on LNG prices and government revenue.
  - Global financial market instability could affect prospects for external commercial financing or FDI.
- Upside risks:
  - Potential for a second LNG project, further mineral resource development, and increased trade with Asia.
- Policy caution:
  - Prospective new mineral and LNG projects should not divert attention from the need to tighten fiscal and monetary policy now and allow for greater exchange rate flexibility.

### Executive Board assessment and recommendations
- Directors’ appraisal:
  - Commended authorities for achieving impressive economic growth in recent years but noted adverse effects from sharp drop in commodity prices and slowing non-resource sectors.
  - Stressed need for prudent macroeconomic policies to ensure debt sustainability and safeguard the external position.
- Fiscal policy recommendations:
  - Strong fiscal consolidation needed to keep government debt-to-GDP ratio on a downward trajectory over the medium term while safeguarding key social outlays.
  - Strengthen expenditure prioritization and public financial management; develop a medium-term debt management strategy.
  - Welcome to government’s efforts to set up a Sovereign Wealth Fund; make fund operational soon and channel resource revenues from the fund through the budget to ensure transparency and accountability.
- Monetary and exchange rate recommendations:
  - Greater exchange rate flexibility called for; scope for further depreciation to safeguard external buffers and eliminate FX market imbalances.
  - Allow the exchange rate to move more quickly to a market-clearing rate and mop up excess liquidity to strengthen monetary policy effectiveness.
- Structural reforms:
  - Decisive implementation urged: improving infrastructure and law and order; investing in health and education; strengthening agriculture and SME sectors and access to finance; increasing competition in the banking sector; reducing business costs; accelerating SOE reform.
  - Encouraged timely implementation of AML/CFT legislation and further efforts to improve statistics and institutional capacity.

### Authorities’ views (overview)
- Authorities broadly concurred with the outlook.
- Authorities noted El Niño drought could prolong a temporary mine closure and worsen a poor harvest of crops.
- They emphasized upside to growth from prospective extractive projects (including a second LNG project and several major gold-copper projects) over the longer term.
- Concurred with need for ambitious fiscal consolidation while avoiding cuts in priority areas (infrastructure, health, education, law and order); for 2015 they will consider postponement of some lower-priority projects.
- Reiterated commitment to adhering to the Santiago Principles in operation of the SWF, while noting little resource revenue would be saved in the near term owing to PNG’s huge development needs.
- Will consider IMF technical assistance to support development of a MTDS.

### Fiscal policy — staff findings and recommendations
- Baseline and staff alternative:
  - Authorities’ plan to cut expenditures by K 1.3 billion in 2015 would still yield an increase in the debt-to-GDP ratio (from 36 to 45 percent) over the medium term.
  - Staff encouraged limiting debt to 35 percent of GDP by 2020 via the staff’s alternative adjustment scenario.
  - Achieving the staff target would require:
    - a more ambitious set of measures totaling K 2.0 billion in 2015; and
    - lower deficits relative to the baseline by 1 percent of GDP in 2016, and by about 2 percent of GDP from 2017 through 2019.
- Rationale and instruments:
  - Under-execution of expenditure suggests room for cuts and reprioritization.
  - Staff encouraged considering the NRPB as an underlying fiscal target to insulate fiscal policy from resource revenue volatility.
- Revenue measures:
  - Staff encouraged measures to strengthen revenue collection, including suspending the Infrastructure Tax Credit until the IRC makes recommendations based on an audit of the scheme, and other measures recommended by the Tax Review Committee.
  - Tax Review Committee recommendations under review:
    - increase of the goods and services tax rate from 10 percent to 15 percent;
    - raising the income tax threshold from K 10,000 to K 15,000;
    - reducing the corporate income tax rate from 30 percent to 25 percent.
  - Revenue measures would likely yield significant additional revenue only starting in 2016.
- Expenditure cuts:
  - Staff’s adjustment scenario requires a net expenditure reduction of about K 2.0 billion in 2015 (about 30 percent from goods and services and 70 percent from low-impact capital expenditures), and continued spending restraint in subsequent years while protecting high priority social spending (health, education, law and justice, agriculture).
- Budgetary financing and debt management:
  - Identifying sufficient financing in 2015 is expected to be challenging; planned asset sales are likely to be delayed.
  - Banks and superannuation funds have mostly reached internal limits on sovereign exposure, limiting appetite for additional government securities and leading to a sharp rise in T-bill yields.
  - Announcement of a suitably ambitious fiscal adjustment plan at an early date would bolster market confidence ahead of a planned debut US$1 billion sovereign Eurobond placement.
  - Important to put in place a Medium-Term Debt Management Strategy (MTDS) to increase financing efficiency and minimize costs and risks associated with new external funding.
  - Central bank should refrain from providing direct financing to the government.
  - An updated DSA indicates PNG’s risk of external debt distress remains low.
  - Overall public debt amounts to about 56 percent of GDP once arrears to a superannuation fund and other liabilities are taken into account.
    - Arrears and liabilities included: arrears to a superannuation fund (6.5 percent of GDP), SOE debt (7.5 percent of GDP), and the UBS loan (6.8 percent of GDP).

### Monetary policy and exchange rate — staff findings and recommendations
- Exchange rate regime and FX market:
  - FX trading band introduced in June 2014; restricted USD/kina movement resulted in a change in de facto exchange rate regime classification from floating to a crawl-like arrangement, effective April 2014.
  - Kina has depreciated more slowly than currencies of other commodity exporters; staff stressed allowing the kina to depreciate more quickly to clear the FX market and restore external competitiveness of non-resource exports.
  - Staff supported maintaining the FX trading band in the near term to avoid a sharp widening of bid/ask spreads, but recommended developing a plan to improve FX market efficiency and transparency over time, drawing upon follow-up IMF TA.
  - PNG maintains an exchange restriction subject to IMF approval under Article VIII, Section 2(a) arising from requirement to obtain a tax clearance certificate prior to making payments or transfers for certain current international transactions.
- Monetary stance and liquidity management:
  - Mission advised mopping up excess liquidity to increase effectiveness of monetary policy transmission, tighten the monetary stance, and dampen downward pressures on the kina.
  - Near-term BPNG measures advised:
    - increase the cash reserve requirement (CRR);
    - encourage transfer of government balances from commercial bank accounts to BPNG;
    - step up use of open market operations;
    - establish an interbank interest rate corridor as recommended by recent IMF TA.
  - Staff advised BPNG to refrain from providing direct financing to the government to safeguard independence and operational effectiveness.
  - Staff does not anticipate significant real sector effects from monetary tightening given massive expansion in LNG production this year.
  - Staff agreed that BPNG should maintain an adequate level of international reserves.
- Authorities’ views on monetary and FX policy:
  - Authorities emphasized USD/kina rate was market determined and that the market, not BPNG, was keeping the rate at its current level.
  - They stressed avoiding undue exchange rate volatility and high bid/ask spreads and noted that a faster pace of depreciation may be inflationary given PNG’s heavy reliance on imports.
  - Authorities acknowledged that excess liquidity inhibits monetary transmission but noted inflationary pressures had remained contained to date.
  - BPNG reiterated its request for follow-up IMF TA regarding participation in the FX market and stands ready to absorb excess liquidity and tighten monetary policy should inflationary pressures intensify.
  - BPNG reiterated intention to avoid any direct financing of the government budget deficit and saw no need to reform the Central Banking Act or to strengthen its balance sheet.

### Financial sector — findings, risks, and policy recommendations
- System soundness and vulnerabilities:
  - PNG’s financial system appears robust with strong indicators of bank capital adequacy, asset quality, liquidity, and profitability.
  - BPNG should remain vigilant to sector-specific risks, particularly the potential impact of lower government spending and temporary suspension of a large mining operation on assets exposed to affected sectors (real estate, transport, logistics).
- Macroprudential policy and AML/CFT:
  - Macroprudential policies should limit buildup of systemic vulnerabilities.
  - BPNG should continue to enhance a macroprudential policy division and set up a comprehensive database including sectoral loan data and household and corporate debt measures.
  - Authorities are encouraged to continue strengthening the AML/CFT regime; key legislation has been passed which could facilitate removal from the FATF gray list.
- Structural barriers and financial development:
  - Structural barriers impede financial access and development: lack of competition, underdeveloped capital markets, and a shallow/inefficient FX market.
  - Lack of competition:
    - Three large banks (two Australian banks and one domestic bank) dominate credit provision.
    - Wide interest rate spreads reflect oligopolistic banking structure and costs/risks of doing business.
    - Priority: reduce entry barriers (including for microfinance), encourage adoption of new technologies such as mobile banking and microfinance products.
  - Underdeveloped capital markets:
    - Banks’ assets concentrated in government securities; excess liquidity suggests government borrowing has not crowded out private sector borrowing.
    - Banks and superannuation funds are reaching internal limits for government exposure, prompting need to diversify financing sources including via a prospective US$1 billion Eurobond.
    - Authorities should promote domestic capital market development and a secondary market for government securities.
  - Shallow FX market:
    - Interbank FX market is one-sided given the overvalued exchange rate and structural shortage of FX.
    - Mineral tax receipts account for about two-thirds of FX inflows; FX transactions are highly regulated by BPNG.
    - Authorities should focus on measures to eliminate FX market distortions.

### Financial development and inclusion — authorities’ actions
- Legislation in place for micro-insurance products and mobile banking services.
- Authorization of five microfinance institutions.
- Authorities report being roughly halfway towards the goal of reaching 1 million previously un-banked citizens, 32 percent of which are women.
- BPNG will consider a follow-up strategy leveraging World Bank, ADB, and PFIP support.

### Structural reforms and inclusive growth
- Priority reforms: agriculture, infrastructure, law and order, health and education, SME support, competition policy, SOE reform.
- Constraints highlighted:
  - Electrification rate reaches only 12 percent of the population (ADB engagement priority).
  - 2014 World Bank Enterprise Survey: 81 percent of businesses reported investment decisions adversely affected by poor security; 67 percent identified crime as a problem (regional average 16 percent).
  - Collateral constraints for SMEs: high collateralization requirements and customary land that cannot be used as collateral.

### Debt sustainability, DSA findings and recommendations
- DSA summary:
  - PNG’s risk of external debt distress remains low based on PPG external debt assessment.
  - Factoring in public domestic and private external debt and contingent liabilities, overall risk of debt distress remains heightened.
  - Public debt declined from 62 percent of GDP at end-2004 to about 22 percent in 2011, but rose to around 42½ percent in 2014.
  - Public external debt service ratios rise initially then fall; a short-lived breach in external debt service-to-revenue ratio due to inclusion of a loan moved to a public enterprise.
  - Public debt dynamics stable under baseline but failure to consolidate would worsen debt dynamics.
- Key numbers and assumptions:
  - Domestic debt composition: treasury bills (45 percent) and inscribed stocks (55 percent) with an average maturity of 5 years.
  - Government planning to issue a sovereign bond of around US$1 billion in 2015.
  - Unfunded superannuation arrears about 6½ percent of GDP at end-2014.
  - Public enterprise liabilities estimated about 7½ percent of GDP.
- Policy recommendations:
  - Bring public debt on a downward trajectory over the medium term.
  - Improve spending quality; publish terms and conditions of all loans, including the UBS loan.
  - Use the planned debut sovereign bond issuance to improve the debt profile and cover existing commitments rather than finance new projects.
  - Consider IMF TA on the Medium-Term Debt Management Strategy (MTDS).

### Statistics, technical assistance, and capacity building
- NSO reform and statistics:
  - NSO reform underway with ABS support; plan to publish GDP estimates for 2007-13 (expected November 2015 at time of reporting).
  - Quarterly CPI series published beginning May 2014 (based on 2009-10 HIES); most recent CPI on NSO website is for Quarter 4, 2014.
- Data weaknesses:
  - Annual GFS not reported to STA since 2002; deficiencies in central government tax revenue, nontax revenue, and public expenditure data.
  - Latest BOP data reported to STA are for 2012; financial accounts data are of poor quality.
- TA and collaboration:
  - PFTAC and IMF technical assistance active across PFM, tax, monetary and financial statistics, BOP, and national accounts.
  - ABS secondment to NSO from July 2015 to June 2016 to provide leadership and TA.

### Boxed project and scenario highlights (selected)
- PNG LNG Project:
  - Production expected to reach full capacity of 6.9 million tons per year in 2015.
  - Project started in 2010, led by ExxonMobile, with a total cost of US$19 billion.
  - First LNG shipment in May 2014; expected operational life 30 years.
  - Significant tax revenues from the LNG project are not expected before 2021-22 owing to accelerated depreciation allowances.
- Papua LNG (Elk-Antelope) Project:
  - Industry analysis suggests production estimated at 8 million tons per year.
  - Joint venture composition: Total SA (40.1 percent), InterOil (36.5 percent), Oil Search (about 23 percent).
  - Early works beginning Q3 2016; final investment decision and construction starting in 2017.
  - Total cost estimated around US$15 billion.
- Alternative commodity price scenario (Box 2):
  - Assumption: All mineral prices fall further by 20 percent over 2015-20, with no change in volume; for 2015 the price decline assumed to take effect during the second half of the year.
  - Current account would decline by around 7 percent of GDP relative to the baseline and be expected to remain in deficit over 2016-20.
  - Fiscal position impact: Revenue and the overall balance would decline by about 0.5 percent of GDP on average relative to the baseline.
- External sector assessment (Box 3):
  - Kina depreciated by 16 percent against the U.S. dollar from June 2014 to early October 2015, but excess demand for foreign exchange persists.
  - CGER results: PPP suggests a 25 percent overvaluation; other approaches indicate 4-19 percent undervaluation.
  - Reserve assessments: reserve metric approach suggests current holdings below adequacy (close to 5 months of imports); optimal reserve approach indicates holdings well above the optimal level (about 2.5 months for fixed regime). Estimated long-term opportunity cost of holding reserves: 8.7 percent.

### Budget Strategy Paper (Government, October 19, 2015) — key projections and measures
- Projected fiscal deficit in 2015: 4.5 percent of GDP (3.1 percentage points lower than staff’s projection and close to 2015 budget of 4.4 percent).
- Revenues in 2015: projected K 1.1 billion higher than budgeted.
- Expenditures in 2015: projected K 1.4 billion lower than budgeted.
- Debt-to-GDP ratio in 2015: projected at 34.4 percent.
- 2016 projections (Budget Strategy Paper): total revenue in 2016 projected approximately K 10.4 billion (K 9.9 billion tax revenue; K 0.6 billion non-tax); total expenditure in 2016 projected at K 13.4 billion.
- Medium-term fiscal strategy:
  - Government envisages gradual reduction of deficit for 2016–19 leading to a balanced budget in 2020.
  - Aim to stabilize public debt at 35 percent of GDP and bring debt-to-GDP back to 30 percent by 2020.
  - Considering anchoring fiscal policy via the non-resource primary balance.
- Authorities identified expenditure savings of K 1.4 billion in 2015 and announced revenue measures to raise an additional K 1.1 billion.

### Conclusion and policy priorities (staff appraisal)
- Prudent macroeconomic policies are essential to maintain debt sustainability and safeguard the external position.
- Decisive fiscal consolidation needed to keep government debt-to-GDP on a downward trajectory while protecting high-priority spending.
- Greater exchange rate flexibility and mop-up of excess liquidity recommended to restore FX market clearing and improve monetary policy transmission.
- Structural reforms to improve infrastructure, law and order, health and education, financial inclusion, SME finance, and SOE governance crucial for boosting medium-term inclusive growth.
- Continued TA and capacity building for statistics, PFM, and debt management recommended; next Article IV consultation proposed on the standard 12-month cycle.

*Source: PAPUA NEW GUINEA STAFF REPORT FOR THE 2015 ARTICLE IV CONSULTATION (October 8, 2015).*

### 2013. In early June 2014, the Bank of Papua New Guinea (BPNG) introduced measures to

### PAPUA NEW GUINEA STAFF REPORT FOR THE 2015 ARTICLE IV CONSULTATION

### Key issues and context
- Context: PNG has abundant resources including agriculture, cultural diversity, fisheries, forestry, minerals, and petroleum/LNG; growth has been volatile and LNG production boosted overall GDP growth in 2014-15.
- Main challenge: Severe revenue shortfalls from lower global commodity prices and temporary suspension of a large mining operation require a comprehensive policy response.
- Policy agenda priorities:
  - Measured but ambitious medium-term fiscal consolidation to keep debt-to-GDP on a downward trajectory while safeguarding social outlays.
  - Measures to reduce excess liquidity to increase monetary policy effectiveness and dampen downward pressures on the kina.
  - Greater exchange rate flexibility to restore market-clearing FX conditions.
  - Structural reforms to boost inclusive non-resource growth: investment in health and education, improvement in infrastructure and law and order, increased agricultural productivity, financial development and inclusion, and strengthening of public financial management (PFM).

### Recent developments (selected)
- Exchange rate and monetary actions:
  - In early June 2014, the Bank of Papua New Guinea (BPNG) introduced measures to require authorized dealers to transact with their customers within a trading band of 150 basis points around the official (interbank) exchange rate; this move caused a large de facto currency appreciation. Since then, the kina has depreciated vis-à-vis the U.S. dollar.
- Growth and inflation:
  - Real GDP growth (selected): 2011: 10.7; 2012: 8.1; 2013: 5.5; 2014: 8.5; 2015 (Est.): 9.0; 2016 (Proj.): 3.1.
  - Nonresource growth (selected): 2011: 12.8; 2012: 9.2; 2013: 5.4; 2014: 0.7; 2015 (Est.): 1.5; 2016 (Proj.): 3.8.
  - CPI (annual average): 2011: 4.4; 2012: 4.5; 2013: 5.0; 2014: 5.3; 2015 (Proj.): 6.0; 2016 (Proj.): 6.0.
- External sector and reserves:
  - Gross international reserves projected around $2 billion in 2015 (equivalent to 3 months of total goods and nonfactor services imports); reserves remain below staff’s assessment of adequacy.
  - Current account (including grants) in percent of GDP: 2011: -23.6; 2012: -53.6; 2013: -31.8; 2014: -4.2; 2015 (Proj.): 4.6; 2016 (Proj.): 3.8.
- Fiscal developments:
  - Mid-Year Economic and Fiscal Outlook (MYEFO) projected a K 2.5 billion revenue shortfall in 2015 (equivalent to 5.5 percent of GDP) compared to the K 1.3 billion shortfall expected in the budget.
  - Central government operations (percent of GDP): Revenue and grants: 2011: 30.4; 2012: 29.2; 2013: 28.2; 2014: 27.3; 2015 (Proj.): 24.7; 2016 (Proj.): 25.7. Expenditure and net lending: 2011: 28.7; 2012: 32.4; 2013: 36.1; 2014: 34.5; 2015 (Proj.): 32.3; 2016 (Proj.): 31.2.
  - Net lending(+)/borrowing(-) [Overall balance] (Revenue - expenditure): 2011: 1.7; 2012: -3.2; 2013: -8.0; 2014: -7.2; 2015 (Proj.): -7.6; 2016 (Proj.): -5.5.
  - Government gross debt (percent of GDP): 2011: 23.0; 2012: 26.7; 2013: 34.0; 2014: 35.6; 2015 (Proj.): 39.4; 2016 (Proj.): 41.1.
- Financial sector and inclusion:
  - No generalized credit boom; overall credit growth moderate and broadly in line with nominal GDP since 2010.
  - PNG’s ratio of domestic private credit to GDP is well below the average for comparators; low levels of financial development and access persist despite progress with mobile banking.
- Selected country indicators (2014 unless noted):
  - Nominal GDP (2014): US$16.8 billion.
  - Population (2014): 7.5 million.
  - GDP per capita (2014): US$2,232.
  - Quota: SDR 131.6 million.
  - US$/kina (end-period): 2011: 0.4665; 2012: 0.4755; 2013: 0.4130; 2014: 0.3938.

### Outlook
- Short- and medium-term projections:
  - Real GDP growth expected to expand strongly by about 9 percent in 2015 reflecting LNG production; non-resource GDP projected to grow by 1½ percent in 2015 and by about 3½ percent in 2016.
  - Medium-term growth expected to converge to about 3 percent, supported by agriculture and APEC 2018 preparations; 2018 growth projected to slow to 1½ percent and stabilize at 3 percent over the longer term.
  - Inflation expected to stabilize around 5 percent over the medium term.
  - Current account expected to turn into a surplus in 2015 as the LNG plant has its first full year of operation.
- Reserves and external financing:
  - Gross international reserves projected to remain at around $2 billion in 2015 and strengthen modestly over the medium term.

### Risks
- Downside risks increasingly prominent:
  - Fiscal consolidation necessitated by weaker-than-anticipated revenue performance will dampen non-resource growth in the short run.
  - A weak global economy could further dampen external demand and commodity prices.
  - Over the longer term, LNG developments in Australia and shale gas developments globally could continue to put downward pressure on LNG prices and government revenue.
  - Global financial market instability could affect prospects for external commercial financing or foreign direct investment.
- Upside risks:
  - Potential for a second LNG project, further mineral resource development, and increased trade with Asia.
- Policy caution:
  - Mission emphasized that prospects of new mineral and LNG projects should not divert attention from the need to tighten fiscal and monetary policy now and allow for greater exchange rate flexibility.

### Executive Board assessment and recommendations
- Directors’ appraisal:
  - Commended authorities for achieving impressive economic growth in recent years but noted adverse effects from sharp drop in commodity prices and slowing non-resource sectors.
  - Stressed need for prudent macroeconomic policies to ensure debt sustainability and safeguard the external position.
- Fiscal policy recommendations:
  - Strong fiscal consolidation needed to keep government debt-to-GDP ratio on a downward trajectory over the medium term while safeguarding key social outlays.
  - Strengthen expenditure prioritization and public financial management; develop a medium-term debt management strategy.
  - Welcome to government’s efforts to set up a Sovereign Wealth Fund; make fund operational soon and channel resource revenues from the fund through the budget to ensure transparency and accountability.
- Monetary and exchange rate recommendations:
  - Greater exchange rate flexibility called for; scope for further depreciation to safeguard external buffers and eliminate FX market imbalances.
  - Allow the exchange rate to move more quickly to a market-clearing rate and mop up excess liquidity to strengthen monetary policy effectiveness.
- Structural reforms:
  - Decisive implementation urged to boost medium-term growth prospects: improving infrastructure and law and order; investing in health and education; strengthening agriculture and small- and medium-size enterprise sectors and access to finance; increasing competition in the banking sector; reducing business costs; accelerating reform of state-owned enterprises.
  - Encouraged timely implementation of AML/CFT legislation and further efforts to improve statistics and institutional capacity.

*Source: PAPUA NEW GUINEA STAFF REPORT FOR THE 2015 ARTICLE IV CONSULTATION (October 8, 2015).*

### 11.      Authorities’ views. The authorities broadly concurred with the outlook. They noted that the

### _cr15318 - 11.      Authorities’ views. The authorities broadly concurred with the outlook. They noted that the

### Authorities’ overall view
- The authorities broadly concurred with the outlook.
- They noted that the longer-lasting drought caused by El Niño could prolong a temporary mine closure and worsen a poor harvest of crops.
- They placed somewhat greater emphasis than staff on an upside to growth from a number of prospective extractive sector projects, including a second LNG project and several major gold-copper projects, over the longer term.
- The authorities concurred with the need for ambitious fiscal consolidation while avoiding cuts in key priority areas such as infrastructure, health and education, and law and order.
- For 2015, they will consider postponement of some lower-priority projects.
- The authorities reiterated commitment to adhering to the Santiago Principles in the operation of the SWF, while noting that little resource revenue would be saved in the near term owing to PNG’s huge development needs.
- The authorities will consider IMF technical assistance to support development of a MTDS.

### Policy discussions — near-term macro stability and medium-term growth
- The staff’s view: maintain macroeconomic stability in the near term and raise growth in the medium term via:
  - a measured but ambitious medium-term fiscal consolidation path;
  - measures to reduce excess liquidity and tighten monetary policy; and
  - greater exchange rate flexibility.
- In the medium term, structural reforms are necessary to improve financial deepening and resilience and boost inclusive growth.

### Fiscal policy — findings and staff recommendations
- Baseline and staff alternative:
  - Authorities’ plan to cut expenditures by K 1.3 billion in 2015 would still yield an increase in the debt-to-GDP ratio (from 36 to 45 percent) over the medium term.
  - Staff encouraged limiting debt to 35 percent of GDP by 2020 via the staff’s alternative adjustment scenario.
  - Achieving the staff target would require:
    - a more ambitious set of measures totaling K 2.0 billion in 2015; and
    - lower deficits relative to the baseline by 1 percent of GDP in 2016, and by about 2 percent of GDP from 2017 through 2019.
- Rationale and instruments:
  - Under-execution of expenditure suggests room for cuts and reprioritization.
  - Given volatility of resource GDP and revenue, staff encouraged considering the NRPB as an underlying fiscal target to insulate fiscal policy from resource revenue volatility.
- Revenue measures:
  - Staff encouraged measures to strengthen revenue collection, including suspending the Infrastructure Tax Credit until the IRC makes recommendations based on an audit of the scheme, and other measures recommended by the Tax Review Committee.
  - Tax Review Committee recommendations under review:
    - increase of the goods and services tax rate from 10 percent to 15 percent;
    - raising the income tax threshold from K 10,000 to K 15,000;
    - reducing the corporate income tax rate from 30 percent to 25 percent.
  - Revenue measures would likely yield significant additional revenue only starting in 2016.
- Expenditure cuts:
  - Staff’s adjustment scenario requires a net expenditure reduction of about K 2.0 billion in 2015 (about 30 percent from goods and services and 70 percent from low-impact capital expenditures), and continued spending restraint in subsequent years while protecting high priority social spending (health, education, law and justice, agriculture).
- Budgetary financing and debt management:
  - Identifying sufficient financing in 2015 is expected to be challenging; planned asset sales are likely to be delayed.
  - Banks and superannuation funds have mostly reached internal limits on sovereign exposure, limiting appetite for additional government securities and leading to a sharp rise in T-bill yields.
  - Announcement of a suitably ambitious fiscal adjustment plan at an early date would bolster market confidence ahead of a planned debut US$1 billion sovereign Eurobond placement.
  - Important to put in place a Medium-Term Debt Management Strategy (MTDS) to increase financing efficiency and minimize costs and risks associated with new external funding.
  - Central bank should refrain from providing direct financing to the government.
  - An updated DSA indicates PNG’s risk of external debt distress remains low.
  - Overall public debt amounts to about 56 percent of GDP once arrears to a superannuation fund and other liabilities are taken into account.
    - Arrears and liabilities included: arrears to a superannuation fund (6.5 percent of GDP), SOE debt (7.5 percent of GDP), and the UBS loan (6.8 percent of GDP).
- Public financial management and SOE reform:
  - Strengthen PFM: implement PEFA recommendations, improve cash management and the IFMS rollout.
  - SOE reform needed to minimize fiscal risk and enhance transparency and governance.
  - Return on equity (ROE) averaged 10.5 percent between 2003 and 2007, but fell to 3.4 percent in 2007–12.
- Sovereign Wealth Fund and related institutions:
  - Final stage of SWF legislation approved by Cabinet.
  - Ensure all resource revenues flow through the budget and that Kumul Trust governance enhances transparency and efficiency of public investment.
  - Continued commitment to implementing EITI is important.

### Monetary policy and exchange rate — findings and staff recommendations
- Exchange rate regime and FX market:
  - FX trading band introduced in June 2014; restricted USD/kina movement resulted in a change in de facto exchange rate regime classification from floating to a crawl-like arrangement, effective April 2014.
  - The kina has depreciated more slowly than currencies of other commodity exporters; staff stressed allowing the kina to depreciate more quickly to clear the FX market and restore external competitiveness of non-resource exports.
  - Staff supported maintaining the FX trading band in the near term to avoid a sharp widening of bid/ask spreads, but recommended developing a plan to improve FX market efficiency and transparency over time, drawing upon follow-up IMF TA.
  - PNG maintains an exchange restriction subject to IMF approval under Article VIII, Section 2(a) arising from requirement to obtain a tax clearance certificate prior to making payments or transfers for certain current international transactions.
- Monetary stance and liquidity management:
  - Mission advised mopping up excess liquidity to increase effectiveness of monetary policy transmission, tighten the monetary stance, and dampen downward pressures on the kina.
  - Near-term BPNG measures advised:
    - increase the cash reserve requirement (CRR);
    - encourage transfer of government balances from commercial bank accounts to BPNG;
    - step up use of open market operations;
    - establish an interbank interest rate corridor as recommended by recent IMF TA.
  - Staff advised BPNG to refrain from providing direct financing to the government to safeguard independence and operational effectiveness.
  - Staff does not anticipate significant real sector effects from monetary tightening given massive expansion in LNG production this year.
  - Staff agreed that BPNG should maintain an adequate level of international reserves.
- Authorities’ views on monetary and FX policy:
  - Authorities emphasized USD/kina rate was market determined and that the market, not BPNG, was keeping the rate at its current level.
  - They stressed the need to avoid undue exchange rate volatility and high bid/ask spreads and noted that a faster pace of depreciation may be inflationary given PNG’s heavy reliance on imports.
  - Authorities acknowledged that excess liquidity inhibits monetary transmission but noted inflationary pressures had remained contained to date.
  - BPNG reiterated its request for follow-up IMF TA regarding participation in the FX market and stands ready to absorb excess liquidity and tighten monetary policy should inflationary pressures intensify.
  - BPNG reiterated intention to avoid any direct financing of the government budget deficit and saw no need to reform the Central Banking Act or to strengthen its balance sheet, citing negative capital largely attributable to valuation losses on international reserves from the rapid appreciation of the kina in 2011-12; balance sheet has improved following the depreciation of the kina and partial recapitalization using non-tradable securities.

### Financial sector — findings, risks, and policy recommendations
- System soundness and vulnerabilities:
  - PNG’s financial system appears robust with strong indicators of bank capital adequacy, asset quality, liquidity, and profitability.
  - BPNG should remain vigilant to sector-specific risks, particularly the potential impact of lower government spending and temporary suspension of a large mining operation on assets exposed to affected sectors (real estate, transport, logistics).
- Macroprudential policy and AML/CFT:
  - Macroprudential policies should limit buildup of systemic vulnerabilities.
  - BPNG should continue to enhance a macroprudential policy division and set up a comprehensive database including sectoral loan data and household and corporate debt measures.
  - Authorities are encouraged to continue strengthening the AML/CFT regime; key legislation has been passed which could facilitate removal from the FATF gray list.
  - Continue effective implementation of AML/CFT tools to address risks of politically exposed persons and ensure robust domestic and international cooperation.
- Structural barriers and financial development:
  - Structural barriers impede financial access and development: lack of competition, underdeveloped capital markets, and a shallow/inefficient FX market.
  - Lack of competition:
    - Three large banks (two Australian banks and one domestic bank) dominate credit provision.
    - Wide interest rate spreads reflect oligopolistic banking structure and costs/risks of doing business.
    - Priority: reduce entry barriers (including for microfinance), encourage adoption of new technologies such as mobile banking and microfinance products.
  - Underdeveloped capital markets:
    - Banks’ assets concentrated in government securities; excess liquidity suggests government borrowing has not crowded out private sector borrowing.
    - Banks and superannuation funds are reaching internal limits for government exposure, prompting need to diversify financing sources including via a prospective US$1 billion Eurobond.
    - Authorities should promote domestic capital market development and a secondary market for government securities.
  - Shallow FX market:
    - Interbank FX market is one-sided given the overvalued exchange rate and structural shortage of FX.
    - Mineral tax receipts account for about two-thirds of FX inflows; FX transactions are highly regulated by BPNG.
    - Authorities should focus on measures to eliminate FX market distortions.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 28.      Authorities’ views. The authorities broadly concurred with the need to promote financial

### _cr15318 - 28.      Authorities’ views. The authorities broadly concurred with the need to promote financial

### Authorities’ views on financial development and inclusion
- Authorities broadly concurred with the need to promote financial development, improve the capital market, and reform the FX regime over the medium term.
- BPNG actions and initiatives:
  - Legislation in place for micro-insurance products and mobile banking services.
  - Steps to enhance financial literacy through education and safeguard consumer protection.
  - Authorization of five microfinance institutions.
- Financial inclusion progress:
  - Authorities report being roughly halfway towards the goal of reaching 1 million previously un-banked citizens, 32 percent of which are women.
  - BPNG will consider a follow-up strategy for the coming year, leveraging recent work and support from the World Bank, ADB, and Pacific Financial Inclusion Programme (PFIP).
- Staff recommendation related to FX regime and monetary policy:
  - BPNG should allow the exchange rate to be more market-determined and move quickly to a market-clearing rate, supported by suitably-tight fiscal and monetary policies.
  - To facilitate adjustment and improve monetary policy effectiveness, BPNG should mop up excess liquidity in the banking system.
  - Staff does not recommend Fund approval of the tax clearance certificate regime as it is not temporary and has not been imposed for balance of payments reasons.

### Boosting inclusive growth — findings and priorities
- Structural reform agenda emphasis:
  - Agriculture and enabling environment for business are appropriately emphasized.
  - Continue work with ADB and World Bank to enhance productivity (e.g., Productive Partnerships in Agriculture Project for smallholder coffee and cocoa producers), fill infrastructure gaps, and facilitate access to finance.
  - Concentrate on reforms to lower the cost of doing business and increase competition.
  - Continued investment in health and education, improvements in infrastructure and law and order are important.
- Infrastructure constraints:
  - Major obstacles in agriculture: lack of access to market for perishable products.
  - Lack of access to affordable electricity is a critical constraint; the electrification rate in PNG is among the lowest in the world.
- Health and education:
  - Social indicators show challenges of basic needs despite recent efforts to improve access, including vocational training.
  - Provision of services and facilities such as health clinics should be expanded and improved, especially in rural areas.
- Law and order:
  - Chronic law and order problems hinder ease of doing business, business startups, and tourism potential.
  - 2014 World Bank Enterprise Survey: 81 percent of businesses reported that decisions for further investment or expansion were adversely affected by the poor security situation.
  - 67 percent of firms identified crime as a problem; this compares with the East Asia and the Pacific regional average of 16 percent.
- Access to finance:
  - PNG remains among the most under-banked economies in the region despite efforts to promote financial sector development and financial inclusion.
  - Main obstacles to bank credit, including for SMEs: high level of collateralization required and large share of customary land that cannot be used as collateral.
  - Addressing these constraints is important to allow better financial access for SMEs and support growth.

### Other issues — macroeconomic statistics
- Authorities are firmly committed to improving macroeconomic statistics.
- Recognized need for more decisive reform to address institutional weaknesses in the National Statistics Office (NSO) and enhance coordination with other stakeholders.
- Authorities are moving forward with publication of new GDP estimates for 2007-13, planned for late this year.

### Staff appraisal — macroeconomic outlook and policy recommendations
- Growth and commodity shock:
  - Growth expected to increase to 9 percent this year reflecting the full year effect of LNG production which started last year.
  - Fiscal and external performance adversely affected by the sharp drop in LNG and other major export commodity prices.
  - Prudent macroeconomic policies are essential to maintain debt sustainability and safeguard the external position.
- Fiscal policy:
  - Decisive fiscal consolidation needed to keep government debt to GDP ratio on a downward trajectory over the medium term.
  - Authorities strongly encouraged to adopt a more ambitious package of fiscal measures to narrow the fiscal deficit this year and over the medium term.
  - Encouraged to adopt medium-term fiscal anchors appropriate to the context of a commodity producer.
- Public financial management (PFM) and spending priorities:
  - Better expenditure prioritization and improvement in PFM crucial for improving development outcomes.
  - High priority should be given to implementing high-impact projects and improving delivery of frontline health and education services.
  - Recent progress welcomed (publication of PEFA document and finalized roadmap); authorities encouraged to implement PEFA recommendations, including strengthening cash and treasury management practices.
- Sovereign Wealth Fund (SWF):
  - The SWF should be put into operation as soon as practicable.
  - Important to ensure all public resource revenues are channeled through the budget to improve transparency and better target national priorities; consistent with SWF’s role in macroeconomic stabilization and wealth sharing.
- External buffers and exchange rate:
  - A further depreciation is needed to safeguard external buffers and eliminate imbalances in the FX market.
  - BPNG should allow exchange rate to be more market-determined and move quickly to a market-clearing rate, supported by suitably-tight fiscal and monetary policies.
- Structural reforms:
  - Moving decisively to implement structural reforms will help boost medium-term growth prospects: improve infrastructure and law and order, invest in health and education, attract more FDI, accelerate SOE reforms, and reduce business costs.
  - Revival of agriculture and strengthening of the SME sector supported by innovations in financial inclusion are vital for improving livelihoods.
- Macroeconomic statistics:
  - More decisive action needed to improve macroeconomic statistics.
  - Authorities’ commitment to reforming the National Statistical Office noted; IMF TA continuing to assist reform efforts and improve capacity.
  - Staff looks forward to publication of new GDP estimates later this year.
- Consultation cycle:
  - It is proposed that the next Article IV consultation with PNG will be held on the standard 12-month cycle.

### Boxed updates and scenario highlights
- PNG LNG Project (Box 1):
  - Production expected to reach full capacity of 6.9 million tons per year in 2015.
  - Project started in 2010, led by ExxonMobile, with a total cost of US$19 billion.
  - First LNG shipment in May 2014; expected operational life of the project is 30 years.
  - Construction costs financed by 30 percent equity and 70 percent debt.
  - Significant tax revenues from the LNG project are not expected before 2021-22, largely due to accelerated depreciation allowances.
- Papua LNG (Elk-Antelope) Project (Box 1):
  - Industry analysis suggests production estimated at 8 million tons per year.
  - Joint venture composition: Total SA (40.1 percent), InterOil (36.5 percent), Oil Search (about 23 percent).
  - Early works would begin in the third quarter of 2016, final investment decision and construction starting in 2017.
  - Total cost estimated at around US$15 billion.
- Other Major Mining Projects (Box 1):
  - Projects scheduled over the medium term include Wafi-Golpu (gold and copper), Frieda River, Solwara 1, Yandera, Mt. Kare, Imwauna, and new deposits near OK Tedi.
- Alternative commodity price scenario (Box 2):
  - Scenario assumption: All mineral prices (LNG, crude oil, gold and other metals) fall further by 20 percent over 2015-20, with no change in volume; for 2015 the price decline assumed to take effect during the second half of the year.
  - External balance impact: Current account would decline by around 7 percent of GDP relative to the baseline, and be expected to remain in deficit over 2016-20.
  - Impact on overall balance of payments would be almost entirely offset by the financial account since most commodity export receipts are kept offshore; international reserves would remain broadly unchanged compared to the baseline.
  - Fiscal position impact: Revenue and the overall balance would decline by about 0.5 percent of GDP on average, relative to the baseline, owing to lower mineral tax revenues and LNG dividends.
  - Compared to the impact of the previous commodity price adjustment, the impact would be much smaller because resource revenue had already fallen from K 2.4 billion (in the 2015 budget) to K 0.6 billion (under the baseline) for 2015.
- External sector assessment (Box 3):
  - Staff’s overall assessment: medium-term external position is broadly in line with fundamentals and desirable policies; CGER-like estimates produced mixed results.
  - Kina movements:
    - Kina has depreciated by 16 percent against the U.S. dollar from June 2014 to early October 2015, but excess demand for foreign exchange persists.
  - CGER results summary:
    - PPP approach suggests a 25 percent overvaluation.
    - Other three approaches indicate a range of 4-19 percent of undervaluation.
  - Reserve assessments:
    - Reserve metric approach suggests current reserve holdings are below the level deemed adequate (estimated to be close to 5 months of imports).
    - Optimal reserve approach indicates current holdings are well above the optimal level (about 2.5 months of imports for the fixed regime).
    - The estimated long-term opportunity cost of holding reserves is 8.7 percent; given potential data quality issues, more weight should be placed on the reserve metric approach.

*Source: IMF staff report content in the supplied document.*

### Introduction

### Introduction

### Macroeconomic and external context
- Nominal GDP (2014): US$16.8 billion 1/
- Population (2014): 7.5 million
- GDP per capita (2014): US$2,232
- Quota: SDR 131.6 million
- Current account balance (2015, Est., in millions of U.S. dollars): 794
- Trade balance (2015, in millions of U.S. dollars): 4,666
- Exports, f.o.b. (2015, in millions of U.S. dollars): 9,177
  - Of which: Resource (2015): 6,926
- Imports, c.i.f. (2015, in millions of U.S. dollars): -4,512
- Gross official reserves (end‑year, 2015, in millions of U.S. dollars): 2,105
  - Reserves (in months of goods and services imports, c.i.f., 2015): 3.1

### Fiscal sector — findings and projections
- The overall deficit is expected to remain substantial in 2015.
- Mineral revenues are expected to fall by half in 2015, largely due to lower commodity prices.
- Government debt remains low relative to the average of APD low‑income countries.
- Selected fiscal indicators (central government operations):
  - Total revenue and grants (2015, in percent of GDP): 24.7
  - Total expenditure (2015, in percent of GDP): 32.3
  - Net lending(+)/borrowing(-) [Overall balance] (2015, in percent of GDP): -7.6
  - Nonresource overall balance (2015, in percent of GDP): -9.2
  - Gross public debt (2015, in percent of GDP): 39.4
  - Domestic gross government debt (2015, in percent of GDP): 28.0
  - External gross government debt (2015, in percent of GDP): 11.0
- Central government cash flows (Table 2, selected, in millions of kina):
  - Revenue and grants (2015, Est.): 11,174
  - Expenditure (2015, Est.): 14,613
  - Net acquisition of nonfinancial assets (2015, Est.): 4,622
  - Net lending(+)/borrowing(-) [Overall balance] (2015, Est.): -3,440
- Nonresource nominal GDP (2015, in millions of kina): 34,929

### Monetary sector — findings and indicators
- The policy stance has remained unchanged while excess liquidity has increased, given insufficient sterilization of FX inflows.
- Banks have solid capital buffers and NPLs are low.
- Private sector credit growth has slowed to single digits from earlier peaks.
- Monetary aggregates and central bank balances (selected, end‑period, in millions of kina):
  - Reserve money (2015, proj.): 5,424
  - Broad money (2015, proj.): 20,574
  - Net foreign assets, Bank of Papua New Guinea (2015, proj.): 4,910
  - Net domestic assets, Depository corporations (2015, proj., annual % change): 19.4
  - Broad money (2015, annual percentage change): 9.9
- Interest and financing costs:
  - Financing cost indicators shown include T‑Bill (1 year) and CBB (91 days) series (charts).

### Financial sector structure and soundness
- Bank vulnerability and soundness indicators:
  - Nonperforming loans to total loans (2014): 1.4
  - Capital to risk‑weighted assets (2014): 34.5
  - Return on assets (2014): 2.0
  - Loan‑to‑deposit ratio (2014): 57.2
- Financial access and inclusion:
  - PNG is among the most under‑banked in terms of commercial bank branches per 100,000 adults (2013) and ATMs per 100,000 adults (2013), relative to regional peers.
  - Mobile bank accounts (2012, per 10,000 adults): PNG: 94
  - Commercial bank loans (2013, in percent of GDP): PNG is low relative to other Pacific Island countries.
  - Loan accounts with commercial banks (2013, per 1,000 adults): PNG data shown as low relative to peers.
  - Use of credit (2013): urban/rural and male/female breakdowns show reliance on informal loans especially in rural areas.

### Growth, commodity prices, and medium‑term outlook
- Real GDP growth (2015, proj.): 3.1
  - Resource sector growth (2015, proj.): 60.2
  - Nonresource growth (2015, proj.): 0.7
- CPI (period average, 2015, proj.): 6.0
- Medium‑term scenario (selected):
  - Real GDP (2020, proj.): 3.2 (percent change)
  - Current account (in percent of GDP, 2015): 4.6
  - Gross official reserves (2020, in millions of U.S. dollars): 2,704
- Assumed commodity prices (July 2015 IMF WEO projections):
  - Gold (U.S. dollars per ounce, 2015): 1,277
  - Copper (U.S. dollars per ton, 2015): 5,644
  - Oil (U.S. dollars per barrel, 2015): 59

*Source: _cr15318 - Introduction*

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

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

### External Risks
- Persistently low energy prices triggered by supply factors reversing only gradually, and weaker demand  
  - Relative Likelihood: M H  
  - Impact if Realized: Lower LNG prices would reduce fiscal revenue, export proceeds, and foreign reserves. Development of future LNG projects may be jeopardized.  
  - Staff Advice on Policy Response: 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.
- Structurally weak growth in key advanced and emerging economies (the “new mediocre”)  
  - Relative Likelihood: M/H  
  - Impact if Realized: Potential for a further drop in commodity prices (see above). Lower export demand would worsen the trade balance, weaken fiscal revenue/reserves.  
  - Staff Advice on Policy Response: Allow the kina to depreciate to boost non-resource exports; accelerate structural reforms to improve competitiveness.
- Tighter or more volatile global financial conditions  
  - Relative Likelihood: H  
  - Impact if Realized: Volatility may affect the climate for raising external debt. However, the low external debt stock and financial integration would limit impacts on PNG.  
  - Staff Advice on Policy Response: Slow or cut expenditure growth to avoid external debt issuance. Accelerate structural reforms to take advantage of any competitiveness improvement.

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

- Note on the Risk Assessment Matrix (RAM): The RAM shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

### Appendix II. Papua New Guinea: Authorities’ Responses to Fund Advice

### Monetary, Financial and Exchange Rate Policies
- Remove excess liquidity to improve monetary policy effectiveness and reduce downside pressure on the kina exchange rate.  
  - Authorities’ action: The BPNG continues to actively consider options to withdraw liquidity. The CRR has remained at 10 percent, after having been increased in September 2014.
- Maintain a floating exchange rate regime to help absorb external shocks.  
  - Authorities’ action: The official interbank exchange rate was unchanged from October 2013 to early June 2014, when the BPNG introduced a foreign exchange (FX) trading band of 150 basis points around the official interbank rate, leading to a de facto kina appreciation of around 17 percent. Since then the exchange rate has depreciated by 16 percent, but excess demand for foreign currency has persisted.
- Implement FATF AML/CFT recommendations.  
  - Authorities’ action: Five AML/CFT bills have recently been enacted, and guidelines will be issued to complement the Anti-Money Laundering and Counter Terrorist Financing Bill 2015. A National Coordinating Committee has been established across 15 different institutions.

### Fiscal Policy
- Adopt a fiscal policy stance consistent with putting public debt in line with the government’s targets and ensuring debt sustainability.  
  - Authorities’ action: The authorities have announced an expenditure review, and plan to cut spending in 2015 with the possibility of a supplementary budget in October.
- Improving the quality of spending.  
  - Authorities’ action: A draft PEFA assessment was completed in April 2015, and identified several areas of weakness, including weak cash management. The authorities have recently published the PEFA assessment and finalized the PFM roadmap. Priorities include the completion of the IFMS rollout, to address shortcomings in collection and recording of accounting information.
- Improving revenue collection through improved tax compliance and rationalizing tax exemptions and concessions.  
  - Authorities’ action: The authorities are continuing efforts to improve revenue collection. The 2015 budget included a review of fees and charges, measures to improve GST and rental income tax compliance, tougher penalties for convicted tax offenders, and an increase in tobacco excise duties. Further measures are expected to result from the comprehensive tax review, which is nearing completion.
- Safeguard the integrity of the SWF for it to play a key role in managing PNG’s resource revenues.  
  - Authorities’ action: SWF legislation was passed in late July 2015. The SWF will comprise a Stabilization Fund and a Savings Fund, both expected to be operational in 2016. The law allows for taxes, dividends, and asset sale proceeds to be paid into the Stabilization Fund.

*Source: Appendix I. Papua New Guinea: Risk Assessment Matrix (from _cr15318).*

### Appendix II. Papua New Guinea: Authorities’ Responses to Fund

### Appendix II. Papua New Guinea: Authorities’ Responses to Fund Advice (concluded)

### Structural Reform: Fund Recommendations and Authorities’ Policy Actions
- Recommendation: Improve revenue transparency, including taking required steps to secure EITI membership.
  - Policy action: EITI candidacy was attained in March 2014.
  - Achievements: recruitment of a National Head of Secretariat; progress on the first EITI report which is due in December 2015.
  - PNG expects to undertake EITI validation by early 2017.
- Recommendation: Improve governance and accountability of public enterprises.
  - Policy action: The 2015 Budget announced work to develop and implement several SOE policies including: a dividend policy; an on-lending and guarantee policy; and a community service obligation policy.
  - Policy action: Legislation enacted in 2015 will see state-owned assets previously held in IPBC transfer to Kumul Consolidated Holdings.
- Recommendation: Ensure the Kumul trust and companies’ political independence and focus on stated corporate goals.
  - Policy action: Legislation has recently been passed for the establishment of three Kumul subsidiaries.

### Statistics: Fund Recommendations and Authorities’ Policy Actions
- Recommendation: Develop a strategic plan to resolve the long-standing shortcomings in the CPI and national accounts statistics.
  - Policy action: The authorities have initiated a three-stage plan to reform the NSO.
  - Policy action: The NSO has shown signs of improvement, as reflected in recent data releases.
- National accounts data context and TA:
  - Most recent official national accounts published by NSO: National Income, Expenditure and Product for reference years 1993–98 (compiled using the System of National Accounts 1968).
  - Subsequent preliminary NA estimates using the 1993 SNA for 1994–2004 rebased to 1998 prices were prepared but recommended against publication by the 2006 STA multisector mission.
  - Since reference year 2002, the Treasury Department began estimating the NA; the Bank of Papua New Guinea also compiles but does not publish its own GDP estimates.
  - Since August 2013, six TA missions by PFTAC reviewed national accounts methodologies and data sources and advised on improved use of administrative data including tax data.
  - A detailed work plan prepared with the ABS for the NSO: to produce GDP estimates in current prices for the period 2007-13. These estimates should be released in November 2015 and GDP estimates in constant prices should be released later.

### Fund Relations — Key Institutional and Financial Indicators (as of dates listed)
- Membership Status:
  - Joined: October 9, 1975; Article VIII
- General Resources Account (SDR Million; Percent Quota):
  - Quota 131.60 100.00
  - Fund holdings of currency 131.16 99.66
  - Reserve position in Funds 0.45 0.34
- SDR Department (SDR Million; Percent):
  - Net cumulative allocation 125.49 100.00
  - Holdings 9.19 7.32
- Outstanding Purchases and Loans:
  - SDR Million Percent Quota 0.00 0.00
- Latest Financial Arrangements (Stand-by; Approval Date — Expiration Date — Amount Approved (SDR million) — Amount Drawn (SDR million)):
  - Stand-by 3/29/2000 9/28/2001 85.54 85.54
  - Stand-by 7/14/1995 12/15/1997 71.48 35.34
  - Stand-by 7/31/1991 9/30/1992 26.36 0.00
- Projected Payments to Fund (SDR million; based on existing use of resources and present holding of SDRs):
  - Forthcoming 2015 2016 2017 2018 2019
  - Principal
  - Charges/interest 0.01 0.06 0.06 0.06 0.06
  - Total 0.01 0.06 0.06 0.06 0.06

### Safeguards, Exchange Rate, and Article IV
- Safeguards assessments:
  - BPNG was subject to a transitional assessment based on its Stand-By Arrangement approved March 2000 and expired September 2001; transitional assessment completed May 4, 2001; currently BPNG is not subject to the Safeguards Assessments policy.
- Exchange rate arrangement:
  - De jure arrangement: floating.
  - From April 2014 the Kina reduced volatility and followed a trend within a 2 percent band against the U.S. dollar.
  - De facto arrangement reclassified from floating to a crawl-like arrangement, effective April 11, 2014.
  - PNG maintains an exchange restriction subject to IMF approval under Article VIII, Section 2(a) arising from requirement to obtain a tax clearance certificate prior to making payments or transfers for certain current international transactions.
- Article IV consultations:
  - 2014 Article IV discussions: August 8–22, 2014.
  - Staff report discussed by Executive Board and consultation completed on November 10, 2014.
  - Papua New Guinea is on the standard 12–month consultation cycle.

### Technical Assistance from IMF Headquarters — Areas and Dates (selected)
- FAD:
  - Joint FAD/PFTAC mission March 2000: ROSC Fiscal Transparency Module (published October 2000).
  - Missions: December 2000; February 2002; May 2011 (sovereign wealth fund management); March 2013 (extractive industries fiscal regime).
- LEG:
  - Mission November 2005 (tax administration law drafting); July 2006 (AML/CFT development); August–September 2007 (Revenue Administration Bill finalization).
- MFD/MCM:
  - Peripatetic TA on bank regulation and supervision (2001, February–March 2007, July–August 2009, February 2010) and other topics including reserve management (June 2006, September 2007, March/July–August 2009, January–February 2010) and effectiveness of monetary policy (February–March 2015).
- STA:
  - Multisector statistics mission September 2006; high-level visit December 2007; TA on monetary and financial statistics (April 2005, May 2006, April 2008, November 2009, May 2010, February 2013); BOP and IIP (June 2008, November 2009, May–June 2013, February 2014, July 2015); government finance statistics (2012, May and October 2013, April–May and October 2014, April 2015, September 2015); GDDS metadata (January 2012).
- Resident Representative:
  - Regional Resident Representative Office for Pacific Island Countries opened September 13, 2010 (based in Suva, Fiji). Mr. Tubagus Feridhanusetyawan is the current resident representative.

### Relations with the Pacific Financial Technical Assistance Centre (PFTAC) — Activities and Support
- Role: PFTAC is a regional technical assistance institution operated by the IMF with financial support from ADB, Australia, Korea, the European Union, and New Zealand. Member countries include Papua New Guinea.
- Public Financial Management:
  - PFTAC assisted preparation of a ROSC published October 2000.
  - From early 2014 through early 2015 PFTAC trained PNG staff for a PEFA Self-Assessment; in March 2015 PFTAC and FAD conducted an external PEFA assessment corroborating most Self-Assessment findings.
  - PFTAC and FAD worked with Department of Finance to develop a PFM Reform Roadmap.
  - ICT assessment mission May–June 2014 and subsequent ICT specialist short-term missions starting May 2014 to mid-2015 to support IFMS expansion and ICT reform strategy.
  - 2015 support included short-term missions reviewing cash management, reconciliation, and reporting processes.
- Tax Administration and Policy:
  - PFTAC has not supported the IRC in revenue administration due to strong support from two Australian Programs: Strongim Gavman Program (SGP) and Economic Public Sector Program (EPSP).
  - New IT system rollout includes applications for withholding taxes, Goods and Services Tax and Corporate Income Tax; peripheral modules to follow over the next twelve months with project completion by 2017.
  - A tax review diagnostic by an accounting firm has issued a report and issues papers currently under discussion.
- Financial Sector Regulation and Supervision:
  - No current PFTAC involvement; historical attachments and support noted for supervisory training in 2007–2008; no subsequent request for assistance from BPNG.
- Economic and Financial Statistics:
  - PFTAC conducted a series of six TA missions since 2013 to assist NSO, BPNG, and Treasury in improving national accounts statistics.
  - PFTAC focused TA on improving capacities at the NSO in the context of the NSO reform process initiated by authorities in 2014.
  - ABS seconded two staff to PNG NSO from July 2015 until June 2016 to provide leadership, management advice, and TA on data collection.

### Joint Matrix of Bank-Fund Collaboration — Select Items
- IMF work program:
  - 2015 Staff Visit May–June 2015
  - 2015 Article IV mission August 2014; Board discussion expected in October 2015
- Bank and Fund information sharing: semi-annual or more frequent; ongoing.

### Relations with the Asian Development Bank (AsDB) — Engagement Priorities and Indicators
- PNG joined AsDB in 1971.
- 2011–2015 CPS guided AsDB engagement; active portfolio expanded from $350 million in 2010 to $1.1 billion in 2014.
- Indicative resources for 2016–2018 total $637.0 million.
- Indicative country allocations of ADF resources for PNG during 2016–2018 amount to $133.0 million.
- Indicative non-lending program for 2016–2018 totals $3.2 million, of which $1.5 million is for project preparatory TA.
- Sector focuses and selected facts:
  - Transport: support for land transport and civil aviation, possible maritime opportunities; emphasis on PPPs, knowledge management, TA for maintenance and financing.
  - Energy: support investments in renewable energy, transmission and distribution efficiencies; address lack of access to affordable and reliable power which currently reaches only 12 percent of the population.
  - Health: focus on maternal and child health, HIV/AIDS, and infectious diseases; program lending to support regulatory and management reform and health workforce recruitment.
  - Water and urban infrastructure: treated water supply coverage around 20 percent; 80 percent of urban households lack access to latrines; 94 percent of all cities and towns are unsewered; 80 percent of all sewage generated is discharged untreated.
  - Public sector management: emphasis on accountability, transparency, natural resource revenue management, and improved infrastructure budgeting and coordination.
- Public Sector Loan Approvals and Disbursements, 2004–2015 (In millions of U.S. dollars):
  - Loan approvals by year:
    - 2004 19.0
    - 2005 0.0
    - 2006 53.0
    - 2007 100.0
    - 2008 100.0
    - 2009 120.0
    - 2010 70.3
    - 2011 195.8
    - 2012 41.5
    - 2013 305.9
    - 2014 0.0
    - 2015 0.0
  - Loan disbursements by year:
    - 2004 19.2
    - 2005 21.5
    - 2006 29.3
    - 2007 27.4
    - 2008 19.8
    - 2009 17.4
    - 2010 27.9
    - 2011 26.2
    - 2012 74.46
    - 2013 177.0
    - 2014 133.73
    - 2015 111.25
  - Note: 2015 disbursements are projections as at August 31, 2015.

### Statistical Issues — Assessment Summary (as of September 24, 2015)
- Overall: Data provision has some shortcomings, but is broadly adequate for surveillance. Most affected areas: national accounts, fiscal accounts, and balance of payments.
- National Accounts:
  - Accuracy and reliability affected by inadequate source data.
  - NSO’s most recent published national accounts cover reference years 1993–98.
  - Detailed work plan with ABS prepared for NSO to produce GDP estimates in current prices for 2007-13 (release expected November 2015) and GDP estimates in constant prices to follow.

*Source: Appendix II. Papua New Guinea: Authorities’ Responses to Fund Advice (concluded) — _cr15318 - Appendix II. Papua New Guinea: Authorities’ Responses to Fund Advice*

### 2016. PFTAC conducted two sub-regional training courses during 2014 and 2015 to

### _cr15318 - 2016. PFTAC conducted two sub-regional training courses during 2014 and 2015 to

### Statistical capacity and price statistics
- PFTAC conducted two sub-regional training courses during 2014 and 2015 to support development work.
- Reforming the NSO is underway with support from the ABS.
- Price statistics compiled by the NSO:
  - Quarterly wholesale price index (WPI) compiled but not published.
  - Quarterly consumer price index (CPI) compiled.
  - In May 2014, the NSO began to publish a new CPI series based on the 2009-10 Household Income Expenditure Survey, ending 35 years of the CPI using a consumption basket from the late 1970s.
  - The most recent CPI published on the NSO website is for Quarter 4, 2014.

### Government finance statistics (GFS) and fiscal data weaknesses
- Annual GFS have not been reported to STA since 2002.
- Data received through 2002 suffered from insufficient coverage and timeliness.
- Deficiencies identified:
  - Central government tax revenue, nontax revenue, and public expenditure data are deficient.
  - Development budget expenditures and utilization of grants and project loans are recorded with long lags.
  - Few records on the use of trust accounts are available.
  - Tax revenues collected by authorities (extra-budgetary units) are generally not reflected in central government financial information; this includes the portion of value-added tax directly transferred to provinces by the revenue agency.
  - Interest payment records are accurate but there are timing issues regarding recording of interest on discounted securities.
  - These weaknesses contribute to discrepancies in domestic financing between monetary and debt estimates and fiscal records.
- Migration to GFSM 2014:
  - Papua New Guinea Government is preparing to migrate to Government Finance Statistics Manual 2014 (GFSM 2014) for budget estimate and outturn presentations.
  - Authorities are participating in the Japan Administered Account (JSA)-funded three-year regional GFS capacity-building project since 2013.
  - JSA funding for GFS TA to PNG has been extended through 2018.

### Monetary and financial statistics (MFS) and financial sector surveillance
- Monetary data are now produced and reported to STA on a regular basis.
- Bank of Papua New Guinea (BPNG) progress:
  - Introduction of the standardized report form (SRF) for the central bank, other depository corporations (ODCs), and other financial corporations (OFCs).
  - 2013 mission introduced general insurance companies into OFCs institutional coverage and an improved SRF for OFCs.
- Most monetary statistics published in International Financial Statistics (IFS) are currently aligned with the Monetary and Financial Statistics Manual (MFSM).
- Financial soundness indicators (FSIs):
  - BPNG has compiled selected FSIs for deposit takers to support the financial sector assessment.
  - PNG is participating in a three-year (FY2014–FY2016) TA project on FSIs funded by the Government of Japan and is expected to submit FSI data and metadata to STA for posting.

### External sector statistics (ESS) and reporting to STA
- Latest balance of payments data reported to STA are for 2012.
- Annual BOP data are derived from the International Transactions Reporting System (ITRS).
  - ITRS coverage is lower than that of customs declarations database.
  - Marked differences exist between official exports/imports of goods and trading partners' reports.
- Financial accounts data are of poor quality due to major deficiencies, especially in private external debt and foreign direct investment.
- Use of administrative data for the PNG Liquefied Natural Gas project’s transactions is highly required to improve ESS.
- Three TA missions under the JSA Project on ESS improvement since May 2013; overall improvements have been very modest.
- Reporting history to STA:
  - GFS for publication in Government Finance Statistics Yearbook and IFS last reported for 1999–2002, covering only budgetary central government.
  - Monetary data reported to STA for IFS on a regular monthly basis.
  - BOP data for 2010 reported to STA for Balance of Payments Yearbook and IFS.
  - National accounts data for 2004 reported to STA for IFS.

### Data standards and participation
- Papua New Guinea began participation in the General Data Dissemination System (GDDS) in 2012.
- No data ROSC assessment has been done for Papua New Guinea.

### Debt Sustainability Analysis (DSA) — summary findings and outlook
- This DSA indicates that Papua New Guinea’s (PNG) risk of debt distress remains low based on an assessment of public and publicly-guaranteed (PPG) external debt, consistent with the 2014 DSA.
- Factoring in public domestic and private external debt and contingent liabilities, the overall risk of debt distress remains heightened; failure to consolidate fiscal position would worsen debt dynamics.
- Background and recent debt dynamics:
  - Public debt declined from 62 percent of GDP at end-2004 to about 22 percent of GDP in 2011, but rose to around 42½ percent in 2014.
  - PPG external debt declined from over 50 percent of GDP in 2001 to around 16 percent in 2014.
  - Around 70 percent of current public external debt is owed to the Asian Development Bank and the World Bank.
  - Domestic debt composition: treasury bills (45 percent) and inscribed stocks (55 percent) with an average maturity of 5 years.
  - Main creditors are resident banks and superannuation funds.
  - Government planning to issue a sovereign bond of around US$1 billion in 2015.
- Underlying assumptions:
  - Medium-term growth and current account developments will be heavily influenced by extractive sector and LNG price outlook.
  - Economic activity projected to continue to grow in 2015 as LNG production reaches full capacity.
  - Current account deficit narrowed in 2014 due to winding down of LNG project construction; expected to turn into a surplus in 2015 with LNG exports coming on stream.
- External DSA baseline:
  - All PPG external debt ratios stay well below indicative thresholds.
  - Short-lived breach in the external debt service-to-revenue ratio due to inclusion of a loan moved to a public enterprise.
  - Present value of external debt stock expected to rise in near term because of an Australian $1.2 billion loan (6.8 percent of GDP) contracted in early 2014, but fall over the medium term as this loan is repaid and new external borrowing is expected to be moderate.
  - Public external debt service ratios rise initially then fall to very low levels reflecting small external debt stock and predominantly concessional terms.
  - Breach of external debt service-to-revenue ratio in 2016 is short-lived and mainly due to inclusion of the UBS loan moved to NPCP; without the UBS loan the indicator would remain below the threshold.
  - High levels of private external debt could create balance of payments pressures but mitigated by loans backed by LNG cash flows.
- External shock scenarios:
  - PNG vulnerable to extreme shocks despite low external debt burden; these shocks have low probability.
  - Protracted breach of PV of debt-to-GDP ratio under historical scenario and near breach under export shock scenario.
  - Near breach of external debt service-to-revenue ratio under export shock scenario when sovereign bond is rolled over.
  - Historical scenario effectively keeps imports at elevated LNG-project levels and rules out expected LNG export increases — considered very unlikely given LNG production commencement.
- Public DSA:
  - Public debt dynamics remain stable under baseline with public debt burden expected to decline continuously over projection period.
  - Risks to outlook:
    - Failure to consolidate fiscal position would significantly increase debt burden.
    - Unfunded superannuation arrears estimated about 6½ percent of GDP at end-2014.
    - Public enterprise liabilities estimated about 7½ of GDP, though data incomplete and not up to date.
  - Customized scenario (“All other liabilities”) shows noticeable increase in public debt burden when these liabilities are included; scenario assumes full amount of superannuation arrears added to debt stock and 100 percent of SOEs debt realized and added to debt stock, with SOEs debt stock assumed to grow in line with nominal GDP.

### Authorities’ views and recommended actions
- Authorities agreed with DSA findings: current risk of debt distress is low, but fiscal consolidation is crucial for debt sustainability.
- Authorities acknowledged continuation of current fiscal stance is not sustainable and expenditure restraint is needed.
- Authorities recognized importance of more comprehensive data on debt and other liabilities, particularly off-budget and public enterprise debt, for assessing overall debt burdens.
- Authorities will consider an IMF technical assistance mission on the Medium-Term Debt Management Strategy (MTDS).

### Conclusion and policy recommendations
- Conclusion:
  - Papua New Guinea’s PPG external debt remains at low risk of debt stress.
  - Overall risk of public debt distress remains heightened due to rising public domestic debt and contingent/non-contingent liabilities.
  - Failure to consolidate fiscal position would result in unsustainable debt dynamics.
- Policy recommendations and priorities:
  - Bring public debt on a downward trajectory over the medium term.
  - Focus on improving spending quality to maximize development outcomes within a restrained resource envelope.
  - Publish the terms and conditions of all loans, including the UBS loan, to ensure fiscal transparency and debt sustainability.
  - Use the planned debut sovereign bond issuance to improve the debt profile and terms and cover existing commitments rather than finance new projects.

*Source: IMF Staff Report for the 2015 Article IV Consultation — Debt Sustainability Analysis and country statistical assessment (content as provided).*

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

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

### Overall framing
- Macroeconomic assumptions for this DSA are generally more conservative than those for the previous DSA.
- Projections of GDP growth and external current account are somewhat lower than those for the 2014 DSA, as are projections of the primary fiscal balance.
- This largely reflects a less favorable outlook for the resource sector owing to lower commodity prices and a temporary mine closure.
- LNG prices are assumed to decline by about 30 percent in 2015 and by around 5 percent in 2016, reflecting the recent plunge in oil prices.
- The government plans to spend K 3 billion over 2015-18 on the preparations for APEC 2018. Thus, 2018 will see a winding down of construction activity, with overall growth projected to slow down to 1½ percent in 2018 and stabilize at 3 percent over the longer term.

### Real economy and inflation assumptions
- Real GDP growth is projected at around 4 percent on average over the medium term, and to slow to 3 percent in the long run.
- Inflation is expected to be about 3½ percent over the medium term and will stabilize at 5 percent in the long run.

### External sector assumptions
- The current account (including grants) will turn into a surplus in 2015 as LNG production comes on stream and imports related to the LNG project subside.
- The current account is projected to be 5 percent of GDP on average during 2015-20.

### Fiscal and financing assumptions
- The primary fiscal balance is estimated to be in deficit of 5 percent of GDP in 2015.
- During the current medium-term fiscal strategy period (2013-17), a continuous primary deficit of 4 percent of GDP on average is expected.
- After 2024, the primary fiscal balance is projected to turn into a surplus, with an average of 0.4 percent of GDP during 2024–34.
- The grant element of loans is expected to average around 35 percent.
- A sovereign bond reduces the grant element of loans when it is issued and rolled over with a 10-year interval.

### Notes on specific projections referenced in the DSA (as presented in the Box)
- LNG prices: decline of about 30 percent in 2015; around 5 percent in 2016.
- Government APEC 2018 preparation spending: K 3 billion over 2015-18.
- 2018 growth: projected to slow to 1½ percent.
- Medium-term average real GDP growth: around 4 percent.
- Long-run real GDP growth: 3 percent.
- Medium-term inflation: about 3½ percent.
- Long-run inflation: 5 percent.
- Current account (including grants) average 2015-20: 5 percent of GDP.
- Primary fiscal balance: deficit of 5 percent of GDP in 2015.
- Medium-term (2013-17) continuous primary deficit: 4 percent of GDP on average.
- Primary balance 2024–34 average: surplus of 0.4 percent of GDP.
- Grant element of loans (expected average): around 35 percent.
- Sovereign bond roll-over tenor referenced: 10-year interval.

*Source: Box 1. Macroeconomic Assumptions Underlying the DSA Update (Statement by the Staff Representative on Papua New Guinea, October 30, 2015).*

### 1.  On October 19, 2015, the Government of Papua New Guinea (PNG) released the

### On October 19, 2015, the Government of Papua New Guinea (PNG) released the 2016 Budget Strategy Paper

### Budget projections and key indicators
- Projected fiscal deficit in 2015: 4.5 percent of GDP (3.1 percentage points of GDP lower than staff’s projection and close to the 2015 budget of 4.4 percent).
- Revenues in 2015: projected to be K 1.1 billion higher than budgeted.
- Expenditures in 2015: projected to be K 1.4 billion lower than budgeted.
- Debt-to-GDP ratio in 2015: projected at 34.4 percent (slightly below the 35 percent of GDP ceiling and lower than staff’s projection of 39.4 percent).
- 2016 Budget reporting: will use the GFSM 2014 methodology and aggregate numbers for total revenue and expenditure will be revised accordingly.
- 2016 projections noted in the Budget Strategy Paper (footnote): total revenue in 2016 is projected at approximately K 10.4 billion with K 9.9 billion tax revenue and K 0.6 billion non-tax revenue. Total expenditure in 2016 is projected at K 13.4 billion.

### Medium-term fiscal consolidation and priorities
- Government envisages gradual reduction of deficit for 2016–19 leading to a balanced budget in 2020.
- Consolidation measures underpinning the plan include:
  - further expenditure prioritization,
  - planned refining of the tax regime,
  - structural reforms in public enterprises.
- Budget priorities: health, education, law and order, agriculture, and infrastructure.
- Authorities aim to stabilize public debt at 35 percent of GDP and return to a balanced budget and bring debt-to-GDP back to 30 percent by 2020.
- Authorities are considering anchoring fiscal policy via the non-resource primary balance and seek further discussion with IMF staff.
- Authorities have expressed interest in IMF technical assistance to review and update the medium-term debt strategy.

### Fiscal adjustments in 2015 and revenue measures
- Authorities identified expenditure savings of 1.4 billion kina in 2015 while avoiding cuts in priority areas (education, health, infrastructure, law and order).
- Announced revenue measures to raise an additional 1.1 billion kina from tax collections and dividends from state entities.
- Combined adjustments contain the 2015 budget deficit to 4.5 percent of GDP, close to the originally budgeted deficit of 4.4 percent.

### Public financial management and institutions
- Authorities committed to strengthening PFM to improve cash management and effectiveness of spending.
- PEFA assessment recommendations include overnight reconciliation of cash into a single public account and greater use of electronic funds transfer.
- PFM roadmap highlights improved cash management among key reforms.
- Authorities embedding multi-year budgeting and sector-led budgeting to prioritize projects with demonstrated outputs, outcomes and impacts.
- Establishment of a new Sovereign Wealth Fund (SWF):
  - Legislation for the SWF passed by Parliament in July 2015.
  - Commitment to operate the SWF consistent with the Santiago Principles.
  - SWF to include a stabilization fund (to protect against commodity volatility and provide reliable budget revenues) and a savings fund (to invest real value of extracted resources overseas).
  - All investments to be managed by an independent and qualified board.

### Macroeconomic outlook and risks
- PNG expected to grow strongly in 2015 at 9 percent (14th consecutive year of economic growth).
- Growth impacted by lower commodity prices and the El Niño weather pattern affecting mining, agriculture, forestry and fisheries.
- Resource sector growth supported by commencement of the PNG LNG project; non-resource sectors growing more slowly, with lower activity in construction and manufacturing.
- Medium-term outlook: growth expected to return to long-term average, but risks include:
  - further falls in commodity prices,
  - worsening of the drought (could prolong closure of the Ok Tedi mine beyond the first quarter of 2016 and further affect agricultural output).
- Upside prospects: potential for further resource projects in the medium-term (including for a second major LNG project).

### Monetary policy, exchange rate and reserves
- Headline inflation projected to be around 6 percent for 2015.
- Monetary policy stance: neutral for the time being; Bank of Papua New Guinea (BPNG) stands ready to absorb excess liquidity and tighten if inflationary pressures emerge.
- Kina depreciation: depreciated by over 16 percent relative to the US dollar in the last year.
- BPNG interventions: intervening to meet some excess demand in the foreign exchange market to avoid undue delays in meeting import orders.
- Authorities emphasize avoiding excessive exchange rate volatility and are exploring options to improve foreign exchange market operation; have requested further technical assistance.
- International reserves by end-2015: projected to be close to USD 2 billion, which staff estimates would provide import coverage for 3.1 months.
  - Footnote: BPNG measures this as sufficient to cover 7.9 months of total imports and 15.6 months of non-mineral imports (excluding non-factor services and on the basis of 2015 figures).
- Expected increases in reserves from planned sovereign bond proceeds and anticipated sale of government equity in the LNG project to local governments and landowners.

### Financial sector development and structural reforms
- Financial sector assessed as sound: commercial banks maintain strong balance sheets and non-performing loans remain low.
- Authorities promoting financial development and increased access to finance, including through mobile banking.
- Financial inclusion: over half a million people brought into the banking system within two years, nearly a third of these being women.
- Progress on AML/CFT legislation expected to facilitate removal from the Financial Action Task Force’s gray list.
- Structural reform priorities to support diversification and inclusive growth:
  - public investments in roads and increased access to finance to support agriculture,
  - development of forestry, fisheries, and tourism,
  - Competition Review and Financial Sector Services Review to identify reform areas,
  - transparency and governance reforms, enhanced secured lending arrangements, and reduction of unnecessary regulatory burdens to improve the business environment and support SMEs,
  - PNG’s participation in the Extractive Industries Transparency Initiative to contribute to an improved investment climate,
  - governance reforms to promote greater efficiency and improved management of state-owned enterprises.

*Statement by Barry Sterland, Executive Director for Papua New Guinea and Ian South, Advisor to Executive Director, October 30, 2015.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15318.pdf_