IMF Executive Board Concludes 2010 Article IV Consultation with Papua New Guinea

Public Information Notice (PIN) No. 10/73
June 10, 2010

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2010Article IV Consultation with Papua New Guinea is also available.

On May 19, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Papua New Guinea on a lapse of time basis. Under the IMF’s lapse of time procedures, the Executive Board completes Article IV consultations without convening formal discussions.

Background

Macroeconomic performance has improved, but Papua New Guinea remains a poor country highly exposed to commodity price fluctuations. GDP per capita remains low and improvement has lagged other low-income countries in the region. An unattractive investment environment, due primarily to weak infrastructure, problems with governance, and high crime, curtails development.

Real activity was relatively unaffected by the global downturn, with growth easing to roughly 5 percent in 2009 from 7 percent in 2008. A number of factors contributed to this favorable outcome. The country’s financial sector was insulated from the turmoil in global capital markets and domestic credit continued to grow, albeit at a slower pace than in the preceding few years. Export demand also held up, as stimulus measures in other Asian countries supported demand for commodities, the country’s main export. Finally, following a prudent fiscal policy during the years of booming commodity prices left the government in a position to fund a significant fiscal expansion that help support domestic demand.

Over the course of 2009, inflation moderated substantially. After peaking in September 2008 at roughly 13 percent, inflation fell to under 6 percent by end-2009, primarily from declines in international food and energy prices.

After maintaining a tight monetary stance since mid-2008, the Bank of Papua New Guinea (BPNG) reduced the policy rate in December 2009. Despite increasing with the decline in inflation, real lending rates are currently below their long-term average, suggesting monetary conditions are accommodative. After several years of posting surpluses, the stimulus in 2009 shifted the fiscal balance into a deficit of almost 8 percent of GDP. With the 2010 Budget targeting fiscal balance, a significant portion of the stimulus is being withdrawn.

Following several years where both the real and nominal effective exchange rates were stable, the turmoil in global markets in late-2008 and early-2009 induced a period of volatility. However, the exchange market has stabilized and effective exchange rates have returned close to their previous five-year averages. The decline in export commodity prices shifted the current account into deficit in 2009 for the first time in six years. However, external debt rose only modestly to about 29 percent of GDP at end-2009.

Executive Board Assessment

In concluding the 2010 Article IV consultation with Papua New Guinea, Executive Directors endorsed staff’s appraisal, as follows:

We commend the authorities for maintaining a medium-term fiscal framework. However, recent slippages in the implementation of the framework have undermined its stabilization objective. Spending from accumulated mineral revenue above the framework’s limit imparted a fiscal stimulus in 2009 larger than warranted. Although the 2010 budget reduces the stimulus, the planned level of spending is likely to be too expansionary given the expected strength in private activity. Further, spending from trust accounts outside the budget will add to demand pressures. Delaying some infrastructure spending would ease overall demand pressures and help ensure that good value is achieved from this spending.

The construction phase of the Liquefied Natural Gas (LNG) projects will increase the difficulty of maintaining macroeconomic stability and enhancements to the Medium-Term Fiscal Strategy (MTFS) could be helpful. First, it would be prudent to lower the assumption of normal mineral revenue to 3 percent of GDP between now and 2014, when LNG production should commence. This would reduce pressures from public spending during a period of strong private spending and the increased public savings could be used to finance currently unfunded government liabilities. Second, annual consultation between the monetary and fiscal authorities should determine how much of the 4 percent of GDP limit from above-normal mineral revenue can be spent.

The implementation of the MTFS needs to be strengthened. The fiscal credibility built during years of adherence to the framework can be easily lost, reducing long-term growth prospects. Strict adherence to the framework will also help deliver the fiscal prudence required to guard against unfavorable public debt dynamics from vulnerabilities such as those arising from potential LNG project delays, lower commodity prices, and weaker external demand.

With LNG projects underway, now is the time to develop a sovereign wealth fund (SWF) to manage. The best way forward is a financing fund that directs all public spending through the budget, thereby enhancing macroeconomic stabilization and helping to ensure high quality spending aligned with development objectives. To maximize the long-run development impact of LNG income, domestic absorption capacity will need to guide the rate of drawdown. Further, to minimize the potential for currency appreciation that would undermine the welfare of rural populations that depends on agriculture exports, the fund’s resources should be invested offshore. To effectively achieve its objectives, the SWF needs to be integrated into the macro framework and thereby supported by other fiscal institutions, such as the MTFS and the Fiscal Responsibility Act.

Although inflation declined over 2009, monetary policy needs to be focused on emerging inflation pressures. Compared to the recent episode of high inflation, domestic demand will play a more important role in driving inflation up, which implies a greater risk that high inflation could become entrenched in expectations. The central bank should be tightening monetary policy now with a view to achieving real lending rates of around 6 percent. Further, to contain inflation and manage inflation expectations, they should be prepared to maintain real lending rates around this level, or higher if significant overheating occurs.

Closer coordination of monetary and fiscal policy is desirable. Public trust accounts should be moved to the BPNG and procedures to automatically deposit above-normal mineral revenue with the central bank should be introduced. This will give the BPNG better control over domestic liquidity and market interest rates, strengthening the effectiveness of monetary policy. Also, the net cost to the public sector would be reduced by limiting the need to use high-cost central bank bills to remove excess liquidity.

Indicators suggest that the financial sector remains sound. However, to safeguard financial health, banks should be encouraged to maintain strict lending standards as credit demand increases in line with opportunities associated with the LNG projects. Furthermore, all financial institutions need to guard against overexposure to the property sector that could become significantly overvalued during the LNG construction phase.

The projected widening in the current account deficit is not expected to threaten external stability. The exchange rate is estimated to be broadly in line with fundamentals and reserves remain adequate to address potential balance of payments needs.

To achieve the Development Strategic Plan it will be essential to better align development spending with priorities and reinvigorate the reform process. There has been some progress on reform, with increased competition in telecommunications, aviation, and power. However, more needs to be done, particularly with those state-owned enterprises that will see considerable increases in demand for their services from the LNG projects. The government’s commitment to implement a public-private-partnership policy is encouraging and could potentially facilitate significant private investment in infrastructure. Improvements to security and the business environment would also yield significant benefits.


Papua New Guinea: Selected Economic and Financial Indicators, 2006–10


Nominal GDP (2008): US$7.8 billion 1/

         

Population (2008): 6.2 million

         

GDP per capita (2008): US$1,267

         

Quota: SDR 131.6 million

         

  2006 2007 2008 2009 2010
        Est. Proj.

  (Percent change)

Real sector

         

Real GDP growth

2.3 7.2 6.7 4.5 8.0

Mineral

-8.5 -0.1 -1.0 -1.8 5.5

Nonmineral

3.9 8.1 7.6 5.3 8.2

CPI (annual average)

2.4 0.9 10.7 6.9 7.1

CPI (end-period)

-0.9 3.2 11.2 5.7 8.5
  (In percent of GDP)

Central government operations

         

Revenue and grants

37.2 37.3 32.6 28.3 27.9

Expenditure and net lending

30.7 28.4 30.0 35.7 29.5

Overall balance (including grants)

6.5 8.9 2.5 -7.4 -1.6

Nonmineral balance 2/

-7.8 -7.5 -7.4 -11.2 -6.9
  (Percent change)

Money and credit (percentage change)

         

Domestic credit

19.4 5.5 31.3 30.2 25.2

Net credit to government

-13.3 -82.3 -147.7 -843.5 84.7

Credit to the private sector

38.2 34.4 39.4 17.3 20.0

Broad money

38.9 27.8 11.2 19.3 18.7

Interest rate (182-day T-bills; period average)

3.7 4.4 5.9 7.2
  (In millions of U.S. dollars)

Balance of payments

         

Exports, f.o.b.

4,324 4,822 5,823 4,617 5,742

Of which: Mineral

3,506 3,673 4,262 3,516 4,584

Imports, c.i.f.

-1,991 -2,629 -3,148 -3,430 -5,424

Current account (including grants)

442 208 805 -541 -1422

(In percent of GDP)

8.0 3.3 10.0 -6.8 -16.1

Exceptional financing (net)

0.0 0.0 0.0 0.0 0.0

Gross official international reserves

1449 2087 1988 2571 2432

(In months of nonmining imports, c.i.f.)

12 14 11 12 7

(In months of goods and services imports)

4 4 4 6 4

Public external debt

         

Public external debt-service-ratio (percent of exports) 3/

4 4 2 2 2

Public external debt-to-GDP ratio (in percent) 3/

21 17 13 13 12
           

Exchange rates

         

US$/kina (period-average)

0.327 0.337 0.370 0.363

US$/kina (end-period)

0.330 0.353 0.373 0.370

NEER (2000=100, end-period)

79.3 77.1 82.3 83.8

REER (2000=100, end-period)

100.9 96.5 109.4 117.9
           

Nominal GDP (millions of kina)

16,897 18,798 21,626 21,784 24,620

Sources: Papua New Guinea authorities; and IMF staff estimates and projections.

1/ Based on period average exchange rate.

2/ Measured from below the line in the fiscal accounts.

3/ Includes central government, central bank external debt, and statutory authorities.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.



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