IMF Executive Board Concludes 2014 Article IV Consultation with Papua New Guinea

IMF Executive Board Concludes 2014 Article IV Consultation with Papua New Guinea

On November 21, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Papua New Guinea, and considered and endorsed the staff appraisal without a meeting on lapse-of-time basis. [2]

Papua New Guinea’s economy is experiencing an important transition, which presents major challenges in the near term to maintaining macro-financial stability, but also important opportunities if managed properly. In the face of a winding down of large liquefied natural gas (LNG) project construction, the government has embarked on a large fiscal expansion starting in 2013 to accelerate development and cushion the non-resource economy. However, this policy shift has significantly reduced the country’s fiscal space and led to an increase in government debt, likely to exceed legislated targets by end 2014.

With LNG production and exports now starting, resource sector growth is projected to surge in 2015, but spillovers to the rest of the economy may be more limited. Inflation has moderated from its peaks during the construction boom and is likely to remain reasonably low given the global outlook for commodity prices. Meanwhile, the external current account deficit has fallen significantly since 2013, as imports related to the LNG project passed their peak. With LNG exports now coming on stream, the current account deficit is expected to narrow further in 2014 and turn into a surplus in 2015. Nevertheless, lower commodity prices, weaker mining output, and a reduction in LNG project-related capital inflows have led to depreciation pressure on the kina since mid-2013. In early June 2014 the Bank of PNG (BPNG) introduced measures to require authorized dealers to conduct transactions 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 been depreciating at the rate of 5-10 basis points per week.

Risks to economic growth are increasingly tilted toward the downside. Weaker-than-expected growth of the global economy could weigh on external demand and commodity prices. Over the longer term, LNG and shale gas developments around the world could reduce LNG prices and government revenue. This might also have implications for future inflows of foreign direct investment. Domestically, lower growth could weigh on property valuations. On the upside, potential exists for a second LNG project and new mining operations in the near to medium term.

The ongoing economic transition calls for adjustment of macroeconomic policies to safeguard macro-financial stability. Foremost, fiscal consolidation, anchored by government’s existing debt targets, would help achieve this objective. Meanwhile, better expenditure prioritization could improve development outcomes. Greater exchange rate flexibility is needed to cushion the country’s economy from shocks during the transition, while more complete withdrawal of banking system excess liquidity would help strengthen monetary policy transmission and alleviate the downward pressure on the kina. These macroeconomic policy measures should be supported by faster, deeper structural reforms to create an enabling environment for sustained, inclusive growth.

Executive Board Assessment

In concluding the 2014 Article IV consultation with Papua New Guinea, Executive Directors endorsed the staff’s appraisal as follows:

Papua New Guinea’s economy is undergoing an important transition. While the commencement of LNG production will boost overall GDP growth in 2014-15, the slow growth of the non-resource sector calls for a renewed policy focus on inclusive growth in the post-LNG construction era. Prudent macroeconomic policies are essential to maintaining debt sustainability and external and financial stability during the transition.

Following strong government expenditure growth over the past three years, steadfast fiscal consolidation is now needed to ensure debt sustainability. With modest LNG revenue expected over the medium term, expenditure restraint will be key to meeting existing government debt targets and provide an opportunity to align spending levels with absorptive capacity and improve spending quality.

Better expenditure prioritization and public financial management will be crucial for improving development outcomes. High priority should be given to implementing high-impact projects and improving the delivery of frontline health and education services, including through sufficient allocation of critical recurrent expenditure. Recent progress on strengthening public financial management (PFM) is welcomed, but greater efforts are needed in improving the management of trust accounts, cash flows, and public debt, notably transparency in contracting government and State Owned Enterprises (SOE) loans.

The sovereign wealth fund (SWF) should be put into operation as soon as practical. The authorities’ intention to retain the essential features of the original SWF design is welcome, in particular the strong commitment to ensuring resource revenues are channeled through the budget to the greatest extent possible. This move would better enable the use of public resources to achieve development priorities and is consistent with the SWF’s role in macroeconomic stabilization and wealth sharing.

Greater exchange rate flexibility is needed to safeguard external buffers and eliminate imbalances in the foreign exchange market. To these ends, the BPNG should allow the exchange rate to be more market-determined and move quickly to a market-clearing rate through competitive foreign exchange auctions. Over the medium term, Papua New Guinea’s external position is expected to strengthen on account of its macroeconomic fundamentals. To improve monetary policy effectiveness, the BPNG should mop up excess liquidity more fully in the banking system, which would help reduce excess demand for foreign exchange as well as improve monetary policy transmission.

Structural reforms should be accelerated and deepened to create conducive conditions for broad-based growth. Continued efforts are needed to improve infrastructure, security, and health and education outcomes, attract more foreign direct investment, and accelerate SOE reforms in order to reduce business costs, create more jobs, and improve service delivery. A revival of agriculture and a strengthening of the small and medium sized enterprises (SME) sector supported by innovations in financial inclusion will also be vital for improving the livelihood of the majority of the population.

Notwithstanding the recent progress, determined action is needed to improve macroeconomic statistics. Some shortcomings in macroeconomic statistics continue to hamper surveillance and policy making. The authorities’ commitment to reforming the National Statistics Office (NSO) is a strong step in this direction, with increased IMF technical assistance expected to assist reform efforts and to improve capacity.”

Source: International Monetary Fund

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