PNG eyes FTAs with Australia and China

PNG eyes FTAs with Australia and China

Originally published in The Economist Intelligence Unit

PNG's budding free-trade agreements (FTAs) with China and Australia are showing early promise, with both being the subject of feasibility studies. PNG has long-standing ties with Australia, but China's influence has grown over the past decade, as elsewhere in the Pacific. The two countries are PNG's largest trade partners(followed by Japan and Singapore).

FTA with China would build on strong trade expansion

Momentum behind PNG's potential FTA with China has picked up.
After several years of little progress,PNG's prime minister, James Marape, stated that he wanted to complete the FTA at the "very earliest" opportunity during a visit to China in 2022. China has provided a Kina1m (US$280,000) grant to PNG's Trade Office to complete a feasibility study.

A trade deal with China would open several potential economic benefits for PNG. Mr Marape's administration would like to diversify PNG's economy away from mining resources. Better access to the Chinese market holds out the opportunity to develop its food and agriculture exports, in particular, and could entice greater Chinese investment in these areas (and others).

For China, a trade deal with the Pacific's largest economy would chiefly provide geopolitical advantages. It would demonstrate a commitment to regional development and support its goal of developing a region-wide FTA with the Pacific Islands. This would boost its influence in the region as it competes with the US and that country's regional allies (Australia and New Zealand).

China is a significant and growing trade partner, and one with which PNG maintains a large and expanding surplus. Local statistics indicate that China was PNG's second-largest trade partner in 2022, while IMF data collated with a different methodology indicate that it was the largest. Bilateral trade is driven by PNG's shipments of liquefied natural gas (LNG), which expanded rapidly following the completion of the PNG LNG project in 2014. Agricultural exports have also shown promise in recent years. PNG's modest demand for consumer goods keeps its import bill from China relatively low.

FTA with Australia would cement long-standing trade ties

A prospective FTA between PNG and Australia is also moving forward.
A feasibility study, conducted by the Australia-based Centre for International Economics, was due for completion in June 2023 but has yet to be published. It was commissioned to assess the prospects of building on existing bilateral trade agreements, with a focus on expansion to include fisheries and agricultural products from PNG. It also aimed to identify tariff and non-tariff barriers to trade; barriers to investment in PNG in the agriculture and seafood sectors; and model benefits and costs to both countries under a possible FTA.

PNG's main goal will be to broaden its exports to Australia; its shipments are currently dominated by gold, which is then processed. PNG would like to develop more of its own mineral-processing capacity in the long term, and also encourage Australian demand for non-resource exports (especially agriculture). PNG's imports from Australia are led by excavator equipment used in mines; shipments rise during periods of major construction investment in resources. Australia is PNG's largest trade partner, according to local data, and its second-largest based on IMF figures. PNG's trade deficit with Australia has trended wider in recent years(at least according to the IMF).

Similar to China, Australia's motivations are chiefly geopolitical. It is seeking to cement historical ties with PNG as a bulwark against Chinese influence. A closer economic partnership would complement a parallel defence agreement currently under negotiation.

Interest in FTAs is a positive policy sign for PNG

PNG's interest in FTAs indicates a positive shift in trade policy, given the more protectionist regime adopted in recent years. Between 2018 and 2019 PNG introduced 323 tariff line increases to assist local manufacturing companies and raise government revenue. This reversed a 20-year long tariff reduction programme that began in 1999 and had significantly lowered tariff rates across a broad range of categories. The tariff increases implemented an unweighted average rise of 7% in 2018 and 14% in 2019. The PNG government also introduced levy and fee increases on imported oil palm machinery in 2020.

These tariffs and levies have contributed little to government coffers, failing to exceed 3% of government revenue since 2018. In addition, these tariff increases may not assist manufacturers as intended. A study on the effectiveness of the 2018 and 2019 tariffs has yet to be conducted, but a study in 2003 found that the manufacturing sector, then protected by high tariffs, had the slowest rate of expansion. High tariffs also had a negative impact on export industries by raising the cost of imported inputs and punishing large capital-intensive producers.

FTAs with Australia and China potentially stand at odds with the Marape government's other policies to encourage import substitution. For instance, in a bid to promote local timber processing, the government increased the export tax on round logs by 20% earlier in 2023. This follows an increase in the export tax rate on round logs from 32.5% to 59% in 2020, which drove several logging companies out of business and led to a fall in log exports. In addition, the government has announced a ban on round log exports from 2025(although similar promises in the past have not been kept).

For any FTA with PNG to be effective, the government's crawling-peg exchange rate will also have to be revisited. An overvalued kina since 2014 has been detrimental to trade. The Bank of Papua New Guinea (the central bank) has refused to devalue the currency, fearing imported inflation, although this has led to a rationing of foreign exchange and reduced the competitiveness of exports in international markets. Businesses have listed foreign-exchange shortages as the leading constraint they face, and it has been blamed for fuel shortages in 2022‑23.

Devaluing the kina will allow export sectors such as agriculture and fisheries to expand by making their exports cheaper and more competitive.
In addition, a lower exchange rate will allow import-substituting industries to expand as rival imports become expensive. EIU has long argued that kina devaluation was likely in 2023‑25, as a result of moving to a more market-determined exchange-rate. It is a major focus for an ongoing IMF programme of technical assistance in the country.

China FTA is the more promising, but geopolitics could cause complications

Overall, work towards FTAs with both Australia and China is welcome, given that they will encourage PNG to revisit policies that have been detrimental to trade. There is more economic potential for PNG in terms of an FTA with China, suggesting that it will be prioritised between the two deals, but geopolitics could be a complicating factor. PNG's recent lean in its security relations towards the US will cause some unease for China, but we do not believe that the latter is likely to suspend trade talks. We assume that talks on both FTAs will be concluded and deals potentially implemented during our forecast period (2023‑27), supporting broader improvements in PNG's operating environment.

Areas of expertise: Economics and politics in Papua New Guinea and the Pacific; trade policy; economic history