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Papua New Guinea's new economic reality

Papua New Guinea's new economic reality
Published 20 Apr 2016   Follow @jonathan_pryke

There’s a problem with having your economy as one of the world’s most dependent on the natural resources sector; when global commodity prices come down you come down with them. Mongolia, Timor-Leste and Laos, to name a few in our region, have all faced a dramatic change of fortunes in 2015. But none have had it as bad as Papua New Guinea. While this has been discussed for many months, a raft of new reports reveal just how badly the economy, and budget, has been affected by the collapse in commodity prices. This new economic reality is becoming harder for the government to ignore, and tough choices must be made quickly if further economic pain is to be mitigated.

PNG’s not-so-new restrained growth trajectory

PNG’s economic growth prospects returned to the headlines in recent weeks with the release of the ADB’s 2016 Asian Development Outlook (ADO) that projects 2016 PNG growth to fall to 4.3% and 2017 growth to be only 2.4%. With 2016 growth in Asia this year forecast at 5.7%, this is well below the average. For a country that in 2015 had the fastest growth in the region, it has been a sharp and sudden reversal of fortunes.

Prime Minister O’Neill defended the PNG economy by noting that the ADB 'have always been ultra conservative in their outlook'. What Mr O’Neill failed to recognise, however, was that the ADB’s numbers came directly from his own Treasury’s forecasts made in last November’s 2016 budget, from which the graph below is taken.

Figure One: PNG Treasury's economic growth forecasts

Source: PNG 2016 budget

Confirming this trend is the IMF’s latest growth projections, which forecast even lower growth, expecting the economy to grow by only 3.1% this year and falling further to 1.4% in 2018. This will put growth below both PNG’s current population growth rate of 3.1%, and the forecast world average growth. The World Bank has a slightly more optimistic forecast, but it is still not far out of line from the PNG Treasury’s own predictions.

It is important to remember that these are only estimates, and the PNG economy faces both significant downside and upside risk in the near future. What these numbers do show is that the ADB, the World Bank and the IMF all agree with what the PNG Treasury has been saying for almost six months: the most likely scenario for PNG economic prospects in the short-term will be one of restrained growth.

Dramatic fiscal adjustment comes early

While much of the changes at the macro level have been out of the government’s control, huge fiscal expansion and massive shift in expenditure allocations have left the government ill-equipped to protect the budget and core service delivery from this global decline.

At the launch of the 2016 budget, the government finally acknowledged that a fiscal adjustment was necessary after revenue for 2015 was predicted to be 20% less than originally planned. A supplementary 2015 budget (not at the time released to the public) foreshadowed an undisclosed in-year expenditure cut of 10%, combined with dramatic cuts to core services over the forward estimates period. Transport, administration and education budgets were all being slashed in real terms by more than 20% in 2016 alone.

The 2015 Final Budget Outcome, released two weeks ago shows that these cuts have come early and far more dramatically (for a more detailed assessment see Paul Flanagan’s recent analysis). The FBO is a scary document, which shows tax revenue alone for 2015 being close to 10% below 2014 levels. This adjustment brought revenue (when adjusting for inflation) only 3.5% higher than it was in 2010, despite the economy having grown by 51% in the same period. Unable to finance its proposed budget, the government slashed expenditure by 14.3% with education, health and infrastructure, all critical areas of service delivery, being cut by over 30% in a single year. [fold]

Table One: Budgeted, revised and final sectoral expenditure (K million)PNG Treasury 2015 Final Budget Outcome

This table clearly indicates the government’s expenditure priorities:

  1. Debt servicing: Debt servicing made up 9% of expenditure in 2015. Paying interest on Treasury bonds is unavoidable as any default would completely shut PNG out from lending markets in the future.
  2. Paying government wages: Despite efforts to curb the public sector payroll (data for which is not displayed above but can be found elsewhere in the FBO), which takes up a third of all government expenditure, wages came out exactly as budgeted at K3.9 billion. Even this expenditure has come under strain, with delays to salaries occurring this year.
  3. Financing provinces: the decentralisation of expenditure to the province and district level has been a flagship policy for the O’Neill government. Payments to MPs through district and provincial funds alone have increased by almost K1 billion since 2012 to make up 10% of expenditure in 2015.
  4. Discretionary spending and core services: Taken together, the three areas above accounted for 74% of total expenditure in 2015. It is no wonder that we see such savage cuts in other areas.

With such a large amount of allocations already pre-committed, a revenue situation that looks unlikely to change dramatically over the forward estimates, and other large expenditure outlays on the horizon (namely the 2017 election and APEC 2018), this will not be the end of the pain for the government. The government will need to raise K2.1 billion in net borrowing this year to meet its original budget targets. With the planned sovereign bond now on hold, the government needs to quickly move to a plan B for expenditure allocations for the remainder of 2016. Given the cuts that have already taken place in 2015, the 2016 budget as it stands is no longer a credible marker for expenditure. A supplementary budget will again be needed, ideally before November. 

Foreign exchange troubles continue

As the government struggles to maintain its expenditure commitments the private sector is still under strain from the ongoing restriction of access to foreign currency implemented by PNG’s Central Bank (BPNG). This is most evident from Prime Minister O’Neill’s recent announcement that BPNG was looking to secure a $US250m loan facility (the first of its kind) from the World Bank’s International Finance Corporation to help clear the backlog of demand. Without a reversal of global commodity prices such an injection of external finance is certainly needed to clear the backlog without jeopardising the country’s foreign reserves. However, if not matched with policies to accelerate the depreciation of the still significantly overvalued Kina back to a market clearing level, such an action will only be kicking the can further down the road. For more see this excellent coverage from the Financial Times.

Ways forward?

Clearly the PNG government is in a difficult situation. A lot of what led it here, namely the collapse in global commodity prices, was out of its control. But massive expenditure reallocations in the lead-up to (and during) the crash left the government ill-equipped to protect core services. The government can again choose to put its fate into the hands of forces outside of its control, hoping for an increase in global oil prices (which Moody’s doesn’t expect) or a new LNG project (an announcement on which isn’t expected until next year). Or it can take action through a package of expenditure and revenue reforms with the support of new lending from the multilateral system (as detailed by Stephen Howes and Matthew Morris).

With outstanding court cases against the Prime Minister again making headlines and distracting from the desperate attention the economy needs, combined with a looming 2017 election, such bold action seems unlikely. Having the government acknowledge the severity of the challenges the economy is facing would be an important first step.

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