From economic boom to crisis management in PNG

Written by Paul Flanagan

Papua New Guinea (PNG) is a land of contrasts. 2015 started with the prospect of PNG having the highest GDP growth rate in the world at over 21 per cent. It finished in crisis management and cash shortages. PNG proudly celebrated its 40th anniversary of independence, hosted a successful yet expensive Pacific Games and its prime minister strode the world and regional stage. But the 2016 Budget, rushed through Parliament in November given a looming vote of no-confidence, introduced even more extensive expenditure cuts than Greece has endured.

Extensive currency controls are hurting businesses and undermining growth. Local businesses are facing major drops in sales and most believe the outlook will not improve in 2016.

Newspaper stories report shortages of government cash. Funding is not being paid to urgent medical programs, there are uncertainties as to whether public servants will be paid, teacher entitlements are being deferred and superannuation contributions are not being deposited. A sovereign bond was the planned solution to these cash flow problems but it has been put on hold until the middle of 2016, reportedly due to a lack of market interest.

The new PNG LNG project is functioning better than planned and LNG export volumes are booming. This should have been an opportunity for PNG to improve its international credit rating. However both Moody’s and Standard and Poor’s have moved PNG onto a negative watch list. And the high GDP growth rate over the last two years hid the negative growth rate on better measures such as non-resource GDP per capita.

So what has gone so wrong?

The overly simplified short-term answer is to blame the fall in oil prices. Government ministers initially denied that there would be any impact on revenues from LNG, PNG’s largest export, claiming PNG LNG contracts were based on fixed prices.

Officials acknowledged the inevitable budget hit in early August with revenue forecasts being reduced by 20 per cent. But there were no specific expenditure cuts to match the fall in revenues. In early October the government finally recognised the export earnings decrease, yet no changes were made to monetary or exchange rate policies.

The 2016 Budget released in November looked good on paper. This was possibly an attempt to win over potential investors in the proposed sovereign bond solution. But more detailed analysis shows that the budget suffered from serious errors and contained unrealistic levels of expenditure cuts.

A more complex answer to what went wrong is based on the tendency of PNG’s political leaders to focus too much of its hopes on its resource sector rather than its people.

Like in the early 1990s, the government started spending up big before actually receiving any revenues from major new resource projects. PNG’s budget deficit levels reached 9.5 per cent of GDP in 2013 and 8.6 per cent in 2014 — the highest deficits in its history. If the fiscal starting point in 2015 had been similar to the almost balanced budgets of the previous decade, then the fall in commodity prices could have been met with an expansionary fiscal policy rather than fiscal consolidation.

Greater focus on improving the performance of the agriculture sector would do much more for the people of PNG than a focus on the resource sector. Around 80 per cent of PNG’s population still depends on subsistence agriculture. From 2003 to 2015, real per capita growth rates in the agriculture sector averaged only 1.1 per cent per annum — one-third of the growth rate of other non-resource sectors. The high exchange rate is possibly the most important policy instrument that undermines incentives for growth.

Looking ahead, economic policy in 2016 will be greatly affected by the uncertainties of a possible vote of no-confidence in the government and the rapidly approaching 2017 elections.

The easy option will be to talk up the foreshadowed major Papua LNG project. Providing generous tax concessions will help get the project underway. And the investment stage of such a project could start injecting cash into the economy by the time of the 2017 election. But such resource tax concessions are part of the reason for PNG’s current fiscal problems.

A harder path politically would require a more balanced and realistic approach to PNG’s medium-term development. A lower, market-based exchange rate would improve the incomes of agriculture exporters and import-competing industries as well as boost the prospects for foreign investment. The revenue base will need reinforcement and tax reform proposals suggested by the government’s recent tax review need to be embraced. The expenditure focus should be on effective implementation and fighting corruption.

Wages and competition policies also need to support longer-term growth. PNG has muddled through similar crises in the past. But on each occasion, there has been a change of Prime Minister and an international assistance package.

PNG has great prospects, but slow policy responses and a growing number of poor policies hinder its outlook. Yet, given the politics, it is unlikely that PNG will benefit from the leadership required for making the tough decisions rather than taking the easy way out.

Paul Flanagan is a Visiting Fellow at the Development Policy Centre.

This blog was originally published as part of an East Asia Forum special feature series on 2015 in review and the year ahead.

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Paul Flanagan

Paul Flanagan has a longstanding interest in public policy issues in Australia, PNG and more broadly. His 35-year public service career was evenly shared between Treasury/Finance and AusAID. He headed up Treasury’s International Finance and Development Division from 2008-2011 before being seconded to a senior advisor position in the PNG Treasury until August 2013. He is Director of Indo-Pacific Public Policy and Economics, a leading commentator on economic developments in PNG, and a frequent contributor to the Devpolicy Blog.

3 Comments

  • Thanks Frank
    I’ll be in contact to get a copy of the policy as it isn’t available on any websites. There appears to be general agreement that the SME sector is important for more inclusive growth in PNG – and I certainly share that view. The leadership challenge is putting that objective into practice – both in policy formulation as well as implementation. Unfortunately, the new policy sounds as if it may be quite close to the scheme described by Minister Maru early in 2015 which the Prime Minister subsequently described as “unfortunate” – so it would be good to get more details. The ADB’s work on SME policy suggests that broad business policy settings are vital – making it easy to start up and run a small business; creating an environment in which successful businesses are able to grow; and supporting the development of human capital through education and training. “Special policies can have unintended consequences and can ultimately undermine the broader objectives of social and economic development.” I hope that relevant organisations in PNG can make clear to the government the likely consequences of any policy based primarily on taking over existing businesses rather than growing new ones (as implied by your comment). There will be an active debate on the issues – this Crocodile Prize entry and subsequent discussion indicates some of the passion and issues. When reading the media reports of the policy, I was gobsmacked by the objective of creating 500,000 SMEs by 2030. This sounds great but appears based on some very, very optimistic modelling. PNG’s business community should ask for such models to be peer reviewed. My experience is that “money tree” models lead to poor policy decisions. A distinction between the informal sector and the SME sector may also be important in any revisions to the 1992 IPA Act. Pending getting more details, it is not clear from media reports that there has been the necessary hard headed analysis of what actually delivers on the goal of improving well-being for the citizens of PNG. There is much to be learnt from PNG’s own experience with the “reserve list”, on its experience with failed forms of protectionism especially on “infant industry” arguments, and learning from other Asian nations of what actually stimulated inclusive growth. I’ll also be interested to see if the policy talks about removing the foreign exchange restrictions and addressing the over-valued Kina which are hindering the opportunities for PNG’s small businesses to export. Cheers. Paul.
    PS I’ll pass on the Zimbabwe comment. The Australian Financial Review headlines last month got me into trouble. Time will tell. But the SME policy, as well as the recent agriculture policy, seem to be more “muddling down” rather than “muddling through”.

    • Paul, many thanks for your thoughtful and detailed response. It has now been six months since the SME policy was distributed. While the policy has not been implemented it has led to a discouragement of foreign investment especially from investors already in PNG. These investors have the potential to reinvest their depreciation and profits but most are unwilling to do so if there is a policy that illegalizes these investments. The policy has unfortunately led to plans or implementation of disinvestments. The SME Policy comes on top of the problems faced by domestic producers of an overvalued kina and the lack Of foreign exchange. Neither of these critical problems have been adequately addressed with needed changes in policy. Frank.

  • Dear Paul,

    Last Friday Minister Richard Maru and the Prime Minister issued a new SME Policy aimed at making 70% of the companies nationally owned through the required sale of these companies to PNG Nationals. This is probably the most devastating policy we have ever witnessed. All companies with less than 200 employees, K20M in investments, or K15M in Sales are aimed for confiscation. I say confiscation as if we have several thousand companies for sale with the only purchasers| PNG Nationals the price may tumble to 5-6% of book value. Once taken over where is the technical experience to run these companies|? It would appear that we are on a path of Zimbabwe. All is worthwhile of your investigation and printing of a new blog.

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