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PNG’s 2017 Budget – Fiscally Fraudulent

PNG’s 2017 budget was a key opportunity to demonstrate the credibility of the government’s economic management before next year’s election.  It fails.

Foolish games with numbers and unrealistic assumptions severely undermine the budget’s credibility (detailed examples on the revenue and expenditure side are provided below). Indeed, the level of deception arguably approaches fraud – an intention to gain advantage either politically or from investors.

A major winner from the budget are overseas petroleum shareholders with proposed cuts in the company tax rate from 45% (new fields) or 50% (old fields) down to 30%. This will be of particular joy to Oil Search and others that will gain from a new possible Papua LNG project – but they are possibly accessing the lower rate for condensate already. PNG’s tax regime for the petroleum sector was already considered generous relative to world standards – it now will be even more so. And although some of the changes mirror suggestions in the Sir Nagora Bogan tax review, off-setting elements such as the introduction of a capital gains tax and reduced tax incentives are not mentioned in the budget changes. Overall though, the standardisation of rates, and mild action to increase revenues in some other areas, are welcome.

Concessions to the petroleum sector and only moderate tax increases represent interesting choices for a government given the announcement of major cuts in key areas such as health, education and infrastructure. The future expenditure cut pain is also severe with further foreshadowed cuts of 34% in real terms from 2017 to 2021 except for Provinces with “only” a 25% cut.  Even from the 2016 budget, the cuts are very large.  Going against this trend of massive cuts, and in part reflecting the needed priority on the election (K400m) but also the more optional K250m for APEC in 2017, the administrative and “community and culture” areas are the only sectors that grow in real terms between the original 2016 budget and the 2017 budget.  As shown in the table below, in stark contrast to the government’s claimed priorities, the real cuts to health are 29%, to education are 18% and to transport are 35%. No wonder most of the expenditure reduction figures shown in the budget “spin” documents only express the cuts relative to the 2016 revised budget.  This ignores the major  expenditure reductions made between the 2016 budget and the revised 2016 budget flowing from the collapse in domestic revenues. This is at best convenient.  (The sectors of key government priority are shaded in green – they are generally the ones with the largest cuts – all of them incurring greater cuts than the average cut shown in the final row on totals).

 

png-2017-budget-sectoral-expenditure-cuts

Of course, key election elements are protected.  For example, K20m is still provided to fund the “free health” policy.  This represents less than 2% of the total health budget and is minuscule relative to the K315m cut in health in this 2017 budget.  The K20m “free health” policy is a smokescreen for the major cutbacks in health that are hurting church services and the level of assistance provided by health centres.  There is essentially no mechanism for distributing these funds down to rural clinics – so simply banning the collection of any fees means that these clinics are forced to operate without basic medicines or to close down altogether. “Free health” becomes “No health”.

Following are some examples that severely damage the credibility of the budget. There is a systematic pattern of choosing numbers to fit the budget’s key claimed theme of “Responsible Fiscal Consolidation”.  My earlier blogs on the 2015 and 2016 budgets have highlighted a range of errors in the budget numbers.  These were usually clumsy, accidental, or appearing to mainly reflect errors. However, there is an underlying pattern of distorting usual budget forecasting methodologies, not present in previous budgets, that makes it hard to conclude other than that the assumptions are driven to deceive. The gain from the deception is potentially electoral and investment credibility and gain.  Calculated deception for gain amounts to fraud in usual understandings of the term.  This is a budget that should not be trusted.  Some more details on the factors that undermine the budget’s credibility are provided below.

On the revenue side,  the budget assumes that an extra K16 million for the Internal Revenue Commission will magically produce a K400 million increase in revenue – all in 2017. Increased resourcing to the IRC should help increase revenues, but it has not helped over the last two years despite more and better paid staff.

  • The practicalities of needing to go through additional recruitment and training of new staff are ignored.  Such a pay-off figure of K1 extra in IRC resources producing an extra K25 in revenue is unrealistic – the figures used by tax agencies is more usually in the range of 5 or 8 to one over time, not 25 to one.
  • Company tax levels are expected to increase from an estimated K2,305m in 2016 to K3,322m in 2021. This 44% increase just does not seem credible – and it is a vital K1 billion assumption in closing the budget deficit hole.
  • Meanwhile, there are major revenue holes that appear in the budget that are very difficult to explain. In the 2016 revised budget, there is K725m shown as payments into the SWF from the “sale of shares” (Table 14 in Appendix 3). This is a surprise as there appears no public announcement of that sale having been completed.  In accounting terms, this is simply swapping on capital asset for cash – it should be shown as a ‘below the line’ transaction which should not affect the deficit – it just lowers the off budget assets of Kumul Petroleum Holdings – and this may have implications for other debt held against these off-budget assets.
  • Meanwhile, Kumul is paying no dividends through the PNG Sovereign Wealth Fund.  The SWF is effectively dead and certainly the Savings Fund is projected to have no assets going forward.

On the expenditure side, from 2017, there is a straight cut of 11 per cent in nominal terms, and 34 per cent in real terms after allowing for inflation, in all sectors other than provinces.  This is not a credible approach.

  • The impossible claim is that debt servicing interest costs will fall from K1,480m in the revised 2016 budget down to K1,393m in 2017, and then down to K1,290m in 2019.
    • This is just not possible given growing nominal debt levels and the increasing costs of moving the debt portfolio to longer terms (there has been a major reliance on short-term funds to finance the massive increases in government debt – this has distorted debt portfolio planning and the government is intending to move to higher priced but longer term debt to reduce the increasingly high risk of debt rollover default ).
  • At least in the 2016 budget, where smaller deficits were predicted through to 2019, it had the sense to admit that interest costs were likely to rise to K1,553.6m by 2019 (compare the figures in Table 12 of both budgets).
  • Once again, this type of game, despite increasing debt levels, which produces K263m to close the budget deficit, appears to be deliberate and simply deceptive.
  • The flat cut of 34% in real terms to all sectors other than Provinces also indicates a severe lack of forward planning and budgeting systems.  This level of reduction is well above what can be obtained through usual “efficiency dividend” numbers of 2 or so percent per year where sometimes all departments face a similar cut.  This will have to severely cut into departmental programs and staff numbers.
  • Numbers appear to have  been arbitrarily chosen to produce the desired reduction in the deficit and to control debt levels.  The “assumed” cuts from 2017 to 2021 are worth over K4 billion – this  is where all the work is being done to cut the deficit and cut debt levels (Table 12 – 2017 expenditure of K13,350m, 2021 nominal expenditure of K12,462m or K9,133m after allowing for forecast inflation of 7%, 6.6%, 5.6% and 5.2% during the four years – so a cut of K4,217m in 2017 Kina terms).

The financing for the budget deficits also do not seem to be fully considered.

  • For example, Table 10 Appendix 3 still indicates for the 2016 revised budget K2,800m in extraordinary financing.  This is the value of the Sovereign Bond that was assumed in the 2016 but has not been delivered – and is unlikely to be delivered by the end of the year.
  • As noted above, it is also assumed that the PNG LNG shares are sold by the end of the year for K725m.
  • These are key sources of financing given the difficulties of accessing domestic bond markets. There may be a cash flow crunch around the corner if these assumptions do not occur.  The Credit Suisse funding does not get close to filling this looming cash crunch hole.

Overall, it is important to map out a course to return to fiscal sustainability. The massive deficits entered into in 2013 and 2014 were a huge gamble, and the fall in commodity prices means the gamble did not pay off. However, fiscal policy must be credible. There are too many at best errors, but more likely deliberate manipulations in this budget to restore credibility in PNG’s economic management.The best way to fix the budget is encouraging higher domestic economic growth.However, poor policy choices in areas covered in other blogs such as the exchange rate and policies that are likely to undermine growth (SME, land, agriculture). The best option for fixing the budget, stronger rates of broad-based growth, is unlikely.

PNG’s Economic History Since Independence

[This article is being updated to reflect new NSO GDP figures.]

PNG’s 41st anniversary of Independence is tomorrow, so following are some reflections of its economic history.

Key elements of PNG’s Economic history since Independence

Summary
  • The PNG economy is 3.3 times larger in real terms than at the time of Independence.
  • For every Papua New Guinean at the time of independence, there are now, on average, 2.6 people.
  • Jobs growth has not kept up with population growth.
  • Real incomes have fallen by 4% since Independence – a long way from PNG’s understandable aspirations.
  • PNG’s greatest policy mistake since Independence has been too much focus on natural resources (such as LNG, or gold, or logging) rather than people resources.
  • Focusing on natural resources has tended to create a dualistic economy with development benefits captured by few.
  • The resource sector has had very limited impacts on the vast majority of people in PNG and it is highly variable. The start of production from the Kutubu oil fields and new mines in the early 1990s led to massive increases in measured GDP of  36% between 1991 and 1994 – even larger than the 25% real GDP increase over 2014 and 2015 driven by the commencement of the PNG LNG project. However, by 1994, PNG had fallen into recession and cash and foreign exchange shortages.  And by 2015, history is repeating itself as PNG has fallen into recession again after the promise of rivers of resource revenues led to poor fiscal, monetary and structural policies.
  • The resource curse also leads to a “strong Kina”.
  • A “strong Kina” hurts local exporters (including rural farmers), local production and encourages people to invest outside of PNG rather than in PNG. It is likely a key reason why PNG has missed trade globalization. A more competitive price setting with the rest of the world is the easiest policy change to help steer PNG on a better development course.
  • There is widespread and growing concern in PNG about a decline in the quality of government service delivery. In addition to concerns about quality and governance, one element of this is that the real level of government expenditure per person has decreased since independence from K1,873 to K1,851.
  • With larger budget deficits and greater local tax collections, the primary cause for this decline in government expenditure is the significant decline in aid per head. This has dropped dramatically – from around K660 per person down to K170 – a real drop in support per capita of 75 per cent. Falling service delivery is strongly linked to the fall in Australian aid.
  • PNG has enormous potential and opportunities. This potential has not been delivered to its people.
  • May PNG have better policies, better institutions and a more inclusive form of development over the next four decades to better meet the deserved aspirations of its people.
Economic growth since Independence

The PNG economy, after allowing for inflation, is 3.3 times larger than in 1975. Many people doubted that this would be possible at the time of Independence given the challenges and uncertainties facing the new country. This growth is probably clearest in a place such as Port Moresby – it is a much more modern city with freeways, flyovers, luxury hotels, traffic jams, pollution, large shopping complexes and many taller buildings downtown. This in part reflects the strong urban bias of PNG’s economic policies.

For PNG, almost all of this real growth can be accounted for from population increases. Since Independence, the population has increased from 2.9 million to an estimated 7.6 million. For every Papua New Guinean at the time of independence, there are now, on average, 2.6 people.

The total number of people in the formal sector has slightly more than doubled according to Bank of PNG business surveys. While jobs growth is positive (a 2.1 times increase from 1978 to 2014), it is disappointing that it has not even kept up with population (a 2.6 times increase). In other words, the share of working-age people getting jobs in the formal economy has been falling. This is not inclusive growth.

PNG is described as a resource dependent economy. This is unusual terminology as the non-resource sector has accounted for between a high of 93% of the economy (in 1984) and its lowest share of still 70% (in 2006). The resource sector has had very limited impacts on the vast majority of people in PNG and it is highly variable. The start of production from the Kutubu oil fields and new mines in the early 1990s led to massive increases in measured GDP of around 36% between 1991 and 1994 – even larger than the 25% real GDP increase over 2014 and 2015 driven by the commencement of the PNG LNG project. However, by 1994, PNG had fallen into recession.  And by 2015, history is repeating itself as PNG has probably fallen into recession again after the promise of rivers of resource revenues led to poor fiscal, monetary and structural policies.

A better measure of economic performance is to focus on non-resource GDP – shown in orange in Figure 1 (reliable non-resource GDP information is only available from 1980). Non-resource GDP grew very slowly for the first two decades from 1980. Over the late 2000s, there was more rapid growth, but this had slowed by 2010.

Figure 1: Non-resource GDP and GDP per capita in 2015 Kina

non-resource-gdp

An even better measure of economic performance is using per capita figures – so how much income is generally available per person. This is shown in the blue line. Unfortunately, this line trended down through both the 1980s and 1990s. The sharpest decline was related to the economic crisis of the late 1990s. A pattern of recovery slowly commenced from 2005, but this has flattened out since 2012 and is now in serious decline. By 2015, using a five-year average, incomes are four per cent lower than they were in 1980 (the 5-year average of real non-resource GDP per capita was K4,604 from 1980 to 1984 and K4,443 from 2011 to 2015 – a drop of 4 per cent – the drop in real incomes is larger if the comparison is just between 1980 and 2015 – a drop of 8 per cent.) On this key measure of economic well-being, real incomes in PNG have gone backwards. And emerging data for 2016 indicates this continues to get worse.

This is very disappointing, and a long way from the aspirations of people at the time of Independence. It is also a long way from future aspirations shown in Vision 2050. Why is this so?

PNG’s Resource curse – history repeating itself

PNG’s greatest curse flows from the intersection of nature’s resource gifts and economics. The “resource curse” has and continues to destroy many economies. A cure was tried in PNG (through the Mineral Resource Stabilisation Fund – and this was a better model than the current flawed Sovereign Wealth Fund model), but the combination of corruption, poor politics and poor economic policy means the resource curse remains the greatest burden hindering real development. The resource curse underpinned the Bougainville civil war and still risks fracturing the PNG state with daily newspaper reports of landowners being unhappy with their share of resource benefits. In a slow and insidious way, the resource curse impacts on the exchange rate, paralysing opportunities for integrating PNG into the Asian century.

PNG’s greatest policy mistake since Independence has been too much focus on natural resources (such as LNG, or gold, or logging) rather than people resources. Focusing development efforts around people, such as support for smallholder agriculture or encouraging the informal sector, tends to lead to a pattern of development with more widespread and inclusive benefits. Focusing on natural resources has tended to create a dualistic economy with development benefits captured by few.

I am saddened when I read comments in PNG lamenting the decline of the Kina relative to the US dollar since a peak was reached in 2013. A “weak” Kina is considered a source of national shame. As an economist, this is a stupid argument – but more profoundly for PNG’s development, it is a dangerous argument.

For the over 2 million people who earn most of their income from cash cropping, a “strong” Kina is bad news as it means they get less Kina for every bag of coffee or cocoa that they sell. What is known as a “strong” Kina is in fact very bad for all exports and trade competing industries such as agriculture, fisheries, tourism and SMEs. However, for a public servant in Port Moresby, a “strong” Kina means that a bag of rice or a new digital TV will become less expensive.

A “strong” Kina also has social implications. It creates a strong incentive to leave the cash cropping opportunities in rural areas and move to an urban area in search of a formal sector wage. It has strong gender impacts as it undermines the value of the work of women in domestic agriculture. It increases the incentives for Papua New Guineans to send their money overseas either for property investments in Cairns or to send their children to school overseas. It hinders foreign investment in PNG by making it more expensive relative to other destinations.

This one price, the exchange rate, has very powerful impacts on nearly all aspects of development.

The resource curse leads to a “strong Kina”. The best exchange rate measure is something called the “real effective exchange rate” or REER. This measures movements in the Kina relative to its major trading partners as well as inflation rate differences. In the following graph, the higher the curve, the more competitive the PNG economy.

Figure 2: PNG’s competiveness (shown by the real effective exchange rate)

pngs-competitiveness

The initial “hard Kina” policy in the early years after independence was arguably justified on the basis of maintaining macroeconomic stability – but it certainly decreased PNG’s competitiveness at this crucial time in the country’s development. The floating of the Kina in 1994 in response to the poor policies around the Kutubu oil resource boom started an on-going improvement in competitiveness until 2007. However, the effects of the PNG LNG project and poor policy interference in the exchange rate have dropped competitiveness levels to less than at the time of Independence. Improving PNG’s level of competitiveness through the exchange rate is possibly the most important single policy instrument for improving PNG’s development prospects.

However, improving competitiveness will have major distributional implications – those reliant on exports will become better off, those reliant on imports will become worse off. This will generally benefit rural areas and hurt public servants and many urban area residents. It will benefit businesses reliant mainly on domestic PNG production and hurt businesses reliant mainly on imports. There are dynamic elements to such an adjustment. The short-term losers will tend to speak out loudly while the long-term gains for SMEs and new businesses suited to the more internationally competitive opportunities in the Asian century will be silent. Sustaining such a policy is politically difficult. And as there is no “silver bullet” in development, this change needs to be complemented by many general improvements in public policy (such as better regulation, more inclusive and sustainable policies, appropriate infrastructure, improved law and order, less corruption, control of wages and prices, greater gender equality and a better educated and healthier workforce).

Government expenditure falls driven by falls in Australian aid

There is widespread and growing concern in PNG about a decline in the quality of government service delivery, although the experience differs between provinces and even sectors (for example, education appears to be doing better than health).

Amongst these many complaints, there are some mitigating factors. Even maintaining basic service delivery was going to be a challenge given the very large increases in population requiring massive increases in teachers and classrooms and medical staff. A rarely mentioned fact is that the real level of government expenditure per person has decreased since independence (see figure 3). Taking five year averages to smooth out annual fluctuations, real expenditure per person has dropped from K1,873 to K1,851 (the purple columns). So a slight decline in services could be expected even if there wasn’t an increase in corruption or a decrease in the ability of institutions to deliver.

What have been the drivers of this decline? Fiscal policy has been loosened with larger deficits – so this isn’t the cause. Domestic revenue raising per head (the green columns) has risen by just under 30 per cent – a credible performance given the fall in non-resource GDP per capita since independence. The primary cause is the significant decline in aid per head. This has dropped dramatically – from around K660 per person down to K170 – a real drop in support per capita of 75 per cent. Falling service delivery is strongly linked to the fall in Australian aid.

Figure 3: PNG’s budget structure

png-expenditure-and-revenues

Conclusion

PNG has enormous potential and opportunities.  This potential has not been delivered to its people. PNG is burdened with too much of its past. There are still too many remnants of it being a 1975 colony of Australia rather than a modernizing Indo-Pacific nation. Overall, I remain an optimist about PNG’s future but there are still decades ahead of often painful development choices and learnings.

There are many interacting elements that help improve well-being – and the most important ones are not economic ones. However, if I was to suggest one key change in policy priority it would be to focus on people rather than resources.

The resource focus and subsequent “strong” Kina aspirations are yokes on development. This manifests itself through the myth of a “strong” Kina. This myth is biased against local exporters, local production and encourages people to invest outside of PNG rather than in PNG. It is likely a key reason why PNG has missed trade globalization. A more competitive price setting with the rest of the world is the easiest policy change to help steer PNG on a better development course. And it will help deal with nationalistic tendencies without imposing more destructive policies such as import bans or inefficient government led monopolies.

May PNG have better policies, better institutions and a more inclusive form of development over the next four decades to better meet the deserved aspirations of its people.

Launching of PNG Economics website

This PNG Economics website will be launched officially at the Australia PNG Business Forum in Cairns on 15 to 17 May 2016.

This Business Forum is the type of institutional linkages program vital for keeping the people to people links between our two countries. My view is that support for such programs should be the prime form of mutual assistance to PNG through the aid program (with investment, trade and other linkages also being vital). Reasons for such linkages are outlined in some detail in the following submission to an Australian parliamentary inquiry on Australia’s bilateral aid program to PNG by clicking here and public hearing here. This report was released recently – although as it is a Senate Report with a minority of government members, the key recommendations likely to be adopted are shown on pages 85 onwards as shown here.

The recent youth forum involving sharing success stories between young PNG and Australian entrepreneurs is also an excellent example of co-operation (see here).

Following the Business Forum, I will provide some posts on key conference presentations. As a heads up, it now appears quite certain that even the cut-back IFC loan proposal (see earlier post) will not proceed.

Welcome to PNG Economics

Welcome to PNG Economics.  This website is under construction.  New material will be added regularly.

PNG Economics provides timely, accurate, frank and fearless analysis of PNG’s economy and business environment. Such analysis helps answer vital questions facing businesses such as: “What are PNG’s economic opportunities and risks?”; “What strategies are appropriate for PNG’s changing times?” and “Would your business have benefitted from early warnings about exchange rate shortages or a government cash crisis?”. Those businesses which listened to earlier analysis stood to gain a competitive advantage and protect their shareholders and customers. The analysis by the firm’s principal, Paul Flanagan, has been attacked by government, but it has proven to be prescient and accurate. PNG Economics operates this free public website which provides regular high level analysis and general information on PNG’s economy (www.pngeconomics.org). More in-depth analysis, including research for specific firms, is available on a paid basis. The firm also records PNG’s economic history – such as 4K future-proof interviews with business leaders.

This early iteration of the website draws on articles published by that excellent source of development information, the DevPolicy Blog. These articles are on occasion (marked in text) with other members of the Development Policy Centre.  They include comments when provided on that site. See http://devpolicy.org/author/paul-flanagan/ .

As part of future development, this site will include more information suitable for students of economics in PNG, including links to other websites. It will also include links to press coverage of economic issues in PNG. Material on PNG’s economic history, including interviews with former leaders, will also be added.

PNG Economics is part of a broader company, Indo-Pacific Public Policy and Economics Pty Ltd.

The Director PNG Economics is Paul Flanagan. A CV will be provided on an updated site as well as more contact information. Broadly, Paul has 35 years of public policy experience shared between overseas aid (with AusAID from 1986 and 2002) and Finance/Treasury agencies (1978 to 1980 at the Australian Department of Finance, 1985-86 Australian Treasury, 2002 to 2011 Australian Treasury, Feb 2011 to Aug 2013 PNG Treasury, Sept 13 to June 2014 Australian Treasury). He was a Visiting Fellow at the ANU from August 2014 to December 2015. He is now working on his own consultancy firm.