The Bank of PNG, the legislatively independent central bank for the country, lost significant credibility in its recent justification for why PNG has joined the bottom 2 per cent of countries in refusing to release the standard IMF Article IV report on countries (see here).  It remains the only country in the East Asia and Pacific not to release an IMF Article IV report undertaken in 2016.

BPNG provided six “critical issues” for refusing to release the report.  However, on closer examination, there was only one critical issue (fake GDP numbers used by the PNG Treasury).  And that should be the responsibility for the PNG Treasurer to release a statement on why the PNG was suppressing an independent assessment  by the IMF of the PNG economy.

What is the O’Neill government trying to hide on its management of the PNG economy?

International investors will easily through see this statement. PNG’s economic standing and credibility has received a severe down grade with this BPNG statement which confirms many investors’ fears.

Detailed comment

Four of the six “critical issues” mentioned by the BPNG statement were present in the 2015 Article IV report and this did not stop publication. A fifth issue (the last one) is a procedural one on publication without agreement.  The only remaining issue is the fake GDP numbers from March 2016  that the IMF apparently refused to endorse. And this is one for the PNG Treasurer to front up to – not comprising the role of the central bank.

First, on the long-standing methodological differences on how PNG does not use standard international reporting practices on measuring “2.  Months of Import Cover” the 2015 Article IV report reported that the Gross Official international reserves were 3.1 months of goods and services imports in 2015 (see here page 4 about two thirds of the way down the page).  The BPNG has taken great exception to this figure being revised 3.0 of months of imports in 2015 according to the press release.

So why didn’t it object in such a way last year as to oppose the publication of the report of 3.1 months of imports (listed as a preliminary assessment) but strongly objects to a figure of 3.0 of imports??

Second,, BPNG jumps up and down about the incorporation of an Article VIII assessment (issue 3 and 4).  But this did not create issues last year.  Issue “3. No Breaches of Article VIII” clearly indicates that PNG has not yet moved down the path of a multiple currency practice..  However, on issue 4 related to Tax Clearance Certificates, see this quote from the 2015 IMF assessment:  “PNG maintains an exchange restriction subject to IMF approval under Article VIII, Section 2(a) of the IMF’s Articles of Agreement arising from the requirement to obtain a tax clearance certificate evidencing the payment of all taxes prior to making payments or transfers for certain current international transactions.” (end of paragraph 19 here ).

So this was already in the 2015 report which was released.  Why now use it as a grounds for suppressing the 2016 report??

More specifically, the 2015 Article IV report stated in paragraph 37:

“37. A further depreciation is needed to safeguard external buffers and eliminate imbalances in the FX market. To these ends, BPNG should allow the exchange rate to be more market-determined and move quickly to a market-clearing rate. This should be supported by suitably-tight fiscal and monetary policies. To facilitate this adjustment and improve monetary policy effectiveness, BPNG should mop up excess liquidity in the banking system. Staff does not recommend Fund approval of the tax clearance certificate regime as it is not temporary and has not been imposed for balance of payments reasons.”

So in the 2015 report the government of PNG was willing to release the assessment but with disagreements in authorities comments.   Why now suppress the 2016 report which probably had similar conclusions?

The third issue (listed as item 5) was on the “Foreign Exchange market”. The BPNG already stated in the “authorities views” response (so the views of the government of PNG) in the 2015 Article IV report (see page 33) that “The official interbank exchange rate was unchanged from October 2013 to early June 2014, when the BPNG introduced a foreign exchange (FX) trading band of 150 basis points around the official interbank rate, leading to a de facto kina appreciation of around 17 percent. Since then the exchange rate has depreciated by 16 percent, but excess demand for foreign currency has persisted. ”

So last year, the BPNG accepted there was  a defacto appreciation of around 17  per cent in early June 2014.  So why are they now objecting, and using it is a ground to suppress the IMF report??

The biggest broken promise

There is a vital response from authorities in the 2015 Article IV (see here page 11). This comment is of particular interest given the recent confirmations from the Governor of PNG that the central bank is now backstopping government security auctions and so directly financing the government budget deficit.

“BPNG also reiterated its intention to avoid any direct financing of the government budget deficit.”

The central bank has reneged on this vital commitment.

This is a shameful development from the legislative independence of the central bank.

Conclusion

Countries may disagree with IMF assessments.  But releasing their reports with alternative views is the accepted international norm.  PNG has lowered itself considerably by refusing to release the IMF 2016 assessment report.

The arguments for not releasing this report are primarily a lie – PNG released a very similar report in 2015 with its own views last year.

The press release by the BPNG does not add credibility to the independence of the central bank or the government as a whole.

The only new issue is the fictitious view of a magical increase in the size of economy of over 40% in 2013 to bury the debt to GDP ratio breaching legislative limits – and the international arbitrator of the IMF does not accept the revisions.

The PNG Government is very much in election mode.  Unfortunately, and in a trend evident in other countries, the truth is no longer valued as much as citizens once expected from their governments.

This is an immoral development for PNG.

 

 

 

PNG’s government must be embarrassed by the International Monetary Fund’s (IMF) assessment of its economic performance. In an extraordinary step, and the first time in PNG’s 41 year history of Independence, the PNG government has refused to release the IMF’s 2016 summary of the PNG economy. 98% of countries agreed to release this information in 2015 – so the PNG government has moved to the bottom 2% of governments when it comes to economic transparency.

In the IMF’s final press release (see here) before Christmas (generally seen as a good time to bury bad news), the International Monetary Fund indicated that “The [PNG] authorities need more time to consider the publication of the staff report and the related press release.” This appears to be polite IMF diplomatic speak for the PNG government not wanting to release the information. The IMF mission visited in mid-2016. An early draft asking for PNG government comments would have been provided about two months ago. A draft report was considered by the IMF Board on 29 November which would have included PNG’s comments on the staff papers. There has been more than enough time for the IMF’s views to be considered and for the PNG Government to respond.

If there is some genuine reason for needing more time then this could have been provided. In the absence of any explanation for this unprecedented delay for PNG, and an action so out of step with nearly all other countries, it is impossible to conclude other than the PNG government disagrees with the IMF’s assessment. Rather than engaging in open, democratic public debate, it simply doesn’t want alternative views published (at least until after the January Parliament session or the mid-year elections).  This just adds to the emerging pattern of reduced transparency from the O’Neill/Dion government.

Release of the IMF Board’s assessment and the related IMF staff documents is considered “voluntary but presumed” according to the IMF’s transparency procedures. Specifically, these transparency guidelines (see here) state “In 2015, 98 percent of member countries agreed to publish a press release, providing the IMF Executive Board’s assessment of the member’s macroeconomic and financial situation…”. So PNG has joined a very, very small set of countries at the bottom of transparency tables.

Why does this matter?

First, PNG has been actively seeking international financing to cover its foreign exchange and budget financing shortfalls following the largest budget deficits in PNG’s history.  With such a lack of transparency, the chances of obtaining a Sovereign Bond are effectively zero. International investors will be looking for adequate information from a trusted international source (the IMF) to assess the risks of investing in a PNG bond.

Second, such actions will also flow into assessments of PNG by other international lenders – not through formal requirements but through growing concerns about PNG falling back on central bank financing of deficits, moving to a fixed exchange rate and having a medium-term fiscal adjustment path that lacks credibility.

Third, international credit agencies will view this development with concern. Countries with similar or even lower credit ratings do allow this information to be published. The question always becomes “What are they trying to hide?”

Fourth, this will affect broader investor confidence in PNG. It is not just the quality and availability of the resource riches in PNG that attract investors – it is a broader set of issues including economic management and transparency. Hiding information will affect future economic growth possibilities.

Finally, and most importantly, the people of PNG have lost a key source of reasonably independent information for judging the performance of the O’Neill/Dion Government. During 2016 there have been growing doubts about the credibility of information being provided by the Government. More detail on the concerns that could have been alleviated by the IMF assessment are provided in the appendix at the end of this article. They cover issues such as: the Treasurer’s confusion about the actual size of PNG’s economy; the severity of PNG’s falling growth performance; PNG’s unfortunate retreat to printing money; serious credibility issues around budget revenues, expenditures and financing; the move to a fixed exchange rate and linked foreign exchange shortages; and what are increasingly seen as anti-growth policies. If the O’Neill/Dion government was doing as well as it claimed on such issues, it should have been in a position to welcome the IMF report.

Conclusion

I have been critical of many of the PNG government’s numbers during 2016 (details below).  In my blogs, I have talked of recent PNG figures lacking credibility, policy confusion, and even of fraudulent practices in the latest budget. The IMF report could have proven the PNG government was right and that I was wrong.  Instead, the O’Neill/Dion government has chosen a dishonorable path of suppressing information by a well-recognised international source – the IMF.

In 2015, the only two IMF members that did not publish a press release with the Board’s assessments (indeed, they did not publish a press release at all) were Suriname and Dominica. Ironically, less than 12 months later, both countries were in IMF programs trying to sort out economic crises. If there is a change of PNG’s government in mid-2017, it is likely that assistance will have to be sought from the IMF and other concessional sources of finance to help deal with PNG’s partially hidden economic mess. If there is no change of government, and even with the boom of another few big resource projects, PNG is likely to continue down a slippery slope of poor economic outcomes for its people and declining transparency on economic management. That the O’Neill/Dion Government felt the need to hide the feedback from the IMF is a shameful way to start 2017.

Appendix: Detailed issues requiring clarification

GDP size: In March 2016, the government suddenly announced that the size of the economy had increased dramatically – by 53% in 2006 alone and still a magical 40% higher by 2013.  These higher estimates are the entire basis for the government claiming its debt to GDP ratio is just below 30% and thus under the legislated limits under the Fiscal Responsibility Act. But there has been on-going confusion as to what figures to use – the 2017 Budget document used multiple versions (see here).  Even at the recent PNG Mining and Petroleum Investment Conference, the Treasurer stated in his 2 December speech, when talking about the strength of the PNG economy, that it will grow from K47.3 billion in 2015 to over K57 billion in 2017. If we use these nominal GDP numbers with Treasury’s official debt numbers for 2017 of K21.6 billion, the government would be exceeding its debt to GDP limit imposed by the Financial Responsibility Act with a ratio of 37.7% – well above the 30% limit (official central government debt of K21,623.3m from Table 12 of Appendix 3 in 2017 Budget Volume 1 divided by K57,337.6m from Table 1 of the same appendix).  This would directly contradict what his Prime Minister said just 15 minutes earlier to the audience of over 1,000 potential investors. The on-going trouble is that PNG is using two very different sets of GDP numbers.  It is confusing for others, and it appears to be confusing for even PNG’s Treasurer and Prime Minister.  An IMF view on the updated GDP figures would have helped clarify matters for everyone.

GDP growth rates: the government has admitted that GDP growth rates have fallen from their inevitable PNG LNG highs down to a level below or at similar levels to population growth rates. However, there are many other indicators that are so negative that it is almost certain that PNG’s non-resource GDP has gone through a serious recession during 2014 and 2015. The official government figures on growth include real growth in the agriculture sector in 2015 of 1.9%. Such claims were counter-intuitive given that PNG’s subsistence agriculture sector was suffering from its worst drought in 20 years, widespread hunger was being reported, and key cash crop exports had dropped by minus 56% for tea, minus 36% for rubber, minus 20% for cocoa, minus 12% for coffee, minor drop in palm oil, a large increase in copra and copra oil (but the latter account for only around 3% of the total value of agriculture exports – BPNG QEB tables 8.4 and 8.3). The IMF report would have helped clarify the growth story – without such clarification, the conclusion is that the official numbers simply lack credibility.

Printing money: PNG’s central bank started buying large amounts of government securities from the beginning of 2016 (see here).  This is equivalent to printing money. It means that there is no short-term cash shortage, but it also is a very risky approach that undermines confidence, threatens high levels of inflation, exacerbates foreign exchange shortages for the private sector, and puts stress on the entire banking system. The IMF’s views on such developments would have been extremely useful. Without them, it is hard to argue against a view that PNG is heading on a slippery slope towards a Zimbabwe style economic crisis (the author of this article observed this downward drift as Director of AusAID’s aid programs to Africa and the Middle East from 1997 to 1999).

Budget revenues: PNG’s budget revenues have collapsed over the last four years. The main cause has been a fall in domestic revenues reflecting mainly the end of the PNG LNG investment boom and the resultant recession, but also the diversion of dividends to an ambitious government petroleum development company (Kumul Petroleum) and the fall in international commodity prices (see here). Revenue forecasts for 2017 appear to be over-estimated by more than 10%. New tax measures are required to balance out the excessive level of cuts imposed in key areas such as health and education. An IMF view on budget prospects would have been useful, as well as any comments about what has been going on in off-budget funding for state owned enterprises (including the purchase of a 10% government stake in Oil Search shares).

Future budget expenditure: The 2017 budget continued forecasts of very significant cuts to key areas of expenditure such as infrastructure, health and education expenditure (these cuts have exceeded 45% in real terms from 2015 to 2017). The expenditure cutbacks are more severe than those imposed on Greece as part of its austerity program (they balanced expenditure cuts with revenue increases). The move to a more sustainable budget position is necessary after PNG recorded its largest fiscal deficits ever in 2013 and 2014. A shift towards lower deficits is a welcome policy development, but the actual pattern of planned cuts does just not seem credible or appropriate. Specifically, the 2017 budget assumed that there would be identical real cuts in expenditure in all sectors apart from Provinces over the next two years. Such uniform cuts are illogical as they assume, for example, that interest costs will go down despite the continuing growth in public debt. The IMF’s views on these approaches would have been useful, including views on the level of accountability of the extraordinarily high constituency funding through the District Improvement Support Program and the lack of reductions in spending on public service administration. In addition, its views on the actual costs of hosting the APEC conference would have helped deal with differences of view.

Budget financing: PNG is on a treadmill of increasingly short-term public debt that must constantly be re-financed. Using the 2017 budget figures, and excluding the very unlikely K2,800 million assumed from the Sovereign Bond, PNG needs to finance through its domestic auction of Treasury Bills and Bonds nearly K1 billion per month.  The total required financing challenge in 2017 totals at least K13.075 billion  – 106% of total PNG government expenditure.  With the growing likelihood that the private sector will retreat even further from providing financing (for example, the 14 December 2016 weekly auction only raised K218 million of the K726 million being sought) there is likely to be even greater use of printing money – and all of its inevitable risks for PNG’s future. Credit Suisse appears to be the only source of potential external financing – and there is no transparency on the terms of such loans. The Opposition could reasonably argue that it should not honour the servicing costs of loans that were excessive and not in the interests of the people of PNG.

Exchange rate: PNG and the IMF had a disagreement in 2015 as to whether the Kina was based on market-determined levels. With PNG effectively moving from a moving peg against the US dollar to an unquestioned fixed peg since the middle of 2016, this disagreement has been clarified. However, the IMF could have usefully provided some views on how best to deal with the foreign exchange shortages that flow from this fixed pegging.

Growth policies: In what appears to be moves towards pre-election populist policies, the government has put forward policies in areas such as agriculture, land and SMEs that are regarded as undermining PNG’s growth potential. Even PNG’s National Research Institute has expressed concerns about some of these proposals. IMF comments on how these could be improved would be valuable.

In an article for the ANU’s Development Policy Centre eighteen months ago (see here), I congratulated PNG’s central bank (BPNG) for its very constructive stance in stopping its effective printing of money to fund the government’s budget deficit. I noted how this reflected positively on the independence of BPNG, an independence built into its charter by Sir Mekere Morauta (PNG’s former Prime Minister) and Sir Wilson Kamit (PNG’s central bank governor from 1999 to 2009) in response to PNG’s last major economic crisis in the late 1990s.

Unfortunately, this independent role appears to have been reversed from the start of this year. Based on the latest Quarterly Economic Bulletin released on 18 November 2016 and its accompanying tables (esp Table 2-3 for BPNG’s assets sheet see here) PNG appears to have returned to a very slippery slope of effectively printing money by back-stopping auctions in government securities – a practice initially warned about in September 2014 (see here)

As shown in the graph below, the central bank started buying surplus government securities (those that no one in the private market was willing to buy) in September 2014.  This continued through until March 2015 when the bank announced that it had reversed its earlier policy.  This was the end of first phase of effectively printing money.  Over the remainder of 2015, despite the increasing cash shortages facing the government, the central bank persevered with this policy which helped ensure the government finally started to address its budget problems and reduced the risk of accelerating inflation.

In an extremely worrying trend, the central bank started purchasing large amounts of government debt from February 2016.  Over the next five months BPNG acquired K1,167.7 million in extra government securities. This is over half (55.3%) of the government’s expected budget deficit for the full 12 months of 2016. Indeed, for the single month of June 2016, the increase was slightly over K704.8 million – the largest monthly increase in BPNG’s history (the next highest was K508.7 million in October 2014 during the first stage of effectively printing money).

The data stops in June 2016. Has the situation improved since then, or become much worse? I did ask BPNG for any updates on the figures last week but there was no response (which is the usual government reaction to any of my requests for checking or clarification).

So why is this a problem? Primarily because economic history indicates that a central bank buying any surplus government bonds is a very slippery path towards over-heating the economy and hyper-inflation with all of its disastrous impacts for growth and well-being.  This is the Zimbabwe example, the Germany Weimar Republic pre-World War 2 example and many, many others.

A reasonable and accessible summary of the concerns and additional examples are in the Wikipedia article on “hyperinflation” (see here).  This article states “Hyperinflations are usually caused by large persistent government deficits financed primarily by money creation (rather than taxation or borrowing). As such, hyperinflation is often associated with wars, their aftermath, sociopolitical upheavals, or other crises that make it difficult for the government to tax the population. A sharp decrease in real tax revenue coupled with a strong need to maintain the status quo, together with an inability or unwillingness to borrow, can lead a country into hyperinflation.”

As noted in the September 2014 article, “once started, this near printing of money can be a very addictive habit for any government.”

So how is this different from “quantitative easing” in developed countries such as Japan and the US.  There are several important differences.

First, there are very few inflationary risks in these countries – to the contrary, there had been fears in Japan and the US of “deflation” prior to introducing the policies.  PNG’s inflation rate has already started creeping upwards even though its managed depreciation has now stopped.

Second, the “quantitative easing” policies in the US and were directed at restoring private sector economic growth by increasing the level of credit in the banking system – not simply financing a government budget deficit. Government spending may also be important for growth, but that depends on the quality of the government spending. For PNG, recent budgets have seen massive cutbacks in key sectors such as infrastructure (where the level of spending now is less than 2011 ) and key longer-term social investment spending (in effective health and education programs). The biggest areas of expenditure growth have been in interest costs, government administration and political constituency funds – none of which could be seen as pro-growth government spending.

Third, developed countries have used “quantitative easing” as a very transparent and public measure designed to build economic confidence.  In the case of PNG, this appears to be a policy done by stealth. Unlike the start and ending of the first stage of effectively printing money shown in the graph above and described in the top two links, I can find no comment on the public record about this change of approach since February 2016.

Fourth, there is no public “exit” strategy. The return to a government surplus keeps getting pushed back. The lack of transparency inevitably raises fears. Following is a snapshot of the 14 December weekly Treasury Bill results. The government asked financial markets last week for K726.33 million.  The private sector (mainly PNG’s banks, superannuation funds and finance companies) only decided to buy K217.88 million of these Treasury Bills.  The shortfall in that week alone is an extraordinary K508.45 million. Will the Bank of PNG have to step in and pick up the tab?

Finally, PNG does not have the offsetting policies that can help minimise the damage to macro-economic stability from this quantitative easing. Specifically, PNG no longer has a market-related flexible exchange rate, and there is no clear wages policy (although recent indications of some public sector wage restraint is welcome).

The central bank of PNG appears to have moved PNG’s economy back onto a slippery slope of effectively printing money. Providing a blank cheque to the government also squeezes out the private sector in such important areas as getting access to foreign exchange. Alternative financing options for the government’s deficit over recent years have not gone well – the so-called Government Sovereign Bond and the funding from the IFC – and the full costs of the Credit Suisse loan are unknown. Even minor attempts to increase tax in the 2017 Budget appear at risk in the January Supplementary Budget due to political pressures. Expenditure cuts have been too severe and in the wrong areas (see here).  If there is a change of government in mid-2017, much work will be required to restore PNG’s economic credibility.

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).

 

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.

[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

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)

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

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.