Papua New Guinea€¦ · COUNTRY REPORT Papua New Guinea January 2001 The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom At a glance: 2001-02 OVERVIEW

COUNTRY REPORT

Papua New Guinea

January 2001

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

At a glance: 2001-02OVERVIEWThe government has been making progress in implementing its economicreform programme. However, economic activity in all sectors has been fairlysubdued in 2000. The EIU estimates real GDP growth of 2.9% in 2000 andforecasts 3.8% in 2001 and 7.0% in 2002. Economic activity will pick up inthe next few years with the development of major minerals and gas projects.Growth will also be driven by stronger domestic demand as interest ratesfall. Inflation remained high in 2000 but should fall in 2001 and 2002 asprice stability becomes the primary focus of the Bank of Papua New Guinea(the central bank). The current account will remain in surplus in 2001 butwill fall into deficit as imports of capital equipment for these projects risesignificantly in 2002. The kina is steadily depreciating but should remain inan acceptably narrow trading range in 2001 and 2002 as capital inflowscounterbalance the increasing demand for imports.

Key changes from last monthPolitical outlook• Sir Mekere Morauta has reshuffled his cabinet again in an attempt to rid

the government of disloyal members. The former prime minister, SirMichael Somare, was the latest casualty. He was dismissed for not votingwith the government on the integrity bill. The bill was eventually passedby a vote of 84-0.

Economic policy outlook• Changes to the tax regime for gas, oil and mining, announced in the 2001

budget should encourage new exploration and development in theseareas.

Economic forecast• We have revised downwards our estimate for GDP growth in 2000 from

4.1% to 2.9% following a decline in economic activity in all sectors. Westill expect an improvement in 2001 and 2002, however this will be lessimpressive than our previous forecast, at 3.8% and 7.0% respectively.

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Papua New Guinea 1

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2001-027 Political outlook8 Economic policy outlook9 Economic forecast

12 The political scene

15 Economic policy

21 The domestic economy21 Economic trends23 Oil and gas24 Mining25 Agriculture

26 Foreign trade and payments

List of tables

9 International assumptions summary10 Forecast summary12 World commodity price forecasts18 Central government budget22 Quarterly inflation23 Money supply25 Mineral exports, by volume26 Agricultural exports, by volume26 Agricultural export prices27 Balance of payments28 Exports28 Exchange rates29 Public debt outstanding

2 Papua New Guinea


List of figures

12 Gross domestic product12 Kina real exchange rates20 Interest rates23 Kutubu oil price24 Mineral exports28 Exchange rates29 External debt

Papua New Guinea 3


Summary

January 2001

The government has been making progress in implementing its economicreform programme. However, economic activity in all sectors has been fairlysubdued in 2000. The EIU estimates real GDP growth at 2.9% in 2000 andforecasts 3.8% in 2001 and 7% in 2002. Economic activity will pick up in thenext few years with the development of major minerals and gas projects.Growth will also be driven by stronger domestic demand as interest rates fall.Inflation remained in 2000, but should fall in 2001 and 2002 as price stabilitybecomes the primary focus of the Bank of Papua New Guinea (the centralbank). The current account will remain in surplus in 2001 but will fall intodeficit as imports of capital equipment for these projects rise significantly in2002. The kina is steadily depreciating but should remain in an acceptablynarrow trading range in 2001 and 2002 as capital inflows counterbalance theincreasing demand for imports.

The prime minister, Sir Mekere Morauta, will remain in office until the nextelection in June 2002. The integrity bill has finally been approved with themain body of the law coming into force early in 2002. There have been anumber of cabinet reshuffles as Sir Mekere demands loyalty from all membersof the government. There is renewed hope for the Bougainville peace talks.Tension has risen between national and provincial governments.

The 2001 “recovery to reconstruction” budget was passed in November. It is abalanced budget, if arrears are excluded, with a tax reform favouring the poorand providing incentives for mining, gas and oil exploration. Highergovernment revenue and a lower budget deficit are expected for 2000. The IMFreleased the second tranche of the stand-by arrangement in November. Thecentral bank continues to focus on price stability with tight monetary policy.Privatisation plans are in motion.

The government has lowered its GDP growth estimate for 2000 from 4.7% to0.8%. Inflation is down over the quarter and the year. Interest rates continue tofall. The government is seeking financial assistance for the gas pipeline. Oilexports continue on a downward path. A binding agreement has been signedfor the Ramu cobalt-nickel project but there is no third investor yet. Fallingagricultural export prices have continued to hurt producers.

The third quarter was disappointing for foreign trade. There has been littlerespite for the falling kina. External public debt is up slightly over the thirdquarter.

Editors: Danny Richards (editor); Graham Richardson (consulting editor)Editorial closing date: January 12th 2001

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2001-02

The political scene

Economic policy

Foreign trade andpayments

The domestic economy

4 Papua New Guinea


Political structure

Independent State of Papua New Guinea

Constitutional monarchy

Queen Elizabeth II, represented by the governor-general, who is nominated by thenational parliament

The National Executive Council, presided over by the prime minister, has executivepowers; the prime minister is appointed by the head of state on the proposalof parliament

Unicameral national parliament; its 109 members (currently 104 are sitting, with fivevacancies) are elected for a period of five years, 89 representing “open” constituenciesand the rest representing 19 provincial constituencies and the capital district

Each of the 19 provinces has its own government that may levy taxes to supplementgrants received from the national government

Series of regional and magistrates’ courts leading to a Supreme Court at the apex

June 1997; next election due June 2002

Sir Mekere Morauta, the leader of the People’s Democratic Movement (PDM), was electedprime minister by parliament on a vote of 99:5 on July 14th 1999. He leads a coalitiongovernment consisting principally of the PDM, the People’s National Alliance andPangu Pati

National Alliance Movement (NAM); People’s Democratic Movement (PDM); People'sNational Alliance (PNA); United Resources Party; People’s Progress Party (PPP); PanguPati (PP); Advance PNG Party (APP); People’s National Congress (PNC)

Prime minister & minister for finance Sir Mekere Morauta (PDM)Deputy prime minister & minister for forestry Michael Ogio (PDM)

Agriculture Muki Taranupi (PPP)Defence Kilroy Genia (APP)Education John Waiko (PDM)Environment Herowa Agiwa (PDM)Fisheries Ron Ganarafo (PDM)Foreign affairs & Bougainville affairs Bart Philemon (NAM)Health Ludger Mond (PP)Home affairs William Ebenosi (PDM)Lands John Pundari (APP)Labour & employment Charlie Benjamin (APP)Justice Puri Ruing (PDM)Mining Michael Laimo (NAM)Petroleum & energy Chris Haiveta (PP)Privatisation Vincent Auali (PDM)Public service Philemon Embel (PDM)Trade & industry John Tekwie (APP)Transport & civil aviation Alfred Pogo (PDM)Works John Kamb (PDM)

Wilson Kamit

Official name

Form of state

Head of state

The executive

National legislature

Provincial government

Legal system

National elections

National government

Main political organisations

Main members of the NationalExecutive Council

Key ministers

Central bank governor

Papua New Guinea 5


Economic structure

Annual indicators

1996 1997 1998 1999 2000a

GDP at market prices (Kina bn) 6.9 7.1 7.9 9.4 11.4

GDP (US$ bn) 5.2 4.9 3.8 3.7 4.2

Real GDP growth (%) 7.8 –3.9 –3.8 3.6 2.9

Consumer price inflation (av; %) 11.6 3.9 13.6 14.9 17.1

Population (m) 4.4 4.2 4.6 4.7 4.8

Exports of goods fob (US$ m) 2,529.8 2,160.1 1,773.3 1,927.4 2,106.0

Imports of goods fob (US$ m) 1,513.3 1,483.3 1,078.3 1,071.4 1,032.3

Current-account balance (US$ m) 189.0 –192.3 –28.8 97.2 236.5

Foreign-exchange reserves excl gold (US$ m) 583.9 362.7 192.9 205.1 282.8

Total external debt (US$ bn) 2.5 2.6 2.7 2.8 2.9

Debt-service ratio, paid (%) 16.4 20.5 8.6 15.8 14.9

Exchange rate (av) Kina:US$ 1.32 1.44 2.07 2.57 2.74

January 12th 2001 Kina3.31:US$1

Origins of gross domestic product 1999a % of total Components of gross domestic product 1999a % of total

Agriculture 29.5 Private consumption 52.1

Mining & quarrying 22.8 Government consumption 19.1

Manufacturing 9.0 Investment 11.7

Construction 3.6 Exports of goods & services 50.2

Electricity, gas & water 1.4 Imports of goods & services –33.4

Services 33.7 GDP at market prices incl change in stocks 100.0

GDP at factor cost 100.0

Principal exports fob 1999 US$ m Principal imports cif 1994 US$ m

Gold 601.6 Machinery & transport equipment 442.9

Crude oil 537.9 Manufactured goods 334.0

Copper 223.5 Food & live animals 204.2

Coffee 162.3 Chemicals 85.9

Palm oil 131.5 Mineral fuels & lubricants 40.8

Logs 99.5 Total incl others 1,526.5

Total incl others 2,127.5

Main destinations of exports 1999 % of total Main origins of imports 1999 % of total

Australia 30.0 Australia 52.9

Japan 11.9 Singapore 12.7

Germany 6.8 Japan 5.5

South Korea 4.1 New Zealand 4.1

Philippines 2.7 US 3.6

UK 2.6 Malaysia 3.6

a EIU estimates.

6 Papua New Guinea


Quarterly indicators

1998 1999 20004 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

PricesConsumer prices (1995=100) 144.3 140.2 143.6 158.8 163.4 167.6 175.9 178.1 % change, year on year 21.8 14.2 14.1 18.3 13.2 19.5 22.5 12.2

Financial indicatorsExchange rate Kina:US$ (av) 2.16 2.22 2.53 2.78 2.75 2.96 2.50 2.65 Kina:US$ (end-period) 2.10 2.38 2.56 2.96 2.70 2.62 2.43 2.76M1 (end-period; Kina m) 1,111 1,114 1,298 1,367 1,344 1,294 1,252 n/a % change, year on year 10.3 20.3 35.2 32.8 21.0 16.1 –3.5 n/aM2 (end-period; Kina m) 2,732 2,812 2,916 2,982 2,982 2,929 2,990 n/a % change, year on year 2.5 7.7 7.9 6.5 9.2 4.2 2.5 n/a

Sectoral trendsExports Copra ('000 tonnes) 14.9 12.4 14.6 16.6 19.9 29.6 16.9 10.5 Copra oil ('000 tonnes) 12.2 18.1 14.0 11.3 6.9 15.1 9.8 14.5 Cocoa ('000 tonnes) 4.8 7.3 11.2 6.0 4.5 14.2 9.9 9.0 Coffee ('000 tonnes) 19.0 10.8 20.2 33.9 14.3 10.2 20.5 16.7 Logs ('000 cu metres) 395 324 470 230 288 312 322 279 Gold (tonnes) 16.1 12.7 14.8 18.5 17.0 19.4 17.2 16.9 Fish ('000 tonnes) 0.4 0.3 1.3 0.6 0.5 0.4 0.5 0.3 Oil, crude ('000 barrels) 7,322 7,520 7,642 7,735 7,749 5,889 5,930 5,239

Foreign trade & reservesExports fob (Kina m) 1,004 868 1,208 1,454 1,401 n/a n/a n/aImports fob (Kina m) –574 –597 –713 –685 –705 n/a n/a n/aTrade balance (Kina m) 430 271 495 769 695 n/a n/a n/aReserves excl gold (end-period; US$ m) 192.9 138.3 89.1 106.1 205.1 175.7 n/a n/a

Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; IMF, International Financial Statistics.

Papua New Guinea 7


Outlook for 2001-02

Political outlook

Papua New Guineans face a different political future from normal—anunexpectedly stable one. In the short term, parliament has adjourned until July23rd 2001 ensuring the continuation in office of the prime minister, Sir MekereMorauta, until the general elections to be held in June 2002. In the longerterm, the unexpected passing of the Organic Law on the Integrity of PoliticalParties and Candidates on the final day before adjournment, will usher in aperiod of intense learning about the vastly different way that that election, andsubsequent ones, will be conducted and how the resulting parliaments willconduct themselves. New laws will be enacted that, among other things:require the registration of political parties; limit the use of outside funding forpolitical activities; and prevent independent MPs from voting on budgets,participating in votes of no confidence in the government, or voting onconstitutional amendments. There have already been calls for amendments tothe new laws to make registration conditional on well-formed philosophiesand policies. Independents in the past have frequently brought downgovernments, and no prime minister has ever completed a full term. By forcingnominal independents to join a party, the government hopes to limit theirability to disrupt the political scene. MPs who change party between electionswould face the possibility of dismissal, or be forced to stand in a by-election.These restrictions, probably untenable in many other parliamentary systems ofgovernment, appear to favour the financial viability of larger, establishedpolitical parties.

Sir Mekere has brought a sense of stability to domestic politics that wascertainly lacking in the previous administrations since independence in 1975,and has received international recognition for doing so. As a result foreigninvestor confidence should improve, but only time will tell whether the billcan guarantee a stable investment environment in the long term.

The next general election is expected to be held in June 2002, and Sir Mekereand his People’s Democratic Movement (PDM) must be considered theoverwhelming favourites to form the next government. If the economycontinues to improve, as the EIU expects, the prime minister’s popularityshould increase. However, the economy is particularly susceptible to externalshocks, such as sharp declines in commodity prices, and export volumes aresusceptible to climatic and seasonal influences. Major privatisations areexpected during the next two years, which will be controversial, and thecritically important PNG-Queensland gas pipeline project, which is expected toanchor the economy for the next decade, may yet fall through. Any or all ofthese developments could erode support for the government and reviveprospects for the opposition. Moreover, a general election in Papua NewGuinea is a two-stage process; first, the people elect 109 members ofparliament, who then elect, on the floor of parliament, one of their number tobe prime minister. The first stage is very much a tribal matter; prime ministers

Election watch

Domestic politics

8 Papua New Guinea


do not necessarily hold their parliamentary seats, despite their national orinternational standing, a fact that former prime ministers, Sir Julius Chan andPaias Wingti, can both attest to.

Given PNG’s ethnic secessionist history, the country has attracted muchinternational attention following coups in Fiji and the nearby Solomon Islandsin May and June. Despite this, the situation on Bougainville has beenimproving of late, and as a result there has been relatively little spillover intoPNG from the troubles elsewhere in the South Pacific. PNG’s relations withAustralia, meanwhile, have been improving after a rough patch in early 2000.Economic co-operation with the Chinese and Japanese governments has in-creased, based mainly on new financial aid from both countries. Irian Jaya, orWest Papua as it is also called, looms as PNG’s biggest foreign policy challenge.

Economic policy outlook

The government has successfully guided the economy through a period ofrecovery and, with the 2001 budget, is starting on a period of “reconstruction”.The IMF and World Bank have both strongly praised the progress of thegovernment’s economic reform programme and have promised to continuesupporting it. The IMF completed the second review of the standbyarrangement in November, finding PNG on track to achieve the objectives ofthe structural reform programme. The IMF plan is aimed at: restoring disciplinein the budget, securing independence for the Bank of Papua New Guinea (thecentral bank), stabilising the kina, reducing high levels of domestic debt,privatising state-owned enterprises (SOEs) and strengthening politicalinstitutions. The government has undertaken initiatives in all of these areas.Privatisation may be the most difficult issue facing the government as PNG’spoor reputation among international investors could limit interest, andpolitical opposition towards privatisation is also growing. However, the primeminister is determined to complete the privatisation of the Papua New GuineaBanking Corporation, with the first stage of the sale to be completed by April2001. The government also hopes to go ahead with the sale of the Air Niuginiin the first half of 2001.

The government is in a strong position to exceed its IMF-agreed budget target,which calls for a deficit of Kina215.1m (US$86m) in 2000. For the nine monthsto September, the government recorded a budget surplus of Kina33.5m. Inorder to meet its expected full year deficit of Kina 179m, the government needsto spend as much on development projects in the fourth quarter as it did inthe first three quarters, as in 1999. The EIU expects the deficit to be close toKina170m, equivalent to around 1.5% of estimated nominal GDP. Thegovernment announced its 2001 budget on November 28th and forecast abudget deficit of 1.3% of GDP. Debt service payments will account for overKina1bn (US$335m) out of a total expenditure of Kina3.96bn. A record 35% oftotal expenditure has been allocated to development, focusing on priority areasof health, education and infrastructure. The 2001 budget does not include anynew tax burdens but incorporates taxation reforms, the most significant

International relations

Policy trends

Fiscal policy

Papua New Guinea 9


changes being to the tax regime for gas, oil and mining which shouldencourage new exploration and development in these areas. In 2002construction work on major minerals projects should provide added buoyancyto the economy and to government revenue.

The central bank has maintained a restrictive monetary policy through the useof open-market operations and retention of its cash reserve requirement (CRR).Even so, all indicative interest rates and the maximum interbank rate havebeen declining, reflecting the increase in the average level of liquidity in thebanking system. The 182-day Treasury-bill rate, for example, has declined froma high of 28.03% in August 1999 to 13.62% in October of this year. It is likelythat interest rates will continue to fall, but we would expect a pause until thecurrency again stabilises—any further decline in interest rates in the short termwould place additional pressure on the kina. We would expect the governmentto move some time in 2001 towards a more accommodative policy stance,possibly by easing or reducing either the CRR or the minimum liquid assetsratio (MLAR). Monetary policy should become slightly more restrictive again in2002 as growth picks up and new resource development projects accelerate.However, the high import component of major projects, including laboursupply and financing, their remote locations, and their weak linkages to therest of the economy will dampen their domestic impact.

Economic forecast

International assumptions summary(% unless otherwise indicated)

1999 2000 2001 2002

Real GDP growthWorld 3.5 5.0 4.2 4.1OECD 3.0 4.1 3.0 2.7EU 2.4 3.3 3.0 2.6

Exchange rates (av)¥:US$ 113.9 107.6 108.5 104.5US$:€ 1.07 0.92 0.95 1.05SDR:US$ 0.731 0.766 0.779 0.740

Financial indicators¥ 2-month private bill rate 0.27 0.21 0.45 0.98US$ 3-month commercial paper rate 5.18 6.32 6.25 5.25

Commodity pricesOil (Brent; US$/b) 17.9 28.8 23.4 19.1Gold (US$/troy oz) 278.8 283.2 275.0 270.0Food, feedstuffs & beverages

(% change in US$ terms) –18.6 –6.0 10.6 14.1

Industrial raw materials (% change in US$ terms) –4.2 14.2 4.2 9.6

Note. Regional aggregate GDP growth rates weighted using purchasing power parity (PPP)exchange rates.

The EIU estimates world GDP growth in 2000 to have reached 5.0%, thefastest rate of expansion in 16 years. GDP is estimated to have grown by4.4% in Australia, by far PNG’s largest trading partner. After several years of

Monetary policy

International assumptions

10 Papua New Guinea


above-trend performance, economic growth in Australia will slow to 3.4% in2001 and to 3.0% in 2002. Gold and oil are PNG’s largest exports by value,and average prices for both will fall throughout the forecast period, althoughthe price of oil in absolute terms will not drop much below US$20/barrel.

Economic activity in all sectors has been fairly subdued in 2000 and ourestimate for GDP growth is now a more modest 2.9%. Private consumptionand investment have been particularly constrained by the tight monetarystance adopted by the Bank of Papua New Guinea (the central bank). This hasalso contributed to a lack of any major construction projects. Export growthhas not been as robust as expected following the poor coffee and copra cropsand declining volumes in the minerals sector. Associated services such astransportation and wholesale trade have also suffered. GDP is forecast to growby 3.8% in 2001 as we expect conditions to improve, with lower inflation andfalling interest rates creating stronger domestic demand. We expect theagricultural sector to grow by 3.9% supported by a recovery in coffeeproduction. Government approval of the US$850m Ramu nickel-cobalt projectin June means construction work on the mine could start during the secondhalf of the year, providing a boost to growth; although the third projectpartner has yet to be announced. Major work on the US$3.5bn PNG-Queensland gas pipeline project is not expected to begin before late 2001.

Forecast summary(% unless otherwise indicated)

1999a 2000b 2001c 2002c

Real GDP growth 3.6 2.9 3.8 7.0

Gross agricultural growth 15.0 3.2 3.9 3.0

Consumer price inflation Average 14.9 17.1 8.0 8.0 Year-end 13.2 15.0 7.0 6.0

Short-term interbank rate 18.9 18.0 13.5 11.5

Government balance (% of GDP) –2.5 –1.5 –0.6 0.2

Exports of goods fob (US$ bn) 1.9 2.1 2.1 2.2

Imports of goods fob (US$ bn) 1.1 1.0 1.2 1.5

Current-account balance (US$ bn) 0.1 0.2 0.1 –0.3 % of GDP 2.7 5.7 1.6 –4.9

External debt (year-end; US$ bn) 2.8 2.9 3.6 4.4

Exchange rates Kina:US$ (av) 2.57 2.74a 2.90 2.90 Kina:US$ (year-end) 2.70 3.04a 3.10 3.00 Kina:A$ (av) 1.66 1.60a 1.62 1.80

a Actual. b EIU estimates. c EIU forecasts.

By 2002 PNG will benefit from the stimulus of these two very large mineralsprojects. Historically projects of this size have led to sharp increases ininvestment, imports and overall growth. We are, therefore, forecasting GDPgrowth of 7.0% in 2002. All stakeholders in the proposed PNG-Queensland gaspipeline are looking to a favourable response from the Australian governmentto the Papua New Guinean government’s request for assistance in financing its

Economic growth

Papua New Guinea 11


30% entitlement in the project. Investors in both the gas and the nickelprojects will be looking closely at the tax changes introduced in the 2001budget to make Papua New Guinea more attractive to international resourceinvestment.

The continued depreciation of the kina will push up the landed cost of importsand will have lifted the overall inflation average for 2000 to 17.1%. Oil-relatedprice rises will also have been a factor. The central bank has become morecommitted to fighting inflation since passage in June of the new CentralBanking Act, which establishes price stability as its primary focus. Falling pricesfor oil, plus fewer tax rises by the government, should help to restrain inflationduring the remainder of the forecast period. We expect inflation to fall to 8%in 2001 and 2002, with cost-push inflation (relating to the depreciatingexchange rate) tending to dominate the demand-pull variety in the economy,which generally suffers from low levels of capacity utilisation. High levels ofunemployment amongst graduates and school leavers will off-set labourdemand surges related to the new resource projects in 2002.

The kina has come under sustained pressure against the US dollar in recentmonths after reaching a yearly high in early June. The approval of the secondtranche of IMF funding and central bank intervention provided temporaryrelief in November but the currency has continued to slide, ending the year atKina3.04:US$1, at an average of Kina2.74:US$1 for 2000. The kina has notpicked up in the early part of the year as many exporters were expecting andlooks set to fall to levels not seen since the middle of July 1997. However, weexpect an appreciation from this low with the kina stabilising to averagearound Kina2.90:US$1 in 2001. The current account will move sharply intodeficit in 2002 putting pressure on the kina but strong capital inflows, tofinance the new resource developments, should offset these pressures. Weexpect the annual average exchange rate to remain at Kina2.90:US$1, but theday-to-day rate will be subject to fluctuations around this mean.

We estimate a smaller than expected trade surplus in 2000 following a weakthird quarter export performance in terms of both volumes and prices. Thecurrent-account surplus is estimated to have been a robust US$237m(equivalent to 5.7% of GDP). A decline in the value of copper and gold exportsmore than offset the increase in crude oil exports, for which the surge in worldprices was sufficient to offset the export volume decline. Most agriculturalexports also suffered from falling prices and a drop off in volume, with coffeesuffering the worst fate. We expect exports to bounce back in 2001, however,the current-account surplus will shrink to US$69m (1.6% of GDP) as importvalues rise (in preparation for the new mining and gas projects), export pricesfall and oil exports decline. World oil prices will fall by nearly 19% in 2001 andnew supplies from the Gobe and Moran wells will not offset the decliningproduction from the ageing Kutubu fields. The current account will thenplunge into a deficit of US$250m in 2002 as developers of both the Ramu andQueensland pipeline projects import significant quantities of capital goods andconstruction materials to sustain both ventures. This will be sustainable onlybecause the two minerals projects will be accompanied by significant capital

Inflation

Exchange rates

External sector

12 Papua New Guinea


inflows, in the form of commercial borrowings by PNG companiesparticipating in the projects, and through foreign direct investment.

World commodity price forecasts(US$/tonne unless otherwise indicated)

1999 % change 2000 % change 2001 % change 2002 % change

Cocoa (US cents/lb) 51.7 –32.0 40.4 –21.8 42.5 5.1 54.3 27.6

Coffee (US cents/lb; Arabica) 103.9 –23.2 88.2 –16.1 73.0 –17.2 60.5 –17.1

Tea (£/kg) 1.8 –12.8 1.8 5.0 1.7 –5.2 1.7 0.1

Copra 461.5 12.2 301.0 –34.8 194.3 –35.5 198.0 –1.9

Coconut oil 737.1 12.3 452.0 –38.7 319.8 –29.3 325.5 1.8

Sugar (US cents/lb) 6.3 –29.8 8.3 31.9 9.8 18.0 9.2 –5.8

Crude palm oil 436.0 –35.0 311.5 –28.6 269.3 –13.6 275.8 2.4

Palm kernel oil 694.0 1.1 445.8 –35.8 319.5 –28.3 354.0 10.8

Rubber (natural; London; £/tonne) 447.3 –5.8 512.5 14.6 690.0 34.6 915.0 32.6

Crude oil (US$/barrel; Brent) 17.86 39.9 28.77 61.1 23.36 –18.8 19.13 –18.1

Gold (US$/ troy oz) 278.8 –5.2 283.2 1.6 275.0 –2.9 270.0 –1.8

Copper (US cents/lb) 71.1 –5.5 81.3 14.2 83.0 2.2 85.3 2.7

Source: EIU, World Commodity Forecasts.

The political scene

Parliament was adjourned on December 7th until July 23rd, effectively closingthe window of opportunity for the opposition to call for a vote of no-confidence and ensuring continuation in office of the prime minister, SirMekere Morauta, until the general elections in June 2002. On the face of it, this‘survival’ tactic seems rather scheming and evasive, however, votes of no-confidence have routinely brought down governments in the past and haveprevented the development of a stable political environment, which isprecisely what is needed in PNG to ensure the successful outcome of its criticalreform programme. In an attempt to promote transparency, Sir Mekere actuallysubmitted his adjournment motion to the legislature for a vote. In a surprising

Sir Mekere to remain inoffice until June 2002

Papua New Guinea 13


move, the opposition leader and former prime minister, Bill Skate, gave his fullsupport for the motion and stated his belief that for progress to take place inthe country there was no need for a change of leadership. However, Sir Mekerehad to deal with an attempt to bring his government down when, on October31st, the then trade and industry minister, Michael Nali, proposed thatparliament be adjourned until January 23rd creating the opportunity for a voteof no-confidence. This motion was defeated by 62 votes to 32.

Before parliament was adjourned, it finally passed the Organic Law on theIntegrity of Political Parties and Candidates, which will change the way thatthe next election, and subsequent ones, will be conducted and how theresulting parliaments will conduct themselves. The integrity bill is one of themost important legislative proposals to come before parliament (see October2000) and should come into force around February 2001. By then theadministrative systems to handle the all-important registration of politicalparties would need to be in place. Over the ensuing six months political partieswishing to contest the general elections in June 2002 would need to havethemselves registered. Beyond the registration period unregistered politicalparties cannot be lawfully recognised. The body of the organic law shouldcome into force early in 2002, some months before the elections. As importantas the legislation itself, which was championed by Sir Mekere, was the marginof victory: 84-0 following the 79-0 first vote in August. The bill amended PNG’sconstitution, and therefore required a two-thirds majority of the 109 MPs, or73 votes, in two sittings of the parliament. Although some members opposedthe legislation, they chose not to vote—apparently because of widespreadsupport for the bill.

Existing MPs intending to contest the election and aspiring candidates, as wellas political parties, will need to study the quite restrictive changes to the wayelections are held and parliament operates following the implementation ofthe organic law. These restrictions, probably untenable in many otherparliamentary systems of government, appear to favour the financial viabilityof larger, established political parties. The new law places significant restraintson the conduct of independent MPs, who have tended to follow thedestabilising path of political adventurism more than philosophical indepen-dence. It seeks to force independents to align with a registered party. If they donot, and vote for the successful prime ministerial candidate, after the generalelection they become de facto members of the prime minister’s party and MPsaffiliated with a registered political party cannot vote against the party onmatters such as no-confidence, budgets or constitutional changes. Memberswho cross the floor, or resign from a party, will face serious penalties, and maybe forced to stand in a by-election.

Sir Mekere has proved that he was not simply scaremongering when he said,after the first reading of the integrity bill, that he would take “appropriatedisciplinary measures” in the near future with those members of thegovernment coalition who chose not to vote or encouraged others to abstain.With an unrelenting desire to rid the government of any source of instability,Sir Mekere has sacked a number of senior ministers and reshuffled his cabineton a number of occasions. Following the attempt by Michael Nali

Integrity bill is finallyapproved

Cabinet reshuffles as SirMekere demands loyalty

14 Papua New Guinea


(immediately prior to the scheduled final vote on the integrity bill) to move amotion to adjourn parliament until January 23rd, the day after the primeminister’s 18-month grace period lapsed, six ministers were sacked, includingMr Nali and the deputy prime minister, Mao Zeming. Another major reshufflecame as a result of the quite unexpected passage of the integrity bill at the endof the budget session, courtesy of a nod from the opposition leader, Bill Skate.Sir Mekere sacked the foreign affairs and Bougainville minister, Sir MichaelSomare, and the justice minister, Andrew Baing, for not voting with thegovernment in the 84-0 vote. This strategy reinforces what has by now becomea familiar pattern for the prime minister: an insistence on loyalty frommembers of his ruling coalition, and the meting out of punishment to thosewho vote against him, even at the risk, it would appear from editorial opinionand letters columns, of alienating those who regard Sir Michael, the “Chief”, asa national treasure. Not all of the frequent and wide-ranging cabinet reshuffleshave had to do with the integrity bill. In December the United Party (includingthe police minister and party leader, Gabia Gagarimabu, and petroleum andenergy minister, Tommy Tomscoll) was expelled from the coalition for plottingto remove the police commissioner, John Wakon.

Technical officers are scheduled to meet on January 22nd and leaders onJanuary 26th in the continuing peace talks to resolve the decade-longsecessionist revolt on the island of Bougainville, where the three-year-oldceasefire remains in place. This followed informal consultations in Buka onJanuary 5th between Bougainville leaders, including the governor, JohnMomis, the president of Bougainville People’s Congress, Joseph Kabui, and theleader of the bipartisan National Committee on Bougainville, Moi Avei. Theconsultations replaced the postponed formal resumption of peace talks,scheduled for December 27th-28th, following the stalemate and walkout byBougainville negotiators on December 9th. Formal resumption was postponedfollowing the sacking of Bougainville affairs minister, Sir Michael Somare, forreasons associated with the vote on the political integrity bill. Notwithstanding“occasional strong words in the past” and based on a “real commitment topeace” evident in the Buka meeting, the leaders expressed confidence inreaching an agreement on referendum and autonomy for Bougainville.

The position of the national government, outlined in a nationally televisedspeech by the prime minister on September 1st, and later clarified, is that areferendum on independence was still possible, and that the constitutionalchanges necessary to grant autonomy to Bougainville, and allow at some pointa referendum, would be pursued, although the word "independence" wouldnot be used. The prime minister has suggested that several review periods offive years each of Bougainville’s performance as an autonomous provincewould be necessary before an independence vote could be held. During thistime improved political and economic conditions on Bougainville, he hopes,might temper the drive for independence. The rebels have acknowledged thatnone of the constitutional changes allowing autonomy will take effect until adisarmament plan is agreed and implemented.

Renewed hope forBougainville peace talks

Papua New Guinea 15


The three-tier system of government—national, provincial and local—continues to engender political tension between the national and provincialgovernments. In October the National Executive Council (NEC) suspended thegovernments of the Western (Fly River) province, home of the Ok Tedi coppermine, and the Southern Highlands province, the region covering the Kutubuoilfields and the PNG-Queensland gas pipeline project, on the basis ofcorruption and mis-management of public funds. Enga province, which hasthe Porgera gold mine, was given 21 days to respond to allegations of mis-management or face suspension. The response elicited a 14-day notice fromthe national government, which the provincial governor said he will deal withwhen his officers return from the Christmas-New Year break. Lobbying for thepost of administrator is said to be intense. Rumours of two more suspensionnotices surfaced in Wabag, the provincial capital of Enga, at the HighlandsGovernors’ Council conference which concluded on December 22nd. The fivegovernors of 2.5m people noted that suspension of any one governmentaffected all of them. Meanwhile, Southern Highlands administrator, PilaNiningi, began the new year by suspending seven public servants includingtwo deputy administrators, three district administrators and the executiveofficer of a local level government.

Irian Jaya, or West Papua as it is also called, where nearly half the populationhas been settled there from other parts of Indonesia in transmigrationprogrammes over several decades, seems likely to be PNG’s biggest foreignpolicy challenge. The ill-defined, jungle-hidden, shared border will be muchtraversed by both political refugees and independence fighters seeking refuge.Following the meeting in Port Moresby in late December between Sir Mekereand Australia’s foreign minister, Alexander Downer, both governmentsreaffirmed their stand on the issue, saying it was Indonesia’s internal problem.The prime minister has previously emphasised his country’s obligation tohonour the relevant UN resolutions of 1969 and commitments contained inthe Treaty of Mutual Respect, Friendship and Co-operation entered into by thetwo countries in 1986. He had, as recently as September 2000, reaffirmed thisposition with the Indonesian vice president, Megawati Sukarnoputri.

Economic policy

The prime minister, Sir Mekere Morauta, who is also the minister for financeand treasury, presented the 2001 budget to parliament on November 28th.Styled “From recovery to reconstruction” in the logical footsteps of the “Roadto recovery” 2000 budget, it anticipates a consolidation phase and real gains insocial and economic development in 2002. The budget’s underlying fiscalstrategy envisages balanced budgets freeing monetary policy to pursue a stableexchange rate and lower inflation and interest rates. It envisages private sectorinvestment and growth flowing from successful monetary policy andgovernment expenditure geared towards providing the private sector with: lawand order; stable and transparent government; economic infrastructure; and ahealthy, educated workforce. The fiscal strategy is supported by an on-going

National and provincialgovernment tension

PNG will not meddle inIrian Jaya’s troubles

2001 “recovery toreconstruction” budget

16 Papua New Guinea


structural reform programme which, the prime minister emphasises, is home-grown and not imposed by the IMF or World Bank; though both bodies haveendorsed both the programme and the fiscal strategy. These multi-lateralinstitutions, together with bi-lateral government donors, have committed halfof the US$140m of foreign financing needed in the budget. The remainder willbe sought from the same sources in a meeting scheduled for March 2001.

The budget, like its predecessor, contains no new revenue measures, thesehaving been introduced in a supplementary budget immediately on thegovernment’s coming to power in mid-1999. Nevertheless, it is a balancedbudget (budget deficits in both 2000 and 2001 need to be read in the light ofabnormal expenditures on erasing arrears and one-off structural adjustments),which directs 35% of total expenditure, a record share, to the developmentbudget to be spent on such infrastructure as roads, bridges, aid posts andschools. Priority sectors received 57% of the total budget appropriation,excluding debt service, comprising: education, 20.1%; infrastructure, 13.6%;health, 9.4%; law and order, 8.9%; and the economic sector, 5.2%. Asproportions of GDP, the health budget has increased from 2.0% in 1999 to2.6% in 2001; law and order from 2.2% to 2.4%; and infrastructure from 3.2%to 3.7% per cent of GDP. The education budget in 2001 represents 5.5% offorecast GDP, marginally down on the 5.6% in 1999, although it is higher by18% in absolute terms. Two-thirds of the infrastructure budget is formaintenance, including major programmes for the Okuk Highway and allHighlands provinces, with a view to increasing agricultural production andimproving delivery of government services, especially to outlying districts.

In pursuit of macro-economic stability, overcoming arrears is a major objective.Arrears were 1.7% of GDP in 1999, 1.3% in 2000 and are budgeted in 2001 at0.6% of GDP. Non-recurring expenditures associated with the reform programamounted to 1% of GDP in 2000 and are budgeted at 0.6% of GDP in 2001.Excluding arrears and one-off reform expenditures, the budget outcome in1999 was an underlying deficit equivalent to 0.9% of GDP; in 2000 it was asurplus of that proportion; and the 2001 budget is practically balanced.

The 2001 budget balance may put a strain on monetary policy in its efforts tostabilise the exchange rate, inflation and interest rates. In 2000 29% ofexpenditure—comprising the recurrent budget (less interest payments) and thepart of the development budget not financed from external sources—wasfinanced by foreign budget-support grants and taxes and levies on mining andpetroleum. In 2001 this proportion drops to 25%. Any shortfalls in securingthe budgeted Kina231m (US$69.8m) of external financing or the Kina178m ofnet proceeds from asset sales would add to the strain on monetary policy.

The 2001 budget implements in large measure the recommendations of thecomprehensive Taxation Review conducted during 1999 and 2000. Personaltaxation changes are revenue neutral but favour the poor.

A balanced budget, ifarrears are excluded

Tax reform to favour thepoor

Papua New Guinea 17


Changes to personal and corporate income taxation

• Increases in the taxation of housing and vehicle benefits.

• Higher tax-free threshold, increasing from Kina4,000 to Kina5,500.

• Widening of the first tax band, extending from Kina5,500 to Kina16,000.

• Simplified methods of tax-accounting for depreciable assets—asset values less thanKina1,000 may be immediately expensed.

• Stamp duty set at a fixed rate of Kina10,000 in respect of corporate restructuring.

The big tax shake out also affects mining, gas and oil as PNG aims to regain itsformer competitiveness in attracting international capital and expertise.

Changes to tax regime for gas, oil and mining

• The mining levy, an emergency measure introduced in mid-1999, will be uniformlyphased out over four years from January 1st 2002 subject to existing operators agreeingto dispense, on completion, with the long-standing “basket rate” of import duty.

• From January 1st 2001 the company tax rate will fall from 35% to 30% and thedividend withholding tax rate from 17% to 10%.

• The additional profits tax rates have been reduced but an extra tier has beenintroduced. Rates of return between 15% and 20% will attract an additional tax at 20%;and on still higher returns, 25%.

• Exploration incentives have been extended to include a deduction of 25% ofexpenditure anywhere in PNG (previously restricted to the mining lease) and 20 yearloss carry forward limit, previously seven years.

• Depreciation, loss carry forward, exploration and additional profits tax provisionsapply to oil and gas as well as to mining. Gas projects will pay 30% tax, unchanged, andnew oil projects 45%, previously 50%.

• The new arrangements allow the grouping, within one tax “ring fence”, of dedicatedgas fields, processing facilities and pipelines (a matter of specific relevance for theUS$3.5bn PNG-QLD gas pipeline).

• Investors in major mining and petroleum projects will be protected under proposedten-year fiscal stability legislation.

• Projects committed to construction before the end of 2003 would be offered fiscalstability for the term of the initial project debt to a maximum of 20 years.

Tax incentives for mining,gas and oil exploration

18 Papua New Guinea


The Bank of Papua New Guinea (the central bank) reported a Kina34m centralgovernment budget surplus for the three quarters to September 2000. However,in its 2001 budget, the government estimates a deficit of Kina179m for the fullyear, 17% less than budget. By the end of September the government hadspent only 66% of the budget but had collected 72% of revenue. By September53% of the development budget had been spent and 72% of the recurrent one.The government expects to spend as much on development projects in thefourth quarter as it spent in the first three, as happened in 1999. Tax receipts inthe three quarters to September amounted to 79% of the full year budget, off-setting shortfalls in non-tax receipts, where only 45% of budget was achieved,and in foreign grants, only 58%, the latter being a direct result ofaforementioned underspending on the development budget. The government’sfull year revenue estimate, 6% over budget, and the lower deficit seem welljustified by the effects of higher oil prices, robust dividend payments andimprovement in arrears evident in performance to September.

Central government budget(Kina m)

Budget 3 Qtrs Estimate Budget1998 1999 2000 2000 2000 2001

Total receipts 1,991.2 2,569.0 2,866.7 2,073.3 3,040.8 3,223.3 Tax revenue 1,598.2 1,920.7 2,079.3 1,646.2 2,311.0 2,475.9 of which: personal tax 448.8 524.4 560.0 397.9 565.0 650.0 company tax 426.1 505.1 525.0 442.7 683.9 636.7 other direct tax 132.9 168.5 183.9 167.3 227.5 233.4 indirect tax (incl VAT) 590.4 722.7 810.4 638.3 834.6 955.8 Non–tax revenue 279.5 171.2 245.1 110.3 175.1 197.0 Foreign grants 113.5 477.1 542.3 316.7 554.7 550.5

Expenditure 2,128.6 2,801.3 3,081.8 2,039.8 3,220.1 3,364.2 Recurrent expenditure 1,950.7 2,065.7 2,182.4 1,564.2 2,264.5 2,313.1 National Departmental 861.5 959.5 1,069.7 771.1 1,143.6 1,184.5 Provincial governments 621.7 594.4 517.1 384.7 540.2 584.7 Interest payments: 337.2 391.6 380.9 320.2 466.9 410.1 foreign 107.4 132.0 147.6 94.2 169.3 167.0 domestic 229.7 259.5 233.3 226.0 297.6 243.1 Other grants & expenditure 135.3 121.2 219.9 88.0 122.1 142.0 Net lending & investments –4.9 –1.0 –5.2 0.2 –8.3 –8.2 Development expenditure 177.9 735.7 899.4 475.7 955.6 1,051.1

Overall balance –137.4 –232.3 –215.1 33.5 –179.3 –140.9

FinancingExternal financing –116.3 178.2 342.6 –47.0 96.3 230.8Domestic financing 253.7 54.1 –127.5 13.5 83.0 –89.9Total financing transactions 137.4 232.3 215.1 –33.5 179.3 140.9

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Sir Mekere pointed to successful budget outcomes in 2000: reconstructed andstabilised monetary and financial systems; responsible and prudent budgetarymanagement; and total disbursements contained within original appro-priations. He pointed also to the welcome reduction in inflation and interestrates. These achievements, he noted, were all the more remarkable in the light

Higher revenue and lowerdeficit expected in 2000

Papua New Guinea 19


of the depressed economic environment, mainly as a result of low agriculturalexport prices and high petroleum product import prices.

The 2001 budget extends its predecessor’s structural reform program (SRP)introducing new initiatives in pursuit of four key objectives: improvegovernance; sustain macroeconomic stability; improve public sector perfor-mance; and remove barriers to investment and economic growth. The primeminister explained how vetting by the Central Agencies Co-ordinatingCommittee (CACC) of all cabinet submissions had replaced haphazarddecision-making with an orderly process which has boosted the morale and thequality of the work of public servants. The CACC and the chief secretary arecharged with the responsibility for enforcing departmental work plans andfinancial discipline. The auditor-general, the ombudsman commission and theattorney general all will receive additional funding in the on-going fightagainst corruption. The strengthening of the Central Supply and TendersBoard, which began in 2000, will also continue into 2001.

Measures to remove barriers to investment and economic growth, another partof the 22-point SRP agenda, include continued involvement with Asia-PacificEconomic Co-operation (APEC) and the World Trade Organisation (WTO) andthe tariff reduction program, reviewing the reserved activity list and stream-lining procedures for visas and work permits, all aimed at the still-small, formalsector. Missing from the agenda are initiatives to overcome rigidities ininformal land and labour markets, which affect 85% of the population, andhave severely restricted commercialisation of the agricultural sector,particularly in exports, resulting in long-term economic growth in this sectorlagging population growth and making futile supply-side attempts to stimulatea formal sector constrained by lack of domestic demand.

The IMF has released the second tranche of the stand-by arrangement tosupport the balance of payments. This followed the completion by its team onNovember 6th of a two week in-country review of the fiscal out-turn to the endof September and, as estimated for the full year 2000, the fiscal framework forthe 2001 budget and the monetary accounts of the central bank. In keepingwith the IMF's recently-adopted determination to throw off the cloak ofsecrecy it has been tagged with, the team spent time outside official circleslistening to the private sector. Apparently they were surprised to hear a muchgloomier view of the economy than despatches from the local office hadengendered in Washington. The World Bank has been slower than the IMF torelease the second tranche of its assistance—the governance promotionadjustment loan. Its team's visit overlapped the IMF's but it has yet to releasethe second tranche. On December 19th the Bank advised the government thatit wanted to see, in respect of the privatisation of the Papua New GuineaBanking Corporation, the Rural Development Bank and the Motor VehicleInsurance Limited, the issuance of bidding documents, sale advertisements andspecification of community service obligations, as agreed, before releasing thesecond, "floating", tranche.

Extension to structuralreform programme

IMF releases second tranche

20 Papua New Guinea


The SRP requires the continuing independence of the central bank and for it tofocus solely on achieving price stability and maintaining a market exchangerate and market interest rates. The central bank has maintained its tightmonetary policy stance although official interest rates have declined as marketexpectations of inflation have been revised downwards. The central bankgovernor, Wilson Kamit, insists that monetary policy will only be eased whenhe is satisfied that inflation is firmly on a downward trend. This policy stancehas placed a heavy burden on the private sector and many banks and privatesector representatives have called on the central bank to ease its policy stance.

In the aftermath of malpractice in the National Provident Fund and the MotorVehicle Insurance Limited, all financial institutions are now subject to thecentral bank’s powers to license, regulate and supervise.

The prime minister took the opportunity, in the face of serious opposition,particularly from labour organisations, to reiterate the benefits of hisgovernment’s cornerstone privatisation programme also on the SRP agenda.Not least, he said, it would reduce the scope for fraudulent and criminalactivity in the public sector; although it is primarily designed to make theeconomy more efficient. All net proceeds, Kina178m in 2001 and Kina364mover the ensuing three years would go to debt reduction. Community ServiceObligations for each industry affected are the focus of regulatory reviewscurrently underway, as are quasi-monopoly situations. The PrivatisationCommission, charged with ensuring transparency and accountabilitythroughout the privatisation process, is well advanced in bringing the PapuaNew Guinea Banking Corporation to the point of sale, scheduled for April2001. As well, it has commenced the preparation of Air Niugini for sale, alsoexpected in the first half of 2001, and will soon appoint project managers toprepare other major state-owned enterprises (SOEs) for sale. Unlike the bankand the airline which are fully commercial undertakings, utilities such astelecommunications and electricity, both with heavy developmental dimen-sions to them, will not be as amenable to effective privatisation, as progresswith the regulatory reviews will make evident.

Privatisation plans inmotion

Continued focus on pricestability

Papua New Guinea 21


In a determination which has left employers wondering, the Minimum WagesBoard has recommended that the statutory minimum wage be increased fromKina24.68 per week to Kina60 per week. This is the first tribunal convenedsince 1992. Prior to this there were two minimum wages; one for urbanunskilled workers and the other for rural unskilled workers, as well as a numberof minima for different skill levels. In keeping with the first structuraladjustment program, agreed with the World Bank and IMF, the 1992 MinimumWages Board determination deregulated the skills market and eliminated thedual urban-rural wage structure, setting just one minimum wage at the thenrural rate. This meant a substantial reduction in the urban minimum wage,which the current recommendation, in effect, reverses, at the same timeincreasing the rural minimum wage to two and a half times its 1992 level.Since 1992 formal employment has increased by 10%, according to the Bank ofPapua New Guinea’s employment index, about half as much as the population.The board gave most consideration to the change in the kina exchange ratewith the US dollar since 1992 and sought in its determination to restore realincomes lost under the floating exchange-rate regime. The cabinet has yet toconsider the Board’s recommendations, as it is expected to do; although it isnot required to do so.

The domestic economy

Economic trends

In its 2001 budget the government estimated the economy would grow 0.8%in 2000, a disappointing shortfall on the 4.7% projected in the budget a yearearlier. The mining and petroleum sector was the main drag, contracting anestimated 7.9%, non-mining GDP growth being estimated at 3.3%. Crude oilproduction was down on 1999, in the third (September) quarter by one-thirdand for the three quarters to September by one-quarter. The government’sestimates for the full year, down 23.5% on 1999, might prove slightlyoptimistic. Copper production in 2000 was also down on the previous year, byone-third in the September quarter and about one-sixth for the three quartersto September. Full year copper production will be disappointing, with just 60%of government’s estimate being fulfilled by September. Moving both againstand with sectoral trends, gold production for the three quarters to September2000 was up 16% on the previous year but down 8% for the September quarter.With 86% of government’s full-year estimate booked by the end of September,gold could compensate, but only in part, for the shortfalls in oil and copper.Growth in the other export sector, comprising agriculture, forestry and fishing,estimated at 0.9%, is also lack-lustre.

Actual performance, when it becomes known in 2001, is likely to be worsethan these estimates. Whereas the budget estimates 5% growth in manu-facturing, wholesale and retail trade, and transport, the Bank of Papua NewGuinea (the central bank), in its September quarterly bulletin, reports a declinein the level of economic activity in the private sector in the first half of 2000

Government lowers GDPgrowth estimate for 2000

Recommendation toincrease minimum wage

22 Papua New Guinea


compared with the second half of 1999. The central bank’s bi-annual businesssurvey showed a 3% decline between these periods in the value of sales by theprivate sector, excluding mining and petroleum and Bougainville. The declinewas evident in all regions except Lae. It occurred mainly in wholesale trade andtransportation, more than off-setting increases in retail, manufacturing,construction and agriculture. Formal private sector employment, excludingmining and petroleum and Bougainville, according to the central bank’squarterly employment survey, fell 0.2% between the second half of 1999 andthe first half of 2000. Employment increases in retail and wholesale trade,manufacturing and agriculture were not enough to outweigh decreases in allother sectors. Employment also increased in most regions but not sufficientlyto counter losses in the Highlands and the National Capital District.

Headline inflation abated in the third quarter of 2000. The consumer priceindex (CPI) was 1.8% higher than in the second quarter which had recorded a4.3% quarterly increase. All urban areas recorded increases in the third quarter.Between the third quarters in 1999 and 2000 the CPI rose 12.2%, a bigimprovement on the 21.8% increase between the second quarters. The lowerheadline inflation rate reflects the passing out of the effects of the introductionin mid-1999 of the value-added tax (VAT) and increases in excise rates.Excluding such policy effects and the seasonal betelnut and fruit andvegetables, the underlying rate of inflation, a new measure (see October 2000),was 0.6% quarter on quarter and 9.2% at an annual rate. Comparable figuresfor the second quarter were 2.5% and 15.0% respectively.

The 1.8% increase in the CPI in the third quarter comprised mainly: 1.1percentage points in the food expenditure group; 0.4 in the drinks, tobaccoand betelnut group; and 0.21 percentage points in the clothing and footwearexpenditure group. The higher food index masked price reductions, attributedby the central bank to the kina’s appreciation in the second quarter, in suchfood staples as flour, rice, tinned fish, butter and tea. Prices of fuel, power andhousehold appliances also fell for the same reason.

Quarterly inflation

1999 20002 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Index: 1977=100Consumer price index 447.8 495.1 509.5 522.9 548.6 555.6 % change, year on year 14.1 18.2 13.2 19.6 22.5 12.2

Underlying inflationa 414.9 439.6 453.3 465.3 477.0 480.1 % change, year on year n/a n/a n/a 17.0 15.0 9.2

a Revised seriesSource: Bank of Papua New Guinea, Quarterly Economic Bulletin

Total money supply grew 2.2% between end-September 1999 and 2000, a realcontraction in the light of 9.2% annual inflation. An increase by half in netforeign assets was more than off-set by a 9.4% reduction in domestic credit.Net credit to the central government contracted by about a quarter as a resultof the government’s December 1999 swap arrangement with the Reserve Bank

Inflation down over thequarter and the year

Money supply contracts inreal terms

Papua New Guinea 23


of Australia. Credit to the private sector increased by 5.4%, a contraction in realterms. The average level of private sector credit over the three quarters toSeptember was 10.4% higher in 2000 than in the previous year, real growth of1%, but from the second to the third quarters 2000 it fell 3.1%, about 5% inreal terms.

Money supply(Kina m; end-period)

Year 3 Qtr 3 Qtr1997 1998 1999 1999 2000 % change

Domestic credit 2,320.4 2,716.3 2,824.8 2,995.2 2,713.6 –9.4 Non–government 1,480.2 1,747.0 1,747.4 1,748.8 1,763.9 0.9 Private sector 1,063.9 1,372.2 1,516.8 1,462.7 1,541.8 5.4 Official entities 299.0 208.0 158.5 148.4 146.6 9.2 Non-monetary financial institutions 117.2 166.8 72.1 137.7 75.5 –45.2 Central government 840.1 969.3 1,077.4 1,246.4 949.8 –23.8 MRSF –696.4 –677.3 0 –566.8 0 – Other 1,536.5 1,646.6 1,077.4 1,813.2 949.8 –47.6

Net foreign assets 780.8 496.0 675.5 475.8 719.3 51.2

Total money supply (M3) 3,101.1 3,212.3 3,500.3 3,471.0 3,547.3 2.2


Oil and gas

Tax changes introduced in the 2001 budget should give some incentive toexploration which has been for some time at worryingly low levels. Theyshould also facilitate progress on the PNG-Queensland, US$3.5bn gas pipeline,the largest investment PNG has contemplated (see October 2000). Thegovernment of Papua New Guinea has sought assistance from Australia infinancing the 30% of the project it is entitled to under law. Prime minister, SirMekere Morauta, took the opportunity provided by the conference held inSydney on December 4th—conducted annually by the Papua New GuineaChamber of Mines and Petroleum—to publicise the request, emphasising theproject’s benefits to Australia; cleaner, cheaper fuel and a more stableneighbour. Informed Australian media analysis urged the Commonwealthgovernment to assist, suggesting A$250m (US$138.3m) would secure theproject. The Papua New Guinea government acknowledges that it may have toproceed with less than its full entitlement. It has already received pledgedassistance from the European Investment Bank in the amount of A$190m andthe International Finance Corporation, the commercial arm of the World Bank,is another possibility. Once the equity funding is finally in place, closing outnegotiations with customers, the Queensland State Government’s EnergexCorporation and Ergon Energy Corporation, should quickly follow and theproject can move to the US$40m up-front design phase. Earliest completion,initially 2001, then 2004, is now marked at mid-2005.

Crude oil exports, on a declining trend since the first full year of production in1993, amounted to 5.24m barrels in the third quarter 2000, downapproximately one-third on the previous year. Prices, however, were much

Government seeks financialassistance for pipeline

Oil exports continue ondownward path

24 Papua New Guinea


improved. For the three quarters to September, volumes were down one-quarter on 1999 to 17m barrels, but prices doubled. The government’sestimates for the full year, 23.4m barrels worth Kina1.8bn (US$545m), mightprove slightly optimistic. Taxation considerations may have impacted onproduction in a period of abnormally high world prices.

Mining

As for oil and gas, the tax changes introduced in the 2001 budget should giveincentive to mining exploration which has also been at worryingly low levelsfor some time. The changes should also facilitate financing of the US$850mRamu nickel-cobalt project (see October 2000) for which the developers,Highlands Pacific and Orogen Minerals (the majority government-ownedcompany listed on the Australian Stock Exchange) have yet to name the thirdpartner following the granting in June 2000 of the mining licence for theproject. On November 16th in Port Moresby: the state, the Madang provincialgovernment, the landowners and the developers signed the project memoran-dum of agreement. This was the culmination of a process known as thedevelopment forum embracing educational workshops and awareness patrols,which is a binding agreement, subject to review at five-yearly intervals.

On an uptrend since Lihir came on stream in mid-1997, gold exports for thethree quarters to September 2000 were up 16% to 53.5 tonnes compared withthe same period in 1999. However, in the third quarter exports of 16.9 tonneswere 8% down on the previous year. With 86% of the government’s full-yearestimate for both volume and value booked by the end of September, goldseems set to surprise on the upside. The government projects gold productionto fall slightly in 2001 and then trend upwards to be at some 20% more thanthe 1999 level of production by 2004. Misima will exhaust its in-groundreserves in 2001 and move to processing low-grade, stockpiled ore. Lihircontinues to grapple with technical problems. Porgera had a very good year,consolidating its status as a low-cost, world class gold producer. Two goldprospects in Morobe and Eastern Highlands provinces are progressingencouragingly.

Copper exports in 2000 were down on 1999, by 35% to 24,000 tonnes in thethird quarter and by 16% to 87,000 tonnes for the three quarters to September.Prices for the three quarters, however, were 27% higher. Full year copperproduction will be disappointing, just 60% of the government’s estimate beingfulfilled by September. Looking ahead, the government sees copper productionstabilising at around 160,000 tonnes.

There has been no resolution of the differences between the Australian naturalresources conglomerate, Broken Hill Proprietary (BHP), and the governmentover closure of Ok Tedi (see October 2000). BHP wants to close the mine earlybut the government is intent on keeping the mine open until the end of itseconomic life, some ten years from now. Following BHP’s announcement of itsintention to end its direct involvement in the mine, the mining minister,Michael Laimo, has said that a “number” of companies have registered an

Ramu agreement signedbut no third investor yet

Mixed results for gold andcopper exports

A “number” of companiesinterested in Ok Tedi

Papua New Guinea 25


interest in the mine, all of which will need to be thoroughly screened by thegovernment.

BHP also now faces the possibility of a huge pay-out to 30,000 PNGlandowners following the ruling by a Supreme Court of Victoria judge onNovember 22nd to allow the class action against BHP to proceed (see July2000). Landowners are seeking monetary compensation for the damage causedby the dumping of 100,000 tonnes of waste from the Ok Tedi mine into theriver system each day.

Mineral exports, by volume

1999 20002 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3Qtr

Crude oil (‘000 barrels) 7,642 7,735 7,749 5,889 5,930 5,239

Copper (‘000 tonnes) 35.8 37.0 40.4 30.5 32.6 24.0

Gold (tonnes) 14.8 18.5 17.0 19.4 17.2 16.9


Agriculture

Coffee exports suffered big declines for the three quarters to September in bothvolume and price, 27% and 15% respectively, relative to last year. Export valuewas down a massive 38% to Kina217m (US$65.6m) on volume of 47,000tonnes. The third quarter was particularly awful; it accounted for practically allof the volume collapse and prices were off by 28%. With the coffee year endingin October, the government budget fully reflected the sorry story. It projects areturn in 2001 to 66,000 tonnes and thence 5% annual growth.

Palm oil in 2000 overtook coffee as the premier agricultural export crop. Thirdquarter exports were a record 100,000 tonnes, up one-third on the previousyear. For the three quarters to September 236,000 tonnes were exported, 14%more than a year ago. But average prices received were down around 30%. Theprospects for the government’s expected 300,000 tonnes for the full year lookgood. The government is then looking for 5% annual growth from palm oil.

Like palm oil, volumes for copra and copra oil for the three quarters toSeptember were up on last year but average prices received were down, by 11%and 17% respectively. Prices for the third quarter were particularly poor, nearly40% lower than a year ago. Volumes, too, were down, by 10% to 25,000 tonnesyielding Kina24m. Fourth quarter exports of copra and copra oil will be abonus for government. The government budget projects stagnant copraexports but exports of copra oil growing at 10% annually by volume.

Cocoa showed a similar pattern, better volumes than last year but worse prices.For the three quarters to September, cocoa exports were 33,000 tonnes, a one-third increase. September quarter prices were 36% lower than a year ago.However, 9,000 tonnes were exported compared with 6,000 tonnes theprevious year. With 64% of full year value estimate booked by September,cocoa exports look set to be disappointing. The government is expecting cocoa

Falling export prices hurtcommodities producers

26 Papua New Guinea


export volumes in 2001 to be two-thirds more than they were in 1999, then toremain steady.

Hardwood logs make up more than 90% of exports of forest products. AtKina202m for the three quarters to September, exports of forest products werelittle changed from last year, better prices compensating for an 11% fall in logvolume to 914,000 cubic metres. For the third quarter, 279,000 cubic metres oflogs were exported, 21% more than a year ago. Prices, however, were off andvalue increased by just 7% to Kina58m. Log exports for the full year look set tofall well below the government’s estimated 1.5m cubic metres, a level thegovernment projects to be maintained in the years ahead.

Agricultural exports, by volume(‘000 tonnes unless otherwise indicated)

1999 20001 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3Qtr

Cocoa 7.3 11.2 6.0 4.5 14.2 9.9 9.0

Coffee 10.8 20.2 33.9 14.3 10.2 20.5 16.7

Tea 1.8 1.8 2.0 2.6 2.0 2.2 2.3

Copra 12.4 14.6 16.6 19.9 29.6 16.9 10.5

Copra oil 18.1 14.0 11.3 6.9 15.1 9.8 14.5

Palm oil 68.9 64.1 74.4 46.4 49.8 95.6 100.4

Rubber 1.3 0.6 0.7 1.1 0.6 0.9 1.4

Logs (‘000 cu metres) 323.7 470.1 230.3 288.2 312.2 322.4 279.4


Agricultural export prices(Kina per tonne unless otherwise indicated; fob)

Mar Jun Sep1997 1998 1999 2000 2000 2000

Cocoa 1,899 3,130 2,917 2,548 1,888 2,120

Coffee (all grades) 5,505 5,705 5,266 5,719 4456 4,000

Tea 1,600 2,864 2,317 2,065 2,845 2,102

Copra 523 668 1,047 1,000 916 583

Copra oil 1,051 1,310 1,905 1,711 1,781 933

Palm oil 753 1,277 1,331 1,068 876 803

Rubber 1,477 1,490 1,351 2,144 1,615 1,714

Logs (kina/cu metre) 172 145 195 215 180 202


Foreign trade and payments

External payments for the third quarter recorded an overall surplus of Kina26m(US$7.9m) in 2000, down on the surplus of Kina86m in the previous year. Thedeficit on the capital account, Kina275m, was much larger than the Kina176m

A disappointing quarterfor foreign trade

Papua New Guinea 27


recorded for that quarter in 1999. The current-account surplus of Kina261mwas well down on the Kina369m recorded last year. Both the merchandisetrade surplus for the quarter, Kina631m, and the invisibles deficit, Kina372m,were lower in 2000 compared with 1999 when Kina787m and Kina476m wererecorded, respectively. Merchandise exports were down 16% to Kina1.26bn.Merchandise imports fell 12% to Kina631m. Reduced official transfers, mainlyAustralian grant aid, down from Kina58m in the third quarter of 1999 to zeroin 2000, accounted for most of the smaller current-account surplus.

For the three quarters to September 2000, merchandise exports wereKina4.16bn, up 16% on the same period the previous year. Merchandiseimports were up just 1.6% to Kina2bn. On end-month average over the ninemonths the kina bought US$0.372, a 12-month depreciation of 6.3%. Againstthe Australian dollar the kina appreciated by 2.2% to A$0.632. Accordingly,exports have grown in US dollar terms by about 9% and imports have grown inAustralian dollar terms by 4%. The trade surplus for the three quarters,Kina2.13bn, was one-third more in 2000 than in 1999. The Kina1.4bninvisibles deficit was practically unchanged. The current account recorded ahealthy Kina724m surplus, almost three times that in the previous year.Conversely, the capital-account deficit of Kina613m was over twice that of theprevious year. Overall, the balance of payments for the three quarters toSeptember 2000 recorded a surplus of Kina101m compared with a Kina74mdeficit a year ago.

Balance of payments(Kina m)

3 Qtr 3 Qtr1996 1997 1998 1999 1999 2000

Merchandise exports 3,334 3,079 3,707 5,006 1,504 1,262

Merchandise imports –1,996 –2,129 –2,231 –2,760 –717 –631

Trade balance 1,338 950 1,476 2,246 787 631

Invisible credits 611 619 699 691 186 209

Invisible debits –1,633 –1,823 –2,238 –2,620 –662 –581

Net transfers 95 87 187 50 58 2

Current–account balance 411 –167 124 367 369 261

Official capital flows 14 –89 –92 119 –37 –48

Private capital flows –147 134 –189 –305 –186 –194

Non–official monetary sector transactions –46 –61 31 –6 34 –53

Change in offshore account balances 237 –46 –114 22 13 20

Capital–account balance 58 30 –364 –170 –176 –275

Net errors & omissions –37 14 –23 –29 –48 40

Overall balance 432 –123 –276 160 86 26

International reserve level 789.1 666.9 390.9 550.8 314.0 651.6


The pattern of merchandise imports for the three quarters to September 2000was similar to that in the third quarter, where falls in general merchandiseimports and imports by the petroleum sector off-set rises in the minerals sector.Oil and minerals accounted for 77% of merchandise exports for the third

28 Papua New Guinea


quarter 2000 and agricultural produce for 18%, forest and marine productscontributing 4.6% and 0.6% respectively. Crude oil accounted for 45% ofsector exports and gold for 42%, copper contributing the remainder. Palm oilcontributed 38% of agricultural exports for the third quarter; coffee, 29%;copra and copra oil, 11%; and cocoa, 8%. For the three quarters to September2000, sectoral shares were the same as for the quarter; commodity shares wereslightly changed. Oil and gold changed places. In the agricultural sector, exportshares for the three quarters were: palm oil, 36%; coffee, 34%; copra and copraoil, 18%; and cocoa, 11%.

Exports(Kina m)

3 Qtr 3 Qtr1996 1997 1998 1999 1999 2000

Agricultural 578.6 777.2 1,020.2 1,165.0 366.2 220.2

Forest products 480.3 433.6 173.2 265.9 54.5 58.4 of which: logs 464.8 409.3 154.2 255.6 49.7 52.1

Marine products 10.4 9.6 42.2 30.4 10.7 7.5

Minerals 2,244.6 1,838.9 2,452.1 3,524.0 1,087.6 971.0 Gold 773.6 718.7 1,227.8 1,546.1 486.4 411.3 Copper 387.0 259.8 395.7 574.3 160.4 113.8 Crude oil 827.7 852.2 813.1 1,382.4 415.0 440.9

Total 3,313.9 3,059.3 3,687.7 4,985.3 1,499.0 1,257.1


The approval of the second tranche of IMF funding and intervention by theBank of Papua New Guinea (the central bank) provided temporary relief inNovember to the decline in the value of the kina since the yearly high in Juneof Kina2.38:US$1. However, the currency has continued to slide since, endingthe year at Kina3.04:US$1, at an average of Kina2.74:US$1 for 2000. TheChristmas and New Year period is traditionally a time when the kina suffersfrom a lack of export receipts, but the kina has not picked up in the early partof the year as many exporters were expecting and has fallen to levels not seensince the middle of July 1997. By year-end 2000, the kina showed a 12-monthdepreciation against the US dollar of 16.2% and a depreciation of 3.4% againstthe Australian dollar. The prime minister has said that the central bank, anindependent institution, would only intervene to ensure that the kinaremained stable. The government is projecting a stable kina in the years ahead,worth 33 US cents and 61 Australian cents.

Exchange rates(foreign currency unit per kina; end-period)

1996 1997 1998 1999 2000 % changea Jan 12th

A$ 0.9653 0.9365 0.7708 0.6086 0.5879 –3.4 0.5410

US$ 0.7553 0.6971 0.4856 0.3922 0.3285 –16.2 0.3025

� 82.17 84.23 63.43 44.74 28.71 –35.8 25.65

� 0.4845 0.4264 0.2933 0.2426 0.2205 –9.1 0.2025

a 2000/1999Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; Bloomberg.

Little respite for the fallingkina

Papua New Guinea 29


During the third quarter of 2000 the government of Papua New Guinea drewdown Kina4.6m from foreign lenders and repaid them Kina52.7m. ButKina76.1m of unrealised exchange-rate losses pushed the level of overseaspublic debt outstanding higher at period end to Kina3.4bn. Since the end ofSeptember 1999, when foreign public debt reached a maximum, driven by thedepreciating kina and despite net loan repayments, debt has eased byKina458m, or 12%. Unrealised exchange-rate gains of Kina657m more thanoff-set Kina199m of net draw-downs associated with the structural reformprogramme agreed with the IMF, World Bank and donor countries. Thegovernment paid Kina94.2m interest on foreign debt in the three quarters toSeptember and Kina27.9m in the third quarter.

Public debt outstanding(Kina m)

Sep1995 1996 1997 1998 1999 2000

Domestic 1,605.7 1,969.5 2,251.7 2,473.0 2,021.3 1,705.6 Treasury bills 1,217.5 1,615.3 1,931.6 2,186.9 1,775.2 1,493.5 Inscribed stock 388.2 354.2 320.1 286.1 246.1 212.1

External 1,718.4 1,811.3 2166.3 2,704.6 3,812.8 3,395.2 International agencies 1,475.8 1,579.2 1,997.4 2,567.5 3,650.4 3,247.5 Commercial loans 227.9 219.6 157.1 124.1 144.6 132.5 Other loans 14.7 12.5 11.8 13.1 17.9 15.2

Total public debt 3,324.1 3,780.8 4,418.0 5,177.6 5,834.2 5,100.8


External public debt up byslightly

Documents

Papua New Guinea€¦ · COUNTRY REPORT Papua New Guinea January 2001 The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom At a glance: 2001-02 OVERVIEW