PNG’s Macroeconomic Outlook

Strategies for Exiting the Boom and Bust Cycle

Dr. Yurendra BasnettCountry EconomistAsian Development BankPapua New Guinea Resident Mission

Strong Headwinds Affecting Growth

Source: Asian Development Outlook Update (2016).

• Economy slowing down. Government revised 2016 GDP growth forecast to 2.2%. 2017 GDP growth expected to be 3.0%.

• Inflationary pressure building up. Inflation in 2016 revised up to 6.5% , and expected to rise to 7.5% in 2017.

• New mining projects in the medium-term provide upside risks.

0

2

4

6

8

0

5

10

15

2011 2012 2013 2014 2015e 2016p 2017p

GDP growth (% per annum, lhs) Inflation (%, annual average, rhs)

Weakened External Position

BOP Accounts (3-mths moving average, USD millions) and USD/PGK

Source: BPNG data; Estimates based on ADB, World Bank & BPNG joint analysis

• Limited FX inflows relative to exports from the mineral sector.

• Loose fiscal policy had contributed to the relatively strong demand for imports and hence foreign exchange.

• FX trading band led to an appreciation of the USD/kina exchange rate and an increase in the outstanding sell kina orders.

Weakened Fiscal Position

0.0 1,000.0 2,000.0 3,000.0 4,000.0

2012

2013

2014

2015

Borrowing (total) External Domestic

Revenue performance and projections

Total borrowing and sources (in Kina millions)

• Sustained fall in commodity prices drastically reduced public revenue. In 2015, overall revenue fell by PGK 2.5 billion (or 21% total revenue), with the largest reduction being in Mining and Petroleum Tax (91%).

• Expansionary fiscal policy started in 2012 led to a large structural fiscal deficit. The deficit increased from 0.3% of GDP in 2012 to 9.6% in 2013 and 8.3% in 2014, which was largely financed through domestic borrowing.

• Existing budget financing measures have reached their limit. Little market appetite for new government securities as financial institutions reach their technical limit on exposure to public debt.

• 2016 Revenue shortfall of PGK 1.9 billion (US$ 633 million).

0

40

80

120

0

200

400

600

800

Bud. Rev. Est. Bud. Rev. Sup. Bud.

2014 2015 2016

$ per barrel$ million

Mining and petroleum taxes Export tax Oil price assumptions

Source: Asian Development Outlook Update (2016).

Cyclical Factors

Source: BPNG data; Estimates based on ADB, World Bank & BPNG joint analysis

• Declining international commodity prices, which started in 2012, generated lower inflows from key export commodities such as copper, gold and oil.

• The El Niño weather phenomenon which began in 2015 reduced mining and agricultural exports and consequently FX inflows and reserves.

• Capital and financial inflows previously associated with PNG LNG construction phase have ceased. -100

-50

0

50

100

150

200

250

300

-100

-50

0

50

100

150

200

250

300

Jan

-12

Mar

-12

May

-12

Jul-

12

Sep

-12

No

v-12

Jan

-13

Mar

-13

May

-13

Jul-

13

Sep

-13

No

v-13

Jan

-14

Mar

-14

May

-14

Jul-

14

Sep

-14

No

v-14

Jan

-15

Mar

-15

May

-15

Jul-

15

Mill

ion

s

Mill

ion

s

Total Net Mineral Flows USD, 3-months MA

Mining Gas Petroleum TOTAL Net Mineral Flows

Total net inflows according to activities associated with resource sector

Structural Factors

• Increasing reliance on resource exports has made the economy vulnerable to external shocks.

• Low productivity in non-mining sector: agriculture, manufacturing and services.

• Key constraint to economic diversification include:• Limited infrastructure.• High/inflated operating costs.• Weak business environment.

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Value added in agriculture (%, rhs) Value added in industry (%, rhs)

Value added in services (%, rhs) GDP growth (%, lhs)

GFCCommodities downturn

Source: ADO (various years)

Historical Experiences

• 1997 to 1998 (Asian Financial Crisis and El Nino): • Depreciation of the kina from PGK 0.75/USD to PGK 0.37/USD, but exports did

not pick up.

• FX reserves deteriorated from 2.6 months to 1.2 months of import cover (US$ 213 million).

• Tax revenue fell by 4½% of GDP in 1998.

• Despite cuts in capital spending, overall deficit widened (equivalent to 2.1% of GDP in 1998 form near balance in 1997).

• The non-resource sector contracted by 2.3 percent (in real terms) in 2000.

• 2008 Global Financial Crisis: • Strong fiscal buffers (built over much of 2000) and growth momentum helped

PNG withstand the impact.

• Swift recovery in global commodity prices.

Source: Based on ADB and World Bank joint analysis

• Economy susceptible to external economic and natural shocks.

• Global commodity price key transmitter of external economic shock.

• Pro cyclical policy stance and reduced fiscal buffers.

• Investments in productive infrastructure and human development.

8

Key Lessons

Improving Fiscal Stance

• Calibrated move to balanced budget by 2020/2021.

• Proactive measures taken to rein ballooning of the deficit.

• Introductions of revenue measures.

• Cutting of non-essential and non-productive expenditures.

• Going forward effective implementation of reforms identified by the Government will be key.

9

Public Finance Management Reforms

• Planning and Monitoring Responsibility Act (2016) aims to strengthen the link between annual budget and medium-term development plan.

• National Budget Framework (2016) will bind annual budget allocation (appropriations) to the national development priorities.

• Public Finance Management Act Amendment (2016): Stronger controls on issuance of warrants and financial reporting, better monitoring of statutory authorities, controls on trust fund accounts, strengthening financial management at sub-national level.

• Reform to Budget Process: Unified budget (recurrent and capital expenditure), Multi-year budget, and two-stage budget process (design and cost approval for capital expenditure). The 2017 Budget will consider SDG priorities.

Prognosis:

• Fiscal consolidation is welcomed, but needs to be done prudently to safeguard development priorities.

• Execution of PFM reform and monitoring of outcomes will be important.

Central Bank’s Monetary Position• Central Bank maintains neutral

policy stance to support economic activity.

• Kina depreciating at a policy determined speed.

• Central Bank plans to purchase of 63 day Treasury Bills for monetary policy signaling rate.

Prognosis:

- The neutral policy stance may not be adequate to reduce the excess liquidity.

- Trading band around the exchange rate is not sustainable.

- Proposed reform to monetary policy signaling rate could reduce fiscal discipline and stoke inflationary pressures.

Retail vs Interbank USD/PGK Rate & Outstanding Sell Kina Orders

Source: BPNG data; Estimates based on ADB, World Bank & BPNG joint analysis

• Weak institutions undermine structural economic transformation.

• Increasing reliance on resource exports has made the economy vulnerable to external shocks.

• Important to increase productivity in non-mining sector: agriculture, manufacturing and services.

• Key constraint to economic diversification include:• Limited infrastructure.

• High/inflated operating costs.

• Weak business environment leads to high mark ups resulting from high concentration ratios.

Source: Asian Development Outlook (2016)

Economic Diversification Vital for Reducing Growth Volatility

1. Sustain investment in infrastructure to support productive sectors.

2. Expand opportunities for private sector participation in non-mineral sector.

3. Invest in human development.

4. Improve performance of public expenditure and increase budget efficiency.

Measures Needed to Avoid Boom and Bust Cycle

Source: Asian Development Outlook (2016)

Em tasol