The Papua New Guinea Economy Outlook

Asian Development Bank

Papua New Guinea’s (PNG) economy should grow by 8.5% this year and 6.5% in 2012 largely due to the recent rise in commodity prices and new project investments in the resource-rich Pacific nation.
Farmers make up the majority of the PNG population, so higher agricultural prices will support local consumption. Gross domestic product expanded by 7.0% in 2010 and 5.5% in 2009.

The monitor credits the $15 billion ExxonMobil-led Liquefied Natural Gas (LNG) Project as being largely responsible for boosting growth in PNG.

“Private investment is strong in PNG as businesses seize the opportunities generated by the LNG Project,” said Charles Andrews, Country Director of ADB’s Papua New Guinea Resident Mission. “The challenge is to ensure the sound management of the revenues gained from these opportunities, and the government has already made some prudent steps in this area.”

Still, rising international food prices, the depreciation of the kina in 2010 and some supply side constraints in skilled labor, construction, and transportation will fuel inflation. The diversification of imports sourced from emerging Asian markets may however be helping to contain wholesale and retail prices. ADB expects inflation of 8.0% this year and 7.5% next year which may require the central bank to tighten monetary policy.
PNG’s 2011 national budget – at $3.5 billion or 14% of gross domestic product – is the largest in the country’s history. The PNG Government expects to generate sufficient revenues to deliver a balanced budget this year, excluding trust fund drawdowns.

The report acknowledged the PNG Government’s commitment to developing a sovereign wealth fund as a means of preserving the expected profits of the LNG project for future generations. It commended the government on its consultative approach and its intention to manage all resource revenues through offshore funds, with all expenditures channeled through the budget process.

The monitor noted that in 2010 much of the windfall revenues from high commodity prices were spent on discretionary capital spending in the supplementary budget. It encouraged the PNG Government to instead spend such revenues on the rehabilitation and maintenance needs of existing public infrastructure.

Key Issues
The budget macroeconomic framework is appropriately cautious in its forecast of future mineral export revenues. The government needs to carefully consider the risk of accumulating public liabilities until public revenues from resource revenues are realized.

  • Through a consultative process, a Secretaries Committee and an interdepartmental working group, chaired by a representative from the Department of Treasury, have been created to oversee the establishment of a sovereign wealth fund. The government intends to manage all resource revenues through offshore funds, with all expenditures channeled through the budget process.While this is a promising strategy, the challenge is to ensure that drawdown arrangements from each fund are coordinated and expended within the absorptive capacity of the public and private sectors.
  • The government decided to move all new trust accounts to the Bank of PNG. Monetary policy effectiveness will be enhanced as the central bank now has better control over banking sector liquidity. Previously, it was constrained by the high cost of using central bank papers to absorb excess liquidity. Existing trust funds at commercial banks should also be moved to the central bank. Eventually, all trust funds should be consolidated with the proposed offshore sovereign wealth fund.
  • There are currently severe supply-side constraints in the construction and transportation sectors as significant development budget expenditures compete with the PNG LNG project and other private sector activities for scarce resources. Delaying nonpriority projects until after the construction boom will raise the efficacy of public expenditures and reduce inflation pressures.
  • Windfall revenues are likely to eventuate if commodity prices remain high. In 2010, much of the windfall revenues were directed toward discretionary capital spending in supplementary budgets. Instead, such revenues should be spent on the rehabilitation and maintenance needs of existing public infrastructure.
  • Real interest rates on government securities and deposits are negative. Given the near-term upside risks on inflation, the Bank of PNG will need to consider tightening monetary policy.
  • During 2010, net foreign assets contributed significantly to money growth. This could potentially fuel inflation if the trend continues into 2011. The Bank of PNG must balance the need to accumulate additional foreign exchange reserve against the cost of sterilizing the liquidity this accumulation creates.

Outlook
  • In the near term, the construction phase of the PNG LNG project, favorable commodity prices, and strong investor confidence will boost economic growth. GDP growth is projected to be 8.5% in 2011 and 6.5% in 2012.
  • Despite the size of the LNG project, the government estimates that only 4.5% of project investment flows will be retained in the local economy, mostly between 2011 and 2013, as most project costs will be for imported goods and services.
  • Supply-side constraints in some sectors, such as the property market in Port Moresby and Lae, skilled labor, construction, and transportation, are creating inflationary pressures. Inflation driven by domestic demand is therefore expected to persist. Rising international food prices and the 2010 depreciation of the kina, in particular against the Australian dollar, will further fuel inflation. ADB expects underlying inflation to increase to 8.0% in 2011 and 7.5% in 2012.
  • A funding agreement for an LNG project led by InterOil, valued at $4 billion, was signed in early 2011. Project developers have announced that construction could begin as early as the fourth quarter of 2011. If this project were to start earlier than planned, then near-term growth and inflation would be significantly higher.
  • Other upside risks include higher commodity prices, increased mining activities, and additional trust fund expenditures combined with the potential lagged impact of 2009 trust fund withdrawals ahead of the 2012 elections.
  • The main downside risk is further delays in large resource projects due to landowner compensation disputes and land access issues.
  • The medium-term economic outlook is clouded by uncertainty over mining production. Several major mines are anticipated to close including Kainantu (2012), Ok Tedi (2013), and Porgera (2015). This would significantly reduce crude oil, gold, and copper exports, and slow growth. There are, however, possibilities that the mine production at Ok Tedi and Porgera will be extended. If this eventuated and the second LNG project commenced early, then growth and inflation would be much higher than current treasury estimates.
  • The increase in imports related to resource projects will widen the current account deficit over the next few years. However, these projects will be financed mainly through foreign direct investment flows, so there is little implication for external stability.
This article was first published by the Asian Development Bank's The Pacific Economic Monitor Issue 7  The full report can be accessed by clicking here

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