Currency and inflation management in PNG

By SOLOMON AWALI

The following piece attempts to briefly shed some light on how the exchange rate and inflationary mechanisms work as some uninformed social media bloggers particularly in the Facebook are politicizing issues such as currency, international reserves and inflation management in PNG to further add "salt to the wound" when PNG is currently being wounded from the recent political turmoil:

Low exchange rate is good for the agriculture sector as exports become cheaper. Imports will become expensive due to the effects of imported-inflation. However, if the domestic cost structure is low and flexible, it can absorb the imported inflation in the short-run. As most developing markets such as ours are considered inefficient due to the presence of market frictions such as high transaction, monitoring and information costs, inflation will always remain a huge developmental threat. Underlying inflation is usually compounded by large inflow of FDIs attracted largely by the extractive industry. In our case we saw this materializing during the height of the USD$19 billion LNG project’s construction phase.

In the absence of ongoing structural reforms to periodically check the entire supply chain of pricing system in the economy (which ICCC is not up to the task to date) particularly the domestic cost-push factors, inflation will continue to hover above target ranges. The central bank does mitigates the effects of inflation via the use of monetary policy tools i.e. both quantitative (e.g., increase in cash reserve rates (CRR) and qualitative (e.g., moral suasion or jaw-boning). This is why periodically the central bank advises governments to restrain spending. Such calls in an inefficient market like ours for some reason usually falls on deaf ears with the exact opposite outcome: more spending sprees. Such expansionary fiscal approaches further exacerbate the underlying causes of inflation by adding more liquidity (cash) to the banking system. As excessive liquidity is bad for the economy, the central bank thru its monetary interventions mops up excess liquidity. For example, recently the central bank has advised the government to transfer multiple government trust accounts held at banks over to central bank and issue more long-term government inscribed stocks as opposed to (short-term) treasury bills.

High exchange rate is also harmful to the economy. One example is exports will become expensive as noted earlier. Our trading partners may opt for cheaper goods from other trading partners. The Federal Reserve in Australia is currently trying to bring a highly valued dollar down to some sustainable level due to this problem. In our case the central bank usually intervenes in the interbank market to bring down the rate in the event that it starts to go up, say above 0.50. Whilst it fluctuates depending on the circumstances in the forex market it should also not be seen as a highly fluctuating currency. A stable exchange rate is the most preferred one. This is why you will not see our kina going beyond 0.5 trading mark. Due to the periodic intervention by our central bank the PNG exchange rate regime is could be safely classified as a managed float.

Last but by no means least, it should be also noted that technically foreign reserves are not there for the government to draw-down to fund public capital investment or recurrent expenditure. It’s there to serve one single purpose: to manage the stability of the exchange rate which in turn instils confidence in the management of our currency. One key source of foreign reserves is exports. Currently, our reserves levels are more than enough to cover 11-months of import cover. Policies to promote exports always remain a good strategy. For example, fiscal incentives to increase our coffee/tea production are obvious ones.

Finally, the critical question going-forward remains: How do we go about diversifying our real economy and financial sector so as to generate much-needed reserves and create more economic opportunities for our people? The need for sound structural reforms is clear and should be on the cards of any reform-minded government's development strategy (policies and programs) agenda. The taxation regime currently under review is one central aspect of broadening the tax base. Another is reforms to attract foreign remittances from PNGans working/living abroad and creating fiscal incentives for PNG-based companies to start businesses abroad. A well-functioning tourism sector is another highly sustainable source of foreign reserves. Financial sector-oriented reforms are another as it touches on remittances and financial education programs which would free up unbankable sectors of the economy as China did in the 1980s in opening up its economy.

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