Economist Paul Flanagan's recent remarks that appeared in PNG Blogs and elsewhere highlight 8 key areas of what looks to be looming financial disaster.  Mr Flanagan's enlightening report is the basis for this discussion and why the performance of each one of the key areas has started to  spook business and investors.  The seriousness of PNG’s current financial situation is becoming very clear.   A little over a week ago the government came very close to failing to come up with the year end public servant pay.  This near disaster occurred despite supplementary budgets designed to avoid such unexpected money shortages.   Another red flag flying high and warning that behind the scenes, PNG's finances are rapidly deteriorating under the O'Neill government.

The 8 key areas of concern are (1) Government lies over the actual size and growth of the PNG economy, (2) Discrepancies  over GDP economic growth rates, (3) Dangerously risking the kina by printing more money to cover government debt; (4) How much revenue is the government actually taking in? (5) Severe additional cutbacks in future government expenditures, (6) What options are left to finance the government budget? (7) Continued collapse of the kina and projected rising prices, and (8) 2017 election campaigning budget blowouts.

1. GOVERNMENT LIES OVER THE ACTUAL SIZE & GROWTH OF THE PNG ECONOMY (as measured by GDP size): In March 2016, the government suddenly announced that the size of the economy had increased dramatically – by 53% in 2006 alone and still a magical 40% higher by 2013. These higher estimates are the entire basis for the government claiming its debt to GDP ratio is just below 30% and thus under the legislated limits under the Fiscal Responsibility Act. But there has been on-going confusion as to what figures to use – totally confusing the matter is the fact that the 2017 Budget document used multiple versions of numbers. Even at the recent PNG Mining and Petroleum Investment Conference, Patrick Pruaitch stated in his 2 December speech, when talking about the strength of the PNG economy, that it will grow from K47.3 billion in 2015 to over K57 billion in 2017. If we use these nominal GDP numbers with Treasury’s official debt numbers for 2017 of K21.6 billion, the government would be exceeding its debt to GDP limit imposed by the Financial Responsibility Act with a ratio of 37.7% – well above the 30% limit (official central government debt of K21,623.3m from Table 12 of Appendix 3 in 2017 Budget Volume 1 divided by K57,337.6m from Table 1 of the same appendix). This would directly contradict what his Prime Minister said just 15 minutes earlier to the audience of over 1,000 potential investors!  Investors are not anywhere as naïve or gullible as the PNG government seems to believe.   It is now crystal clear that the government is using two very different sets of GDP numbers to come up with its projections.  Which is the correct set of numbers and which is not?  Or are neither sets of financial statistics correct?   This has been a major source of confusion for investors and the private business sector, but it seems that the Government is also confused, being that Minister for the Treasury Patrick Pruaitch and Peter O'Neill used completely different statistics to back up their statements.  An IMF view on the updated GDP figures would have helped clarify matters for everyone. By keeping the IMF report secret, everyone, including PNG's investors is left in the dark which is the government’s obvious intent.

2. DISCREPANCIES OVER GDP ECONOMIC GROWTH RATES: the government now  admits that GDP growth rates fell from their LNG Project Development highs down to a level below or near that of population growth rates. PNG has a high level of population growth.  This is like national suicide for development in the sense that when the economy grows less than the population, people end up poorer per capital and with fewer services.  New information about PNG economic growth rate is now so negative that it is almost certain that PNG’s non-resource GDP has gone through a serious recession during 2014 and 2015 which was successfully masked by the lingering activities created by LNG Project Construction.   Official government figures are suspect.  An example is the government statistic that agriculture enjoyed real growth in 2015 of 1.9%.  This makes no sense, given that PNG’s subsistence agriculture sector was suffering from its worst drought in 20 years in 2015.  Widespread hunger was reported in at least 4 highlands provinces (Hela, Southern Highlands, Western Highlands, Simbu).  Moreover it is irrefutable that in 2015, cash crop exports had dropped -56% for tea, -36% for rubber, -20% for cocoa, and -12% for coffee, with minor drop in palm oil production, and a large increase in copra and copra oil (copra and copra oil only account for around 3% of the total value of agriculture exports – BPNG QEB tables 8.4 and 8.3).  

The PNG government was caught red-handed in a lie by stating that the agricultural economy enjoyed real growth of 1.9% in 2015, when that year was racked by export declines in all major agricultural products, plus the severe effect of the El Nino drought on general food production in the highlands.

These illogical government agricultural growth conclusions are some of the clearest evidence that the O’Neill government, through Patrick Pruaitch and James Marape, are presenting false statistics in order to cover up the true state of the PNG economy.   Economists had hoped that the IMF report on the state of the PNG economy for 2015 would have shed insight on what really is going on. Without such clarification by a third party group such as IMF, the PNG government's official numbers for agricultural growth and almost any other assessment of the economy have no credibility.  The government's handle on what is happening to the PNG economy is beginning to look like a joke.

Prime Minister Peter O’Neill, Treasury Minister Patrick Pruaitch, and Finance Minister James Marape ultimately will bear responsibility for the state of the PNG economy during the 5 year term of Peter O’Neill, as well as the state of government revenue and expenditures.

3. DANGEROUSLY RISKING THE KINA BY PRINTING MORE MONEY TO COVER GOVERNMENT DEBT: PNG’s central bank started buying large amounts of government securities starting in early 2016. That is well established by PNG Central Bank data. This is equivalent to printing money. It means that on the face of it, there is no short-term cash shortage noticed by the people. However it is a very risky approach that undermines investor confidence, threatens high levels of inflation (price increases that affect all Papua New Guineans), makes foreign exchange shortages for the private sector even worse when trying to bring in imported goods for resale in stores), and puts stress on the entire banking system. Usually these kinds of actions are the mark of governments desperate to hide the true nature of government borrowing. The IMF’s views on such developments would have been extremely useful, since the O'Neill government has no track record of honesty or credibility with regard to negative financial information. Without being able to read an opposing view by a respected economic analysis organization such as the IMF, it is hard to conclude anything other than that PNG is heading on a slippery slope towards a major Zimbabwe style economic crisis.

The PNG Central Bank buys unwanted treasury bonds and inscribed stock that is sold to cover government debt, by releasing money from its vaults that otherwise is released or held dependent on the growth or contraction of the economy, inflation rates, and other factors. This is equivalent to “printing money” and it is a dangerous strategy that has resulted in the collapse of national currencies elsewhere in the world. The Central Bank began this risky strategy in July 2014, seemed to stop about one year later, then resumed again with a massive buy of government inscribed stocks in June 2016. Lax reporting by the PNG Central Bank, perhaps purposeful, is why there is no information available on treasury bill/inscribed stock buys by the Central Bank during the past 6 months.

4. HOW MUCH REVENUE IS THE GOVERNMENT ACTUALLY TAKING IN? As much as the O’Neill government seems intent on covering up bad news about the budget, the government's numbers alone show clearly that budget revenues have been collapsing for the past four years. The main cause has been a fall in domestic revenues. This mainly reflects the end of the PNG LNG investment boom and the resultant recession. The diversion of dividends to an ambitious government petroleum development company (Kumul Petroleum) and the fall in international commodity prices are also to blame in part. However, the government's emphasis on attributing collapsed commodity prices as the source of the problem is vastly exaggerated. The fall in commodity prices only account for 22% of the government shortfall in revenue that occurred in the 2015 budget. The Prime Minister’s continual message that the government’s fiscal problems are due to the fall in commodity prices is misleading to say the least. The bigger reason is that there has been a dramatic drop in tax revenue flowing to the government. This is confirmation that the PNG economy began to contract in 2014 at a time that the Prime Minister was still promising near double digit economic expansion.

Government revenue forecasts for 2017 already appear to be over-estimated by more than 10% and it is only the first week of January. This shows the incompetency of the Treasury Department in creating accurate revenue estimates. This incompetency first surfaced during the second half of 2014 when world-wide the decline of oil/gas prices was projected, yet the government did nothing to accommodate these projections into the 2015 budget presented in November 2014.

The government’s revenue shortfall is now so severe and expenditures so blown out over intended budget caps that the O'Neill government has no recourse but to raise taxes at a time of economic contraction. This is normally the opposite of prudent economic management. A government should be raising taxes during times of economic expansion, not during economic contraction, because in so doing, it delays economic recovery. It is possible that the government will delay tax hikes until the 2017 election is over but the current recession will not be over by then, nor even in 2018.

It is apparent that the 2017 budget is developing in a way that will negatively affect urban residents in particular. New tax measures are the only obvious solution to balance out the excessive level of cuts imposed in key areas such as health and education, which the Prime Minister denies even making, but which clearly show up in the budget numbers.

Being that the government has no credibility anymore on being able to present accurate projections of budget expenditure and revenue, the IMF Report on Papua New Guinea’s State of the Economy for 2015 would have been useful for PNG economists and planners, relevant to what the IMF sees as the longer term prospects for the nation. Investors in particular would be interested in any IMF comments about the shady off-budget funding for state owned enterprises. Off budget funding during the O’Neill government most famously took the form of the 10% government stake in Oil Search shares through the controversial and very costly UBS loan that the Prime Minister arranged without sufficient consultation with Parliament and the NEC. Now there is a new example: A secret new 'off budget' major borrowing scheme involving the illogical Ramu 2 hydro expansion project, whereby a Chinese government arm, SinoHydro recently, through Treasury Secretary Dairi Vele, was given a Sovereign Guarantee for SinoHydro to borrow upwards of around K1 billion to finance the project, government (not SinoHydro) holding the bag to repay the loan plus interest if somehow SinoHydro mucks up the project so that it can't repay the loan. This is the infamous SinoHydro-William Duma sex + bribe case that appeared all over social media just before Christmas.

A planned hydro capacity expansion (Ramu 2) planned for Yonki Dam was revealed as involving a secret government sovereign guarantee to cover the necessary construction loan of up to K1 billion. This is an example of “off the budget” borrowing that has destroyed the accuracy of the PNG budget to display the true state of government borrowing. The Ramu 2 hydro expansion has turned into a bribery-sex scandal involving high level government officials and State Owned Enterprises Minister William Duma, who was demanding a USD $10 million from intended contractor SinoHydro in order for Duma to recommend that SinoHydro received the contract.

5. SEVERE ADDITIONAL CUTBACKS IN FUTURE GOVERNMENT EXPENDITURES: The PNG's incompetence in accurately estimating expenditure versus revenue affects the entire budget. Even the government cannot cover up the full extent of the disaster. Its 2017 budget continue to forecast substantial cuts to key areas of expenditure such as infrastructure, health and education expenditure (these cuts have exceeded 45% in real terms from 2015 to 2017). As a measure of comparison, what the PNG government is doing to cut back basic services to the people is more severe than what was imposed on Greece by the European Union as part of its austerity program (they balanced expenditure cuts with revenue increases), and which led to widespread riots and protests marches in Greece. The move to a more sustainable budget position became more necessary after PNG recorded its largest fiscal deficits ever in 2013 and 2014, both under the O'Neill's government. However, (1) the contracting economy, (2) inability of the budget to withstand much additional cut to basic health, education, and infrastructure expenditure, (3) current, perilous situation with the kina, and (4) excessive government borrowing from overseas institutions, with all loans denominated in foreign currency, leave few options on how a balanced budget can be achieved for many years. That means additional borrowing which will likely continue to violate the legal ceiling. The government’s shift towards lower deficits is a welcome policy development, but unfortunately, the actual pattern of planned cuts does not seem appropriate or even credible, considering what ha become an O'Neill government tradition of providing misinformation and disinformation on budgetary details.

Violent protests involving thousands of citizens broke out in Greece following budget cuts and other austerity measures that cut back basic services less than what the PNG government is implementing in its own budgets.

Specifically, the 2017 budget assumed that there would be identical real cuts in expenditure in all sectors apart from Province allocations over the next two years. Such uniform cuts are illogical as they assume, for example, that interest costs will go down despite the continuing growth in public debt. The opposite will occur because PNG is now on a borrowing frenzy that is likely to get worse, as higher debt results in higher interest rates that pressure even more borrowing. The IMF’s views would be interesting on what appear to economists to be crazy approaches by the PNG government to deal with its budgetary problems. For example, how does the IMF view the government’s establishment of high constituency funding through the District Improvement Support Program (DSIP) without establishing strong financial accountability, including mandatory audits and prosecutions for mis-use of DSIP funds?

What comment does the IMF have on the government’s lack of reduced spending on public service administration? What were the IMF's views on the massive spending on infrastructure in preparation for the 2018 APEC conference, and the prospects of that government expenditure ever being recovered? From other studied economist eyes, funding the APEC conference at a time when the government is facing multiple economic problems on many fronts, is lunacy. The IMF's third party view on the situation would be especially welcome to foreign investors who are getting cold feet about the government's apparent lack of any ability to carry out prudent fiscal management.

It has been more than 2 years since the Auditor General issued its report that DSIP fund usage isn’t being audited thus preventing prosecution for corrupt mis-use of public funds. Yet, DSIP monies look to be central to the 2017 election and useful for various kinds of vote buying for incumbent MPs in government.

6. WHAT OPTIONS ARE LEFT TO FINANCE THE O’NEILL BUDGET? The government has put itself onto a vicious cycle of creating too much short-term public debt that must constantly be re-financed. This is equivalent to a family who cannot manage their budget and ends up trapped short-term loans just before each payday, repayable at outrageous interest rates. Using the 2017 budget figures, and excluding the very unlikely K2.8 billion revenue that was projected from the Sovereign Bond (which the government's silence on indicates has fallen flat on its face), PNG needs to find some way to use its domestic auction of Treasury Bills and Bonds and come up with nearly K1 billion per month that can be used to balance budget expenditures. In total for 2017, the government is going to have to come up with at least K13.075 billion in new budget revenue, which equates to 106% (that number is not a typo!) of total PNG government spending. The private sector is unlikely to come forward to share the burden. Results from the weekly auction of government bonds makes this very clear: The 14 December 2016 weekly auction only raised K218 million of the K726 million that the government was seeking). This inevitably will force the government into even greater use of the disaster strategy of 'printing more money' (doing so in a sneaky way, i.e. by having the Central Bank "create" more money to buy up government bonds). There are so many examples of what a disaster to the country this will bring, most recently including the hyper-inflation in Venezuela, where money used to purchase goods is being weighted by the kilo rather than the storekeeper looking at the monetary value of the money.

Hyperinflation destroys national economies and tends to impoverish all but the rich. This table shows how Germany’s currency in 1919 went from being worth something to being worth nothing. It all happened because the German government started printing money to cover its growing national debt rather than fund the debt through treasury bonds and other types of loans.

Sadly, the PNG government's credit rating perception has sunk so low that the commercial Credit Suisse bank appears to be the only source of potential external financing at this point. This is of no comfort to the private sector and potential investors in PNG because any commercial bank loans the government arranges comes with conditions and terms that can be hidden from the public eye. The lack of transparency has exponential spillover effects. The less the government shares, the more distrusting become the very agents that are key to financial recovery. – and there is no transparency on the terms of such loans.

7. CONTINUED DECLINE OF THE KINA AND PROJECTED RISING PRICES: It is well established that the value of the kina was at a decade's long high against the US dollar when Peter O'Neill's government came to power in mid-2011. The kina has been sinking ever since, declining from nearly 2 kina to 1 dollar, down to more than 3 kina for 1 dollar, the lowest value in more than 15 years. Other currencies matched up against the kina have followed the same general trend.

The kina reached a 15+ year peak in value just after Peter O’Neill took over as Prime Minister. It has been on a decline ever since.

It is known that in 2015, the IMF had a disagreement with the O'Neill government as to whether the Kina’s value should be based on market-determined levels. In other words, should the kina's value be determined by a supply and demand relationship as is the case with the currencies of every well run economy in the world, or should the kina’s value be artificially propped up?

Since the middle of 2016, there has been a change in policy, probably because there was a new tool available to handle the kina a different way. Before mid-2016 the government didn’t have the funds to buy kina to stabilize its value and the value kept slipping but not finding a point of “supply and demand” stability . Now it appears that the kina is being stabilized by the injection of money, most likely the loan money from Switzerland’s Credit Suisse bank. This action, of course, flies in the face of how currency value is managed in sound economies.

Since mid 2016, it has become clear that the government is artificially propping up the kina and stopping it from much further decline in value. This is non-sustainable and is probably a political ploy to keep prices from skyrocketing for consumers. How much of the Credit Suisse loan has been eaten up buying kina to maintain its value is unknown, but when the money runs out, the kina’s decline is likely to be dramatic and painful to consumers.

The suspicion is that the Central Bank of PNG has bowed to political pressure - the cardinal sin of any national Central Bank, being that politicised decision making always eventuates in short term planning that eventually destroys both economies and national currencies. The PNG government quite logically would be pressuring the Central Bank to keep the kina rate stable until the election, so that there is no outrage caused by rising prices caused by a declining kina. Unfortunately this means that the PNG government has trapped itself into a no win vicious cycle that the people of PNG will end up suffering from: (1) currency begins a downwards drift due to too much dependence on imports and/or too little export revenue, (2) consumer prices start rising for import-dependent economies like PNG as the value of the currency declines, (3) government hides the root of the problem and starts pumping in money to stabilize the currency by buying up kina, (4) stabilizing the currency is nonsustainable because of the amount of money it costs to keep the kina at one level, which in PNG has been achieved via high interest commercial bank loans, (5) the pressure on the currency to plunge downwards intensifies, (6) the government finds itself out of money and unable to continue subsidizing kina buying, (7) the currency collapses dramatically, (8) consumer prices shoot through the roof, much faster than wages rise, causing a big increase in inflation, (9) the increasingly inability of people to buy goods at the higher prices causes a major contraction of the economy to occur, whose after effects can last for years, (11) investors run away from investing in the economy, intensifying the economic recession, sometimes turning it into a major economic depression.

The O’Neill government has hidden most of the important details on what is happening with the PNG kina. We only see that the kina has stabilised, which indicates artificial government subsidies that is almost certainly funded by the high interest Credit Suisse commercial bank loan. The O’Neill government is making no attempt to explain how it plans to avoid the disaster result that occurs in nearly every country that dares try to artificially support the value of the national currency for long.

Historically, political parties in PNG funded campaigns through private donations. The donations were originally small sized, but this changed as political parties began to cozy up to selected big business. Prime Ministers fell into the trap of giving progressively larger bribes to newly elected/re-elected MPs to buy their loyalty to form the new government and they had to find the source money from somewhere. The classic instance of this getting out of control was in 2007, when Michael Somare received K40 million from Rimbunan Hijau (RH) through an ANZ bank account, to buy 40 MPs off at K1 million each.

In 2012, however, Peter O’Neill and Don Polye, then in close partnership, dramatically changed how political campaigns are funded by the political parties in power. Unknowingly, the taxpayers began funding campaigns of the political parties in power. This was achieved in 2012 by Don Polye drawing up a K500 million supplementary budget that shifted monies to DSIP and other budget line items where that money subsequently could be withdrawn and used by local level political operatives and spent on vote buying). Possibly all of this is legal.

As a result, the O’Neill government has now institutionalized public funding of political campaign costs for PNC and allied parties. In what appears to be moves towards pre-election vote attracting schemes for the 2017 election, the government has been putting forward policies and practices in areas such as agriculture, land and Small-Medium Business Enterprises (SMEs) that economists would typically condemn as undermining PNG’s potential for sustainable economic growth, as it creates greater dependency on government subsidies. Even PNG’s National Research Institute has expressed concerns about some of these proposals. IMF comments on all this would have been valuable, but unfortunately the O’Neill government has become the first government in PNG history to decide not to release the IMF report and thus not to let the people of PNG as well as potential investors and the private business sector see a third party economic perspective on what exactly is going on with PNG’s economy and government spending.

Children voting in Sandaun Province. The O’Neill government has been the first in PNG history to institutionalise public funding (taxpayers money) of the campaigns of whatever political parties are in power. It is using money holding entities such as DSIP to bring large amounts of money to the level of the voter, where lack of financial accountability can easily result in the money being mis-used for different kinds of election fraud. The new system is open to widespread fraud but gives the ruling party the upper hand in retaining power election after election

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