Highlights

  • Fundamentals look good and are improving
  • The resource sector – key sector of the country – has a positive outlook
  • Persistent foreign currency rationing and import compression hinder trade and payment transfers
  • Public debt is on a fast rise through off-budget borrowing in US dollar (USD)
  • The economy is locked in the resource trap, socio-economic development stalls

Improving fundamentals, positive outlook in the resource sector

At first sight, looking at its fundamentals, Papua New Guinea (PNG) is doing well and has buffers to withstand external shocks. The country’s liquified natural gas (LNG) project plays a key role in that respect. Since LNG production started in 2014, the current account deficit has gradually turned into a double-digit surplus. Rebounded commodity prices have improved terms of trade, further supported PNG’s dominant mineral exports (including gold, its second biggest export of goods) and contributed to reduce the fiscal deficit to less than 3% of GDP last year. Importantly, the financial risk has been improving by the downward trend – about a yearly 10% decline - in PNG’s huge external private debt (more than 180% of current account receipts in 2017) which is gradually repaid by LNG revenues. This is expected to continue in the coming years.

Given this favourable picture, the medium-to long-term political risk outlook seems positive with the prospect of new resources projects being exploited within a few years. Though last February’s record earthquake could hit economic growth and public finances via reconstruction spending, the mining and LNG infrastructures are reported to have been barely harmed. Also, despite sporadic political disruption due to corruption allegations, political stability should be maintained under PM O’Neill’s second mandate with his ruling coalition enjoying a solid majority in Parliament.

Continued foreign exchange rationing hampers imports and delays payments

Still, the country is constrained by inadequate monetary and fiscal policies, and more fundamentally by the resource trap. The protracted exchange policy, that keeps the kina overvalued to control inflation, implies the use of foreign exchange reserves to maintain a stable exchange rate and is combined with a limited access to foreign currency and import compression (thereby contributing to the current account surplus).

Rationing on foreign exchange reserves, which have been kept stable over the past three years, slightly above a 3.5 months import cover, leads to payment delays in non-priority sectors, namely outside the key resource sector. It partly explains the relatively high category 5/7 for ST political risk. In May, the central bank stated that it could gradually make the kina a bit more flexible. This move is uncertain and would in any case be challenging with a stronger US dollar and rising global interest rates. The currency risk would indeed grow especially as the authorities are increasingly seeking USD borrowing to finance their government debt.

The latter highlights a wrong choice too in running the fiscal policy. The fiscal situation is deteriorating with a rising public debt (from a low level though) that would be underestimated as the increasing use of short-term off-budget borrowing could bring the total public debt above 45% of GDP (from 32.6% in 2017). Moreover, weaker fiscal revenues since the drop in commodity prices in 2015 have led the central bank to finance the deficit by printing money. Earthquake-related expenditures and costs from hosting the 2018 APEC (Asia-Pacific Economic Cooperation) Summit next November will add extra budget pressures.

Locked in a resource trap, socio-economic development is hindered

The prolonged foreign exchange shortage affects the economic activity by weighing on the business environment, dampening investments and ultimately keeping real GDP growth below 3%, i.e. a regional low. This situation shows how resource-dependent the PNG economy has become. O’Neill’s government will continue to give it priority by developing new resource projects in future and favouring their access to foreign currency. The lack of economic diversification is detrimental to the non-resources sector which has suffered from two recessions in 2015-2017. It’s a euphemism to say that until now the LNG project has not brought the promised socio-economic benefits to a mostly rural and poor population which still principally lives from subsistence agriculture. State corruption is also often blamed for that. Therefore, social discontent is widespread and sporadically sparks violence around resource projects notably fueled by landowners’ frustrations about environmental degradation and weak financial compensations to land sales.

All those factors combined with data gaps explain why PNG is rated in category 5/7 for MLT political risk. Evolution of Credendo’s risk classifications will greatly depend on the adjustment or not of macroeconomic policies, and on the impact of external financial developments starting with commodity prices, the USD and global interest rates.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com