Credit rating a dark cloud for PNG, policy corrections a possible silver lining

Written by Paul Flanagan

Dark cloudThere have been two recent, positive economic policy developments in Papua New Guinea. First, on 20 May, the Treasury Secretary Mr Dairi Vele announced that a budget review is underway. The review comes after dramatic falls in world commodity prices that have affected government revenue and PNG’s international credit rating. The likely budget cuts will of course be difficult but there is little option if PNG wishes to maintain its macroeconomic stability and growth.

The second positive development was hidden away in a monthly statistical update [pdf] released on 11 May by PNG’s central bank, BPNG. This stated that “The temporary arrangement with the Treasury Department for the Bank to purchase the under-subscriptions (slack) in Treasury bill and Inscribed stock auctions ceased at the end of the March 2015.” Sounds technical and boring but it is a major development that reverses the approach taken back in September. Essentially, it means that BPNG will not simply print money to fund PNG’s growing budget deficits (see below).

This is a very constructive step and BPNG are to be congratulated for such a stance, which is consistent with its charter as an independent central bank. The previous policy led to significant inflationary risks – and PNG’s headline inflation rate had already moved to 9.5 per cent in March 2015.

These two positive economic policy developments occurred against a backdrop of some very worrying economic news for PNG. On 18 May, Moody’s credit ratings agency moved PNG’s sovereign credit rating to a negative outlook. This is a significant blow, and lowers the chances of PNG being able to borrow abroad to fund its large fiscal deficits. PNG retains its “B1” rating but these grades are very different from school grades – a “B1” is in fact four ratings below investment grade (the “junk bond cut-off”) and 13 ratings below the top grade for countries such as Australia and Singapore. PNG joins 13 other countries in the world on a negative rating outlook. The two other countries with B1 negative outlook ratings are Lebanon and Montenegro – not great company. The successful commencement of the PNG LNG project should have been an opportunity for PNG to lift its credit rating.

Moody’s credit analysis gave two reasons for the shift to a negative outlook. First, the widening of fiscal deficits since 2012 have already breached the ceiling of 35% of GDP public debt, as prescribed by the (amended) Fiscal Responsibility Act. Moody’s analysis states:

Government revenue will fall short of the medium-term projections in the 2015 budget due to the impact of lower prices for petroleum, natural gas, and other commodities on royalties, dividends, and the profitability of associated companies. However, the government has not formulated a policy response that would realign expenditures to conform to the planned glide path to a balanced budget by 2017.

Earlier blog posts touched on these issues and the risks they pose for PNG’s credibility in international financial markets. Backing up these concerns was some very worrying news in the latest monthly statistical bulletin from BPNG. During the first quarter of 2015, government expenditure exceeded government revenues by K2,088.8m – 92% of its expected deficit for 2015. At the same time in 2014 there was a surplus of K105.2m, in 2013 a deficit of K403.9m, and over the previous decade, an average deficit of K23m. This is an extremely worrying start to 2015 and shows why a supplementary budget is so important for rebuilding confidence and credibility.

The second reason given for Moody’s shift to a negative outlook was PNG’s weakened external payments position and increased external vulnerability. Foreign currency reserves have halved over the last two years. Moody’s estimates “that the stock of short-term external debt by residual maturity – incorporating both private and public sector debt – now surpasses the level of foreign currency reserves”. The start of 2015 (so with PNG LNG shipments well underway) has been very worrying – there were balance of payments deficits of K319m in January and a K266m in February.

Moody’s also sets out a series of positive factors that balanced the above elements for a continued “B1” rating. These included strong growth, the successful commencement of the PNG LNG project, future prospects for the natural resource base, previous fiscal discipline having lowered debt burdens, and local financing of public debt.

With the knock to investor confidence from Moody’s credit rating shift to a negative outlook, the extraordinary blowout in the fiscal deficit in the first quarter of 2015, the continuing large balance of payments deficits even after the commencement of PNG LNG exports, and pressures on the inflationary front, no more time should be lost before PNG begins on the path of economic adjustment. Hence the importance of the budget review announcement. A Supplementary Budget will be very important for re-establishing credibility. It will need to deal with the immediate revenue shortfalls, as well as map out a path over 2016 and 2017 on how key government programs can continue without damaging deficit levels. Politically, this will be difficult but necessary.

Paul Flanagan is a Visiting Fellow at the Development Policy Centre. 

Paul Flanagan

Paul Flanagan has a longstanding interest in public policy issues in Australia, PNG and more broadly. His thirty-five-year public service career was evenly shared between Treasury/Finance and AusAID. He headed up Treasury’s International Finance and Development Division from 2008-2011 before being seconded to a senior advisor position in the PNG Treasury until August 2013. He is Director of Indo-Pacific Public Policy and Economics, a leading commentator on economic developments in PNG, and a frequent contributor to the Devpolicy Blog.

1 Comment

  • Thanks again for your insights, Paul. It seems the writing is on the wall.

    You have focussed on the macro-economic imperatives, could you perhaps provide some comment on the micro-economic impacts of the changes around the corner?

    The business community is rife at the moment with rumours of an impending and significant depreciation of the kina in response to these issues. I’ve heard as low as US$0.15 which is pretty scary stuff for a bloke trying to run a business. What would be the impacts of this? The inflation rate you mention in your analysis would obviously go through the roof as so many goods and services we rely on are imported.

    I guess the coffee, oil palm and other primary producers will be better off in some ways but their costs in terms of fuel, fertilizer, spare parts, machinery and what not would increase substantially.

    Could also be a boon for tourism – if other policies such as no visa on arrival for Australians did not get in the way. Of course, Indonesians can now get visa on arrival but I wonder how many of them come here for a holiday.

    But what about construction companies? All the “projects” the government boasts about. Would they suddenly become unaffordable or twice as expensive? What if I wanted to build a house, would it now cost twice as much for everything from iron roofing to solar panels and suchlike.

    I’m also wondering about the Oil Search, Exim and other off-shore loans. I guess the repayments would rise significantly in kina terms – how would that impact? Would it also mean if the government decided to sell the Oil Search shares they would have a huge windfall of kina as the kina value of the shares would increase substantially? And then tell everyone what smart economic managers they are.

    The big boys would not have the same issues they are experiencing currently in sending money out of the country so would that suddenly mean huge amounts of cash leaving the county? Especially in the early stages as they try to get in early? How would this impact?
    And what about the small girls and boys, all the thousands of urbanites struggling on the minimum wage when suddenly the pmv fares go up significantly along with the price of rice and tinned fish. Are we looking at the possibility of conditions leading to social unrest?

    Will already exorbitant rents go up even further?

    What will happen to interest rates? Will my current bank loan at 15% interest (in good times!) suddenly be even more of a burden, or will rates go down?

    Gee, when Australia had the GFC it seemed a good time for the little person – low interest rates, government handouts and stimulus, low fuel costs, high dollar.

    I know I’m no economist but I’m worried and can’t help thinking if there are other solutions to current issues rather than the blunt instruments proposed.

    Such as …
    1. Education savings: re-introduce project fees. Amend free tuition to 25% tuition fee subsidies to urban schools (where parents are wage earners), 50% to rural schools and full subsidy to remote schools (where there are few wages earners). Might also help reverse the urban drift.
    2. A freeze on govt. spending in general. Much of it is wasted anyway.
    3. Outlaw personnel emoluments using the govt PGas system. This may be where the huge unbudgeted increase in this area has come from over recent years. People getting around the Alesco system.
    4. 50% reduction in DSIP & PSIP for a year or two.
    5. Fast track some big projects and bring on another construction phase
    6. Look at the tax being paid by some of the largest companies. Introduce a resource tax or suchlike.
    7. Sell the shares!

    Politically impossible, I know, but it seems a shame when the populous pays the price for the mistakes at the top end of town. Some of your readers may have other thoughts.

    Thanks again for the ongoing comment.

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