The twin challenges facing the 2015 Papua New Guinea budget: rebalancing and deficit reduction

Written by Stephen Howes, Ron Sofe

Like many countries, PNG divides its budget into two: the development budget, and the recurrent budget. The recurrent budget is, as the name suggests, to cover the recurring costs of government – the salaries of teachers and health workers, for example, and maintenance, as well as back-office administrative costs. The development budget is for projects – from infrastructure investments to MP constituency funds to donor aid projects.

The 2014 budget was presented in a more integrated way – that is, with less emphasis on this division between development and recurrent – but it still had a development budget or “Public Investment Program”, presented in the budget’s Volume 3. For some time, PNG has had a strategy of expanding the development budget. In the boom years around 2007 and again in 2014, it has reached about 50% of total spending.

Ratio of development to total spending in PNG

Ratio of development to total spending

This makes PNG’s development budget one of the biggest in the world (as a share of total spending). This graphs shows a comparison with the countries we have data for.

Ratio of development to total spending: international comparisons

Ratio of development to total spending - international budget comparisonsSince 1999, the recurrent budget has grown, on average, by 3.5% a year after inflation. That is little more than the growth in the population. The development budget, by contrast, has grown at a real rate of 9.9% a year.

In the current year’s budget, this imbalance was taken to an extreme. Comparing 2014 budget figures with 2013 actuals, the development budget is meant to grow 37% after inflation (more than K2 billion in 2014 prices), whereas the recurrent budget is actually cut by 4% (K 300 million) after inflation is taken into account. The graph below shows the extreme preference given to the development budget in the 2014 budget.

Change in the development and recurrent budgets between 2014 and 2013 after inflation

Change in the development and recurrent budgets between 2014 and 2013 after inflation

This is not sensible budgeting. Expanding the development budget might sound like a good way to promote development, but there is no point building new schools if there are no teachers to teach at them, or new roads if there are no funds for maintenance.

The other problem with such a large and rapidly increasing development budget is that it is impossible to spend. The development budget was meant to increase by about a half in 2013, but in the end it increased by “only” one third. Increasing allocations beyond spending capacity leaves large scope for reshuffling of funds to less urgent priorities, and, ultimately, for corruption.

So the first challenge for the 2015 budget (to be presented in either October or November) is to restore balance to the recurrent budget relative to the development budget. Of course, not all recurrent spending is good, and not all development spending is bad. But PNG needs to hire more teachers and doctors. It needs to spend more on maintenance. This all requires more recurrent spending.

A second challenge for the 2015 budget is that of deficit reduction. PNG’s deficit has increased rapidly in the last few years. Revenue is around its 15 year average of about 31% of GDP, but expenditure is up at 38%, the highest it has been in the last 15 years, and 6 percentage points above the average over the period since. The graph shows the increasing divergence in PNG between spending and revenue.

PNG government spending  and revenue (% GDP)

PNG government expenditure and revenue (per cent GDP)

This can’t be sustained. High deficits for a few years wouldn’t be a problem if revenues were about to take off because of the LNG project. But they are not. Since 2012, the PNG Treasury has been telling us that the LNG project will only be replacing other declining sources of revenue, and that total mineral revenue will remain flat as a percentage of GDP. And that was before the Oil Search loan, which will consume a large chunk of LNG dividends early on.

So the deficit needs to fall, and quickly. The 2014 budget said that the deficit would fall from 6.6% of GDP in 2014 to 2.4% in 2015. But the plan to achieve this involved no increase in spending, and so a significant reduction once inflation is taken into account. That doesn’t sound realistic. Since 2010, the budget has grown by more than 5% a year after inflation and normally by more than 10%.

Will the budget put the brakes on spending? Or will we see another large deficit? Clearly, there will have to be some hard choices made in the 2015 budget. The axe will need to fall on some areas of spending. Given the need for rebalancing, savings should be looked for first in the development budget.

Notes to figures: 1999 to 2013 figures are actuals. 2014 are budget figures. Development spending for 2005 to 2008 and 2012 includes amounts spent through supplementary budgets and trust funds due to extraordinarily high levels of revenue. PNG figures are from budget documents. Development budget shares for countries other than PNG are obtained from national budget documents.

Professor Stephen Howes is Director of the Development Policy Centre at ANU, and Ron Sofe is a Research Fellow at the National Research Institute. If you are interested in the PNG budget, see also Paul Flanagan’s recent post on criteria by which it should be judged. 

 

Stephen Howes

Stephen Howes is the Director of the Development Policy Centre and a Professor of Economics at the Crawford School.

Ron Sofe

Ronald Sofe is a Research Fellow at the National Research Institue in PNG. In 2014 he worked at the Development Policy Centre as one of the awardees of the 2014 Australian Prime Minister’s Pacific Program. He completed his Masters of International & Development Economics at Crawford School of Public Policy, ANU.

6 Comments

  • The irony is of course that the capital expense or national “development” budget, has not produced a substantial increase in the levels of development indicators, such as health and education outcomes, sometimes even a decrease. The political economy of the “development budget” is that it is much more discretionary in nature, and therefore helps elected politicians to deal with their own and their constituents “needs”. At specific institutions, such as the Papua New Guinea University of Technology, the “development” budget is only 10-20% of the recurrent budget. The totality of this budget is invested in infrastructure which is there for everybody to see. Of the “recurrent” or operational expenses over 90% goes to salaries or personal emoluments. Dr. Albert Schram, Vice-Chancellor.

  • Good to see 2015 budget to meet the development aspirations. From past experiences the stereotypical image of public sector bureaucracies in PNG is one of the bloated payrolls and inefficient, corrupt, even indolent behavior. The budget expenditures must be focused on economic growth and development. Recurrent outlays on education and health for example, are investments in human capital that can have major long-term benefits. Wages and salaries constitute a large fraction of the recurrent outlays of government but nothing feasible and tangible is shown on the ground.

    We can realize economic growth and development and change our living standard if our budget expenditure is focused on setting up institutions, incentives, capital investment, human capital, technological knowledge and that implies growth.

  • Tenkyu tru, tupela. Most enlightening. Personally I don’t trust, “trust” funds in PNG as they seem to be a place to park funds until everybody forgets they are there. If they are ever expended for the designated purpose is anyone’s guess. Not to mention if they achieve value for money. Take your point on how they and the other factors influence the reporting and bottom line, though. Thanks very much. Understanding data and trends in PNG must be an economist’s equivalent to the art of herding cats! But I suppose that is the same in many other countries.

    The big picture still seems heartening for PNG. A little like a guesthouse in an under-discovered tourist heaven that knows if it spends on infrastructure and new capacity for a few years (read LNG/mining) it will be fully booked and earning good income for another 20 years or so. Nice! Paying back the investment cost with the early earnings will impact on any initial surplus, but still be a good thing in the long run. And they might even build another guesthouse or two along the way! As long as no-one burns them down, of course.

    Intangible, unpredictable and indirect benefits and impacts of a general confidence in the economic future, even over 2015 before the income starts flowing (the spending already has!), may also be interesting to observe over coming months. It is certainly a more optimistic outlook than many other parts of the globe. It seems understated that over the past 8 years or so while most of the rest of the world has been sweating over their finances, PNG has been quietly booming … with more to come. Plenty of waste and mismanagement, no doubt – but still moving forward. Plenty of problems to manage – Dutch disease, how best to spread the love etc. – but good problems to have in these times and for a country only 38 years into nationhood.

    Look forward to reading more of your articles and insights. Thanks for responding to my comment, I learned something.

  • Richard, as you comment, under-spending of planned budgets can have significant implications. Under-spending in planned budgets can lead to several outcomes in PNG. First, the under-spending can be recognised as simply a timing issue in a multi-year budget. If there have been delays in getting a project going, this should simply shift some funding in future years. This was one of the aims of the introductions of multi-year budgeting in 2012 – to reduce the pressure on the end-of-year spend-up typical of annual budgets. Such a re-allocation will reduce the deficit. Second option is the end of year reallocation process (called the “Close of the Accounts” in PNG). Under-expenditures in some areas are moved to over-expenditures in other areas. This has no impact on the deficit. Arguably, the moves between appropriations are not very transparent in advance and certainly not subject to Parliamentary approval. Possibly this process should be more limited. Thirdly, known under-expenditures can be transferred to a trust fund. This occurred in 2013 where significant under-spends were reallocated to the South Pacific Games expenditures in 2014 (some K386 million) through a “Supplementary Budget”. Under PNG’s current reporting system, this is treated as expenditure in the year the funds are put into the trust account (2013 in this case) and so does not reduce the deficit even though the funds are not actually spent until 2014. This will change as PNG moves from the 1986 to the 2001 Government Financial Statistics reporting requirements when payments into trust funds will not be counted as expenditure. Finally, some of the “under-expenditure” can be based on whether certain financial transactions are regarded as being counted “above or below” the line for determining the deficit. For example, PNG was required to spend K305 million in 2013 to keep its equity share in the PNG LNG project. As this is simply the purchase of equity in a project, some argue that it should be treated as a below the line transaction (a capital financing event that doesn’t affect things such as the delivery of services). The PNG treatment of this changed three times during the last year. The rub is that if such equity purchases are treated above the line, then the PNG’s OilSearch purchase should also be treated above the line. This would blow the 2014 deficit out by more than a billion Kina. If it is treated below the line, then for consistency, asset sales should also be treated below the line. This would mean that possible sales of parts of Air Nuigini and PNG Power should not be counted as helping with the program of reducing the deficit in 2015 (although it will help reduce the level of debt). These types of decisions on how to report various types of spending, and the importance of consistency, will be important for really understanding the 2015 budget.

  • Richard, excellent comments. On the first point, you are right, the tendency to underspend the development budget does keep the deficit down. It happened last year, and I’m sure it will happen this year again. As you say, the budget is simply too optimistic about the government’s spending capacity. On the other hand, however, revenue projections also fell short last year, and will fall short again this year. (Treasury’s Mid-Year Economic and Fiscal Outlook confirms this.) So, even with a shortfall in development spending, this year’s deficit will still be high: somewhere around 6-7 per cent of GDP.

    On the second point, the LNG project will give a huge boost to GDP through its commencement of exports, but most of the revenue associated with the LNG exports will go to pay off debt (the cost of all the infrastructure built). So, most of it will flow off-shore. Taxes won’t be paid for a few years. The PNG Government will get some dividends from its ownership share, but there are two problems. One, mineral revenues have been declining in recent years as commodity prices have fallen, Ok Tedi has done poorly, and oil production has fallen. So the LNG dividends will in part make up for these other declines. And, two, the LNG dividends have now been committed to repay the Oil Search loan, so they won’t be available to fund budget spending.

  • One thing that always confuses me about PNG budgets – and you highlight it in your article – the development spending seems hopelessly optimistic considering the public service’s capacity to implement projects. Buying vehicles and “donations” to various causes seems to be the only way they can spend these funds sometimes.

    Given that view, will the budgeted deficit be such a problem? Perhaps the actual development spending will only be a fraction of what was planned/budgeted for. Or do these funds just get spent, somehow, or spirited away into trust accounts? And, if little income from LNG is expected in 2015, where is the forecast 20%+ growth for PNG coming from??

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