This is an edited extract from a keynote speech delivered by the Assistant Governor of the Bank of Papua New Guinea on behalf of the Governor at the 2023 PNG Update.
Economic diversification can only be realised through cohesive policy reforms to address the inherent structural challenges, such as removing market impediments, strengthening institutions and governance, and improving public infrastructure. Against this backdrop, I want to highlight the main contributions of the Bank of PNG through financial sector development towards economic diversification.
Financial sector development plays a pivotal role in effectively mobilising savings and creating investment opportunities, which leads to capital accumulation and technological progress. Over the years, the Bank of PNG has been delivering policy initiatives and financial infrastructures to address market inefficiencies in the financial sector. The notable contributions are financial inclusion, modernisation of the national payments system, and the current development of the secondary market for government securities. These measures aim to bring the unbanked population into the formal banking system to access financial products and services that can help them to hedge against business cycle risks – that is, during economic downturns, people can use their savings or borrow to smoothen their consumption levels.
I want to admit that the bank has also faced numerous challenges that have limited its ability to effectively achieve its mandated objectives of price stability and supporting growth and employment in the non-mineral sector. The main issues are lack of monetary policy transmission, and persistent imbalance in the foreign exchange (FX) market that have been affecting economic activities in recent years.
You will notice that the interest rate margin between lending and deposit rates has remained high around 7–8% for quite some time, implying that banks make more money from deposits without remunerating the depositors well. Our policy efforts to address this interest rate spread have been hindered by excessive liquidity in the banking system mainly driven by successive fiscal deficit spending. The spillover of this liquidity into imports in turn contributed to the persistently high demand for foreign currency more than offsetting its corresponding supply in the FX market. Since the economy is fully reliant on imports for consumer durables and intermediate inputs, the situation in the FX market bears heavily on domestic economic activities.
One point that I want to stress is, with the Project Development Agreement in place, the surplus trade balance arising mainly from the LNG exports has yet to translate into consistent foreign currency inflows. This has left the economy at the mercy of foreign currency inflows mainly from exports of agricultural commodities. That exemplifies the need for economic diversification driven by both export oriented and import substitution activities to provide lasting solutions to the FX issues we currently face.
Meanwhile, the FX market has been running on a life support from Bank of PNG FX intervention. However, this life support is becoming unsustainable and drastic policy measures need to be undertaken as soon as possible to put the economy back to the path of macroeconomic stability.
I will now turn to broadly touch on the two major reforms undertaken with respect to the central bank. First, by the government in 2021 to modernise the central bank to reflect the changes in economic developments and adapt to international best practice. After two decades, the government amended the Central Banking Act 2001 with the aim to realign the bank’s operations to international best practices of the present era. The main amendments included dual objectives of monetary policy (promote price stability, and growth and employment in the non-mineral sector), granting of full policy decision-making power to the Board, and an increase in direct financing of government budget. Generally, the reforms undertaken were good to ensure dilution of power vested to the Governor, improve transparency and good governance, and improve the efficacy of policy design and implementation.
The second phase of the reforms focused on the regulatory and supervisory roles of the central bank. The review of the functions of the central bank in this area as well as the financial sector are important to ensure the stability and development of the financial sector, and providing efficient services to the public. While the bank fully supports these important reforms, it is also important to mention that maintaining central bank independence is paramount.
While the change had positive benefits, it created new challenges with regards to the efficiency of policy decision-making processes, and direct government financing. The second phase of the review, which is in its final stage, also attempts to address some issues in the first amendment, to empower the central bank to perform its functions effectively.
The second reform is the current IMF [International Monetary Fund] program which the government entered into in March 2023, mainly for budget support rather than the conventional arrangement for balance of payment crisis purposes. The program has stringent conditions in the form of structural benchmarks and quantitative targets that the government and the Bank of PNG must meet to qualify for each tranche of funds to be realised. A total of US$918 million is expected to fund the reforms.
The important reform on the part of the government is to move into budget consolidation in the medium term to achieve a balanced budget and reduce budget deficits. On the part of the central bank, the program requires critical reforms to the monetary and exchange rate policy frameworks.
The monetary policy reform focuses on linking the policy rate to the market interest rates to improve the transmission of monetary policy to domestic interest rates, including the lending and deposit rates. For instance, if the central bank reduces its policy interest rate, that should influence other market rates to decline to make borrowing cheaper for firms and households. The transmission of policy is important to support the broader objectives and policies of the government including the diversification of the economy by influencing the borrowing cost of credit.
With regards to the exchange rate framework, the program requires the bank to adopt an exchange rate arrangement that can restore flexibility in the exchange rate to address currency overvaluation. The expected depreciation of the kina determined by the market fundamentals of supply and demand will allow the exchange rate to fall from its current overvalued level to its market equilibrium level over time. This will try to restore both internal and external balance.
Such a depreciation of the exchange rate to bring about the balance and support growth in the export industries including the agriculture, fisheries and forestry sector – that is, eliminating overvaluation – should make PNG’s exports more competitive, which should support economic diversification efforts. The weaker kina will, of course, have inflationary impact, however this process will be measured and carefully implemented to ensure that inflationary impact is contained – as imports become expensive and expenditure switching should lead to expansion in domestic output.
History shows that we must harness our comparative advantages and invest in the right sectors that will set the course for economic diversification to take place. Indeed there are challenges, but I believe that now is the opportunity to forge the pathway to take us from where we are to greater stability and prosperity.
This is an edited extract from a keynote speech delivered at the 2023 PNG Update. Read the full speech.
Thanks for sharing these thoughts, though it was long overdue considering the Puma energy crisis culminating from BPNG forex issues and the need for policy intervention by the government. When considering this issue at the earliest instance, it becomes evidently clear that the matter was a policy matter, but the approach taken was from the operational side of things. For instance, BPNG is a regulatory institution and operates within the policy and regulatory environment and answers questions of economic and financial policies issues.
This is a clear line of powers and responsibilities, but to engage directly with Puma on this matter by the government is giving the meat to the dogs. Instead of the government stepping over and initiate policy intervention and change, to address this issue, it rather encourages and forces BPNG to go head to head with Puma. Instead of the government playing the mediating role as a neutral party to implement a policy measure and resolve the matter, it rather takes a by stander role and watch 2 completely different entities from different environment engages in a conflict without appropriate dispute resolution measure.
No body is going to develop and implement a policy now, not even BPNG or Puma, the buck stops at the Government, and the Government must take on that responsibility.
Hi’ MC
I would rather suggest the most effective means of communication is through verbal face to face interactions. Therefore, many of our fine officers in various institutions in the country do not really want to live their comfort zone come down to where the people are.
Technology can be of great help in relation towards disseminating vital information but it only reaches those who are able to access such information.
Therefore, I would like to point out some strategic and reliable means towards disseminating such information in PNG context;
* Using Local leaders in the village; Example, Councilors, Village court magistrates, Identified leaders in the community etc.
* Church can also be an avenue to discuss some of this major issue; We often see Church as a place of Worship only but it would be good if we can address issues such as this in the Church because it contributes towards the development of humankind holistically.
* Do public forums and try to get feedback from the general public
* Technologically wise; Most of our rural community still do access radio station network. Therefore, I would rather suggest the usage of radio station to transmit information, however the information must be narrowed down to the understanding of the people; For example using our common Lingua Franca, which is Tok-Pisin to disseminate information.
These are just my suggestions, what do you think?
Thank you for posting this insightful speech.
Would someone be able to clarify what the following “Project Development Agreement” Mr Yabom mentions is referring to?
“One point that I want to stress is, with the Project Development Agreement in place, the surplus trade balance arising mainly from the LNG exports has yet to translate into consistent foreign currency inflows.”
Hi MC, I believe project development agreements refer to agreements between GoPNG and resource companies on how resource projects should be managed, including matters such as royalty payments, tax concessions etc.
For more information you can read this article by Maholopa Laveil: https://www.eastasiaforum.org/2022/06/10/extracting-more-from-papua-new-guineas-resource-sector/
Hi Alyssa,
Thanks so much for clarifying, this is super helpful! I have heard such agreements are mostly negotiated on an ad-hoc basis behind closed doors.
Thanks also for sharing the article by Mr Laveil — I read his excellent piece “Marape’s quest to ‘take back’ PNG’s resources” earlier this year and this one is equally brilliant. Sadly, when it comes to resource and minerals exploitation it seems that not much has changed since the 1950s… https://www.jstor.org/stable/40969537
Hi MC & Alyssia
Thanks for posting an interesting update from one of the most powerful entity in our nation that mainly deals with the regulatory and monitoring systems that governs the economic sector of our nation.
However, the fact of the matter is that many of our people who are affected by this major booming extractive industries are not sure about that actual realities that are happening up there.
My point is that such vital information must somehow reach the people so that they can understand what is going on. Main stream media such as post courier, nationals, and other agency do provide information do have its limitations. However, do the people in the remote part of this nation understand what is going on with the outcome of their resource in a bigger scale?
What are some possible solutions to educate our people about this changes?
Hi Namos,
Thank you very much for your comment! To be honest, I have trouble educating myself on these issues given the degree of complexity and obfuscation involved.
I am far from being an expert but there are a few great resources I often refer to such as PNGEITI (https://www.pngeiti.org.pg/pngeiti-reports/) and PNGi (https://pngicentral.org/about/).
As for how to spread the word, I guess social media is the conventional answer but personally I think that a kind of ‘public lecture’ format (such as the free public lectures provided by academics in Japan post-WW2 to farmers and other civilians who were keen to be educated but could not afford to go to university) is more effective and avoids issues like disinformation/misinformation, accessibility and so on.
But I guess local people in PNG would have better ideas how best to disseminate this kind of information!
What are your thoughts?