Economic Update

Published 30 Apr 2019

The shortage of foreign exchange liquidity in Papua New Guinea’s economy appears to be easing, with increased currency inflows helping to meet the needs of both importers and the financial sector. However, it may be some time before the imbalance is fully rectified.

On March 31 Loi Bakani, governor of the Bank of PNG, issued the reserve’s latest monetary policy statement, with one of the performance highlights showing a strong improvement in the economy’s foreign currency position.

The outstanding backlog in foreign exchange demand fell to PGK320.1 ($94.8m) in February, down from PGK445.4m ($131.8m) at the end of last year and significantly lower than the PGK1.7bn ($514.8m) backlog recorded in December 2017, Bakani said in the statement.

The improved result came largely on the back of the country’s first ever sovereign bond issuance in September last year, which raised $500m, and was supported by higher exports earnings, external financing from the World Bank and Asian Development Bank, and improved mineral tax and dividend payments to the government.

“As a result, the average time taken for the orders to be served has lessened to less than three months over the same period,” Bakani said. “The bank expects further improvement in the foreign exchange market in 2019, partly supported by intervention from the central bank.”

Despite this improvement in the foreign exchange market, the central bank said that the imbalance between supply and demand continued in the early months of this year.

A survey conducted by the bank of private sector businesses found that foreign currency orders were not being met in a timely manner and that authorised foreign exchange dealers (AFEDs) were still rationing the flow of funds to their clients.

With AFEDs focusing on meeting their client’s import order requirements, they were not transferring any surplus to the inter-bank market, which remained inactive due to foreign exchange shortages, the statement said.

See also: The Report – Papua New Guinea 2018

Foreign exchange a longstanding issue

Difficulty in sourcing foreign currency has been a longstanding problem for PNG following the imposition in 2014 of foreign currency trading bands designed to stabilise the value of the kina.

The decision has contributed to excess demand for foreign currency and led to a delay in the processing times of foreign exchange orders. This has constrained investment activity and pushed up inflation by increasing the cost of imports and slowing the pace at which payments can be made to overseas suppliers.

Another factor contributing to the long-running foreign currency shortfall is the high level of fiscal outflow caused by the debt-servicing requirements of major projects such as PNG LNG and other extractive industry developments. This allowed project concession holders to park revenue offshore to pay for overseas borrowings and write off depreciation on allowable capital expenditure of energy projects.

This situation may change in the future, however, with the government conducting a review of both the tax policy and the offshore holding concessions arrangements that are granted to major economic developments.

Banks looking for a boost

The improved currency position should also serve to stimulate the inter-bank market and the rest of the financial sector, according to the “Final Budget Outcome” report for 2018, issued on April 1 by Charles Abel, the treasurer and deputy prime minister.

“The development of the financial sector, which was previously delayed because of the instability in the domestic securities and foreign exchange markets, will now gather pace, as these markets have been stabilised,” Abel said.

In its most recent report on PNG, issued in December, the IMF said the shortage of foreign exchange had dampened growth, compressed imports, and inhibited investment and production in the non-resource sector.

However, the report also stated that the recent improvement in liquidity flows and progress in eliminating the backlog of foreign exchange operations would support the re-establishment of the inter-bank market.

Notwithstanding this optimism, Robin Fleming, Group CEO of Bank South Pacific, told OBG that it may be a little while before the benefits are felt. “This year will remain difficult,” he said. “But 2020 should see a big upturn.”

Such an improvement should also help drive broader economic growth. In a note issued on May 11, ratings agency Fitch cited the improved foreign currency supply as a key factor in its GDP growth projection, with the greater availability of foreign exchange set to boost private sector investment.

The agency maintained its positive outlook for PNG’s long-term growth prospects, forecasting that economic expansion will average 5.2% over the coming decade.

Local manufacturers increasing market share

While the foreign currency shortage has weighed on many segments of the private sector, it has spurred activity among domestic manufacturers.

Taking advantage of the higher costs of imported goods and the reduction in foreign products in the market, many manufacturers have sought to boost their market share with locally made goods, with particular growth seen in the fast-moving consumer goods segment.

The benefits of this rise in demand for local products have not been felt evenly, however, with existing manufacturers already in operation holding an advantage. Despite improved competitiveness for some domestic producers, firms looking to enter the market or expand capacity are likely to be caught out in the foreign exchange bottleneck as they seek new investments for their businesses.