PNG government investment supports local industry

Industry has emerged as one of the bright spots in Papua New Guinea’s economy in recent years, providing a buffer against downturns in the commodity cycle. As natural gas prices fell and related businesses struggled, manufacturing held its own. The weak currency and the lack of foreign exchange that accompanied the downturn may have actually helped matters, as trouble sourcing dollars encouraged the consumption of domestic products. “Locally made goods are now more prevalent,” Phil Franklin, president of the Australian-PNG Business Council, told OBG, “Retailers that used to buy internationally are now buying in-country.”

Efforts to reduce foreign currency outflows by encouraging self-sufficiency and curbing over-reliance on imports have also supported the sector. With a more relevant and consistently enforced legal framework, which includes the imposition of protective tariffs on products that are produced locally, PNG businesses have a better chance to compete. Ashlon Chue, marketing manager of Pacific Industries, told OBG that this change is the most significant for the sector in years, as it gives them a fighting chance in an environment that is already quite challenging.

History

Industry in PNG has historical ties to economy and society that go back decades. Producer and distributor Paradise Foods traces its start to bakeries in Wau and Salamaua in the 1930s, while Pacific Industries, a third-generation, family-run beverage manufacturer, dates to the Second World War. Meanwhile, WR Carpenter and SP Breweries have operated in the country since 1919 and 1951, respectively.

In the decades following independence in 1975, however, manufacturing has not developed as quickly as hoped. The newly appointed government at the time first pursued a strong kina, which kept inflation down but slowed the development of production and exports. Over the long term, low skills and high wages limited progress. The country never adopted the Asian development model of competitive wages combined with investment in human resources, and consequently failed to become a so-called tiger economy.

Openness

PNG is generally regarded as an open and liberal economy, while the government of Prime Minister Peter O’Neill is considered business friendly. However, in Transparency International’s corruption perceptions index for 2017, the country was ranked 135th out of 180 countries, while in the World Bank’s “Doing Business 2018” report, it placed 109th out of 190 economies. Areas for improvement include starting a business (129th), registering construction permits (122nd), enforcing contracts (171st) and resolving insolvency (141st). By comparison, the report ranked Fiji 101st overall, while Vanuatu and Indonesia were in the 90th and 72nd spots, respectively.

Foreign entities do face some challenges when operating in the country, such as a prohibition from owning land and a requirement for approval from the central bank, the Bank of PNG for all investments. Certification is also required from the Investment Promotion Authority (IPA), and companies must inform the authority when control is changed or when the business is significantly altered. Government-owned entities still dominate many areas of the economy, while procurement for contracts worth less than PGK1m ($312,000) is reserved for local interests.

Due in part to the slump in commodity prices, there has been a gradual shift in policy towards greater state involvement. In 2013 the OK Tedi Mine was expropriated by the government, though this was mainly fuelled by mismanagement that had led to decades of environmental damage. In the same year an amendment to the Takeovers Code 1998 gave the Securities Commission of PNG the power to stop a firm from acquiring shares of another if the move is considered to be against the national interest. This applies to any registered firm with more than PGK5m ($1.6m) in assets, with a minimum of 25 shareholders and 100 employees. However, the US Department of State notes that this policy was not used to prevent Zijin Mining’s purchase of 50% of the Porgera mine in May 2015 nor ExxonMobil’s acquisition of InterOil in July 2016.

Although obstacles remain, there have been ongoing efforts to simplify the investment process. The IPA introduced an online registration system in 2013, which allows companies to undertake a wide range of filings digitally. Though the project was delayed for some time due to legislative bottlenecks, the system is now available and fully functioning. Additionally, in 2014 legislation was passed to improve corporate governance and ease regulatory burdens, including increased protections and transparency for shareholders, and clearer and more streamlined processes.

Small But Steady

Manufacturing represents a fraction of the overall economy, but has been a steady and consistent performer over the years, with only a few years of mild decline. The 2018 budget released in November 2017 projected the sector would contribute 2.1% to GDP in 2018, a figure that was almost the same in 2017 and 2016. Over the medium term, this is expected to average approximately 2.3%.

Growth in manufacturing is estimated to hit 4% in 2018, up from 3% in 2017. The construction segment is projected to increase by 4% in 2018, rising from 1.6% a year earlier, while agriculture, forestry and fishing, the largest non-mining category, is forecast to grow by 3.1% in 2018, up from 2.6% in 2017. In total, non-mineral GDP is on track to grow by 3.5% in 2018, compared to 1.9% seen in the previous year.

The oil and gas sector has experienced more dramatic recent fluctuations. As a result of the completion of the massive PNG LNG project launched in May 2014, the segment expanded by a record 287.5% of that year and 93.3% in 2015, before decelerating precipitously to around 2.4% in 2016. Growth was negative in 2017 and is expected to remain so to 2022. This has fuelled criticism of the $19bn venture, which some say has failed to generate the promised level of economic returns.

In a bid to boost the oil and gas industry, the government is targeting energy self-sufficiency, supporting industrialisation efforts by providing a cheaper source of energy. To that end, some domestic market obligations have been made compulsory and non-negotiable. As stipulated in the PNG Natural Gas Policy White Paper, which was approved by the National Executive Council in April 2018, any petroleum-related project that comes on-stream is required make a certain percentage of gas reserve available for the domestic gas market, either to be used in domestic power generation or the petrochemicals industry.

Behind the Numbers

The PNG Business Council points out that positive non-mineral growth may actually understate the importance of resources in the economy, as much of the construction and services work is related to extractive projects.

Despite industry’s steady performance, the overall picture raises other questions. The GDP growth rate was approximately 10% in 2015, falling to 2% a year later and reaching 2.2% in 2017. Projections from the Asian Development Bank put the figure at 1.8% and 2.7% for 2018 and 2019, respectively. Given ongoing uncertainty in the resource sector as a result of commodity price swings and delays to projects in the pipeline, precise figures are hard to predict. Nevertheless, industrial growth is likely to remain steady.

Finding Upside

The economic headwinds in recent years have presented opportunities as well as challenges. Cost concerns have reduced imports, while the lack of dollars and the weak kina have forced many consumers to consider local options. Throughout the country, manufacturers are noticing a rise in orders, and informal businesses are popping up to meet demand for products that were once purchased from overseas. Companies would rather pay in kina than go through the difficulty of sourcing foreign exchange, with steel, fast-moving consumer goods, and small meat products such as saveloy sausages all in demand.

As need for locally produced goods continues to rise, foreign direct investment should begin to target the manufacturing sector, further improving confidence in the business climate going forward. “We are starting to attract significant foreign investment in manufacturing, not only to serve the PNG market, but also other Pacific nations,” Chue told OBG.

Policy & Plans

For decades regulators have been focused on developing the sector, as a means to make it more resilient against the so-called resource curse, as well as to boost employment. In 1984 the Department of Trade, Commerce and Industry put forth a white paper that proposed the establishment of target industries to attract investment. The policy was enacted in the 1990s to reduce the dependency on mining and petroleum resources by boosting manufacturing and exports. However, the results were mixed, with a continuing trend of large amounts of mineral exports, while imports of capital and consumer goods remained high. Tax incentives introduced following the publication of the paper were derived from Australian tax legislation dating to the 1950s. However, investors were offered incentives that often generated many bureaucratic hurdles. Presently, the country is still seeking the right combination of policy and execution to develop its base and ease dependency on imports, though many feel it has gone far in this area and is on the right track. “The general consensus is that the current strategy is very good, and this instils confidence in the market,” Chey Scovell, CEO of the PNG Manufacturer’s Council, told OBG. “We already have witnessed expansion, modernisation and rehabilitation, while employment numbers are on the rise,” he said.

Boosting Business

Infrastructure expenditure in recent years on projects such as the Highlands Highway upgrade has also boosted business in the construction materials and building segments, and enhanced efficiency in the logistics chain.

In March 2016 a 15-year small and medium-sized enterprise (SME) policy was introduced with goals of generating employment, achieving sustainable growth outside the resources sector and distributing wealth through increased economic activity. By using a reserve list that restricts control in certain business categories to citizens, the government hopes to increase domestic ownership from 10% to 70%, expand the number of SMEs from 49,000 to 500,000, and increase their contribution to the economy from 10% to 50%. The efforts are part of a larger, long-term campaign to achieve middle-income status, as a country.

While the SME policy is well intentioned, the main concern is whether the government will be able to encourage more local participation without burdening investors with regulations or excluding them from certain areas. While it is yet to be established, the planned Foreign Investment Review Board will have much influence over these issues, depending on the degree of policy structure and implementation.

Level Playing Field

For years, accusations have been regularly made that foreign enterprises benefit from unfair trading practices, government support from their home countries or economies of scale. Foreign-owned entities in the country have also been accused of avoiding taxes, tariffs and licensing requirements. Local stakeholders have spoken out, requesting the removal of any unfair advantages and loopholes.

The government appears to be listening and is taking a wide range of measures. In May 2017 a crackdown was initiated by the IPA on foreign-owned companies registered as local. Two tests on ownership and control determine whether a company must identify itself as foreign. The main structure being targeted, say attorneys familiar with the measures, is a proxy-type situation where a local shareholder controls the majority of the stock but non-locals actually manage the entity. It is believed that these arrangements are most often found at smaller companies and are not considered an issue for large corporations. “There are concerns that a number of smaller foreign-owned traders entering the market may not be paying the right taxes and duties,” Ian Clough, chairman of Brian Bell Group, told OBG. “This reduces the income for the government and creates unfair competition. We want all to play within the same framework,” he added.

While registration problems have been on the regulators’ radar for years, the authorities took greater action in May 2017, announcing that companies that had not submitted annual returns by the end of the year were to be struck from the IPA registry.

Another concern has been the goods and services tax (GST). Some foreign companies have been accused of under-invoicing and using other means to avoid tax, putting local players at a distinct disadvantage. In 2016 it was reported by the Oakland Institute, a think tank focused on issues such as trade an human rights, that tax avoidance by logging companies was costing the country more than $100m yearly. Recent efforts to more efficiently impose and collect the GST have helped to improve the competitive environment.

Tariff Turnaround

The initiative most celebrated by local industry is the government’s move to delay tariff decreases and raise duties on some items. The Tariff Reduction Programme (TRP) was adopted by PNG at the behest of the World Bank in 1999. After its introduction, the average rate fell from almost 16% to about 2%. However, local entities have long complained that the reform has not been completely successful. As rates were lowered, the government was supposed to invest in infrastructure and improve the operational environment, but some say that this has not happened sufficiently, leaving domestic firms at a disadvantage. Businesses have argued that if import tariffs remain low, many of PNG’s industrial players will not survive.

“Tariffs are good for industry. Some people say the move was wrong, but in fact it was way below the rate required for PNG to join the World Trade Organisation,” Stan Joyce, managing director of SP Breweries, told OBG. “The trend to lower tariffs makes more sense when you are a developed nation. PNG has significant advantages, such as cheap labour, but first it needs to be developed before lowering the tariffs,” he added.

It was announced in the supplementary 2017 budget that duties on imports of certain items would be raised, while the 2018 budget stated that the last round of scheduled reductions under the TRP would be suspended while the programme was under review. It was also stated that moderate increases on duties on key domestically produced products would be introduced, while duties on necessary imports would be reduced or eliminated. As a result, some firms have begun investing in expansions and upgrades to PNG-based factories, with segments such as the agro-processing industry benefitting. A prime example of this is the Innovative Agro Industries development of a PGK130m ($40.6m) dairy farm and processing facility outside Port Moresby, which began production in November 2017.

The legal revisions form part of broader efforts to improve self-sufficiency and reduce reliance on unnecessary imports which consume much-needed foreign exchange. In March 2018 Charles Abel, minister for Treasury, appealed to consumers to purchase more locally made goods. Other measures taken include the offering of an incentive in December 2017 in the form of a rebate from the daily fishing fee of $10,000 for foreign fishing vessels, which process their tuna catches in the country’s factories (see Agriculture chapter).

Outlook

Industry is set for steady growth on the back of government efforts to encourage self-sufficiency and curb reliance on imports. As the prices of commodities continue to increase and the extractive industries recover, the sector is expected to benefit from growing demand and rising prosperity. If the proceeds from new and existing projects are invested in the proper areas, industry could develop into a significant engine for growth. Much will depend on whether the government can overcome the fiscal constraints it faces, and channel investment into further upgrades to reduce logistics costs and improve productivity.

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The Report: Papua New Guinea 2018

Industry & Retail chapter from The Report: Papua New Guinea 2018

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