Public spending cuts in PNG make private participation crucial

 

Although it recorded double-digit expansion during the boom years of 2010 to 2013, Papua New Guinea’s construction industry faces a challenging operating environment in 2017. Growth contracted in 2014 following the completion of a major liquefied natural gas (LNG) project, and contractors have since struggled to regain the momentum of earlier in the decade.

The sector rebounded in 2015 and 2016, with preparations for the 2015 Pacific Games and the APEC 2018 summit helping to maintain stability, although public expenditure remains the driving force of industry activity, and ongoing budgetary cutbacks have dampened the growth outlook for 2017 and 2018. This has created new opportunities for private sector investment, which will play a critical role in supporting future growth.

While efforts to launch major infrastructure projects under public-private partnerships (PPPs) have faced various delays and setbacks, promising progress in launching new transport and utilities projects under the PPP model could establish a valuable framework, keeping the industry on an upward trajectory despite a combination of persistently low global commodities prices, subdued macroeconomic growth, and diminished government and donor spending.

At A Glance

The Department of Works and Implementation (DWI) and the Department of National Planning are responsible for developing and implementing major road projects, while the National Airports Corporation and PNG Ports Corporation develop aviation and ports projects. According to the Commonwealth Network there are 41 private contractors active in the country. Major private players that are active include Avenell Engineering Systems, Curtain Brothers, Global Construction, Lamana Development, Kramer Ausenco, Monier, Leighton PNG and Hornibrook. An increasing number of Chinese firms have also begun operating in PNG in recent years, including China Harbour Engineering Company, China Overseas Engineering Group and China Railway Construction Engineering.

The country’s operating environment can be challenging for contractors – transportation costs are high, a chronic foreign exchange shortage has made importing materials a lengthy and costly process, and land acquisition poses a major obstacle to development of new projects. Regulatory challenges are also significant, and the World Bank’s doing business survey 2017 found that PNG had dropped two spots in the “dealing with construction permits” category, falling from 124th to 126th place out of 189 economies surveyed.

The total number of procedures required to get a construction permit is 17, against the regional average of 15, and approval takes an average of 217 days, compared to the regional average of 134.1 days.

Recent Growth 

Despite these challenges, the industry expanded its capacity and earnings considerably during the construction phase of the $19bn ExxonMobil-led PNG LNG project, which began construction in 2010. The sector’s total share of GDP rose from 14% in 2008 to 16% in 2011, according to the Department of Treasury (DoT), increasing to 21% of GDP in 2014. The real value of construction projects also soared from PGK1.83bn ($580m) in 2010 to PGK3bn ($951m) in 2012 and PGK3.4bn ($1.1bn) in 2013.

Despite cuts to public spending, construction sales have surged in recent months, and the Business Liaison Survey by the central Bank of Papua New Guinea (BPNG) found that construction sales rose by 26.9% in the second quarter of 2016, after increasing by 5.1% in the first quarter. This rise was attributed to ongoing projects including Port Moresby’s sewerage upgrade, work on the six-mile to Bautama road in Port Moresby, road maintenance contracted by Ok Tedi in the Western Province and construction on the Hilton by Star Mountain hotel project. BPNG reports that in the 12 months to June 2016, construction sales rose by 150%.

Macro Slowdown 

Although public and donor funding have been the industry’s primary growth driver since mid-2014, government finances have come under considerable strain over the same period. This coincided with a fall in global oil prices, which dropped from around $115 per barrel in June 2014 to approximately $50 per barrel as of May 2017. The DoT estimates that the construction sector contracted by 8% in 2014 as a result, although public spending on preparations for the 2015 Pacific Games supported an industry rebound in 2015, with the Asian Development Bank (ADB) reporting that the industry was expected to grow by 3.8%, against a 6.4% contraction in 2014. The authorities have been forced to implement public spending cuts in the 2017 budget, as external volatility and depressed commodities prices, particularly LNG prices, pressured government revenues (see Economy chapter).

In an April 2017 analysis of the 2017 budget, Deloitte wrote that the government intends to focus on core objectives, delaying or deferring expenditure on non-critical projects and focusing instead on key capital projects which will generate future revenues. This will negatively impact construction growth in 2017.

Spending Cuts 

Total public expenditure in 2017 is forecast to fall by 3.5% relative to 2016, hitting PGK13.4bn ($4.2bn), of which PGK11.9bn ($3.8bn) is government-funded and PGK1.4bn ($444m) donorfunded via grants or loans. Spending on transportation and utilities, two construction mainstays, will contract significantly in the coming years.

Transport spending will fall by 12.5% in 2017, dropping from PGK1.03bn ($327m) in the 2016 supplementary budget to PGK897.1bn ($284.4m) in 2017. The DoT projects transport spending will continue to decline over the medium-term, falling to PGK887.2m ($281.2m) in 2018, PGK837.1m ($265.4m) in 2019, PGK813m ($257.7m) in 2020 and PGK802.4m ($254.4m) in 2021.

Utilities spending will fall from PGK371.5m ($117.8m) in 2016 to just PGK216.2m ($68.5m) in 2017, PGK213.8m ($67.8m) in 2018, PGK201.7m ($63.9m) in 2019, PGK195.9m ($62.1m) in 2020 and PGK193.3m ($61.3m) in 2021 under current government projects, although rising private sector interest in new hydroelectric power projects could help offset these declines.

In March 2017 the DWI told OBG that its budget for 2017 was set at around PGK640m ($202.9m), the majority of which has been allocated to ongoing projects, although the department still owes PGK200m ($63.4m) of commitments to donor-funded projects.

Maintenance Priorities 

Key spending priorities in 2017 include the 2017 national general election, the 2018 APEC summit, new monitoring, evaluation and compliance activities, and support for the education, health, infrastructure, agriculture, and small and medium-sized enterprise sectors.

However, in a move to keep the deficit level at 2.5% of GDP, the government has cut both operational and capital expenditure, which account for 70% and 30% of total expenditure, respectively. Deloitte notes that capital expenditure was subject to particularly heavy cuts from 2016 levels, falling by 21.2%, or PGK1.08bn ($342m) in 2017 by reducing ongoing government-funded projects across all sectors. The DoT, meanwhile, reports that capital expenditure on construction, renovation and improvements will fall by 26% in 2017 to PGK1.12bn ($355m). New public infrastructure projects are unlikely to be launched within the next several years, with the government and donor agencies increasingly focusing on upgrading and maintaining existing infrastructure.

Implementation Challenges 

Inefficiencies in budget and spending implementation continue to challenge the sector. In an economic analysis for its country partnership strategy, running from 2016 to 2020, the ADB made three primary policy recommendations to reform the public sector, with the third calling for a greater focus on enhancing the quality and impact of public expenditure. The bank writes that capacity shortfalls are the most significant challenge facing the public sector’s ability to implement the budget, while frequent disconnect between budget submissions and the approved budget push staff to rush the design and implementation of unfamiliar projects.

In the construction sector, a lack of feasibility and design work prior to project financing has resulted in unrealistic cost estimates, tendering delays and challenges in attracting private sector construction capacity. Provincial and district governments, which have seen increased public spending in recent years, also often lack the expertise necessary to plan, procure and maintain infrastructure assets, while funding for new capital projects continues to receive priority over recurrent operations. The ADB reports that between 2009 and 2014, recurrent budget allocations’ share of spending fell from 60% to 51%, resulting in chronic underfunding for routine maintenance. Spending shortfalls have already impacted recent industry growth, and the DoT estimated construction growth stood at 1.6% in 2016, a downward revision from earlier estimates of 3%, due to reduced public capital expenditure and a general slowdown in business activities.

Donor Funding

However, the department notes that the sector continues to benefit from major projects funded under concessional loans from donor partners. The Australian government is PNG’s largest source of donor funding. AusAID has been active in financing transportation projects through initiatives including the Transport Sector Support Programme, a long-term strategy aimed at improving road asset maintenance, and maritime and aviation safety standards.

Launched in 2007, the programme has completed several major transport projects in recent years, including a PGK11.6m ($3.7m) effort to seal roads in Bougainville, a PGK139m ($44.1m) bridge reconstruction project for a crossing on the Kumusi River and an extensive visual road condition survey at a cost of PGK3.2m ($1m), which should provide important information for feasibility studies and new road projects.

The Australian government is also channelling new donor funding into Milne Bay’s East Cape Road. In September 2016 the Ministry of National Planning and Monitoring announced that a PGK89m ($28.2m) project, funded by the World Bank, Australian government and PNG government had begun construction. The project will see 51 km of roads upgraded, benefitting up to 200,000 people living along the East Cape road, which runs between the provincial capital, Alotau, and PNG’s most easterly mainland point. The China Overseas Engineering Group has been contracted to undertake upgrading and sealing works from Yalua to Kehelala.

ADB 

The ADB is another major transportation financier for PNG. The bank has worked with PNG since 1971, and stands as its largest multilateral development partner. Financing for development projects between 2016 and 2018 totalled $743.7m and is set to rise to $1.67bn between 2017 and 2019. Its programming focuses heavily on improving basic service delivery, bolstering regional connectivity and building climate change resilience through transportation and infrastructure projects. As of January 2017 the bank’s cumulative lending, grants and technical assistance approvals stood at $2.49bn, of which $1.54bn, or 62%, had been allocated to transportation projects.

The ADB’s two largest projects in the country – the Highlands Region Road Improvement Investment Programme (HRRIIP) and Civil Aviation Development and Investment Programme (CADIP) – have offered support to the construction industry in recent years.

The $480m CADIP is expected to improve the safety, reliability and sustainability of aviation services across PNG, through upgrades and rehabilitation works across the country’s network of airports. The bank began disbursing the programme’s $130m second tranche of funding in 2016 and announced in December that it had approved a third tranche for $248m, which will be used to improve 11 national airports. The first tranche, disbursed between 2009 and 2014, allocated $112m to upgrades including a new instrument landing system and airport parking apron extension at Jacksons International Airport (JIA) in Port Moresby, as well as security upgrades at five regional airports.

Highlands Highway Investment 

The ADB has also committed $400m to the HRRIIP, which will upgrade the 1200-km arterial highway serving an estimated 40% of PNG’s population. The first $100m tranche concluded in June 2016, and was used to reconstruct 65 km of roads linking Laiagam and Pogera, as well as 50 km of road between Mendi and Kandep, connecting the Southern Highlands and Enga provinces.

The second tranche allocated $109m to reconstruct 56 km of road between Mendi and Tambul, 31 km between Kotna and Lampramp, and 31 km between Ialibu and Kagua. The third, approved in July 2016, will provide $129.3m, including $13.1m of PNG government funding, to rebuild four roads spanning 114 km. In early 2017 the bank reported that procurement of civil works and consulting services was under way.

In March 2017 the ADB announced that it had also approved a PGK3.5bn ($1.1bn) financing arrangement which will be used to carry out rehabilitation along 455 km of Highlands Highway connecting Lae’s Nadzab Airport to Mount Hagen’s Kagamuga Airport.

The Japanese government is also active in road projects, and in March 2017 PNG authorities announced construction had begun on a PGK80m ($25.4m) project to repair the Aum and Kapira bridges along New Britain Highway in West New Britain Province. The 203-km highway is a lifeline for the palm oil and forestry industries, standing as the sole transportation route for an estimated PGK1.5bn ($476m) of economic production, and serving more than 180,000 people, local media reports. It is also home to 38 bridges in need of repair.

Donor Decline 

Although donor funding has enabled the delivery of a significant amount of new construction projects in PNG, private sector participation is set to play a more critical role in future construction growth, given a downward trend in loans and grants.

The DoT reports that budgeted grants and loans will drop by 14.6% and 51.3%, respectively, in 2017, falling to PGK1.42bn ($450m). Of this, grants from the Department of Foreign Affairs and Trade in Australia account for PGK727.1m ($230.5m), or 51.7% of the total, followed by ADB loans, with 15.2%, or PGK214.1m ($67.9m), the Japan International Cooperation Agency, with PGK164.9m ($52.3m), or 11.7%, of combined grants and loans. The World Bank reports that total commitments to the country rose from $12m in 2013 to peak at $162m in 2014, before dropping off to $2m in 2015 and $13m in 2016, and then rising to $128m in 2017.

 Private Sector Participation

With both donor and public expenditure in decline, the government is increasingly working with its donor partners to attract new private sector investment into the transportation and infrastructure sector. PPP projects are expected to become a more common feature of infrastructure development, and the government has made good progress in developing a regulatory framework for PPPs with the PPP Act, which was passed in September 2014.

Although the act is still awaiting gazettal to come into force, it will see the establishment of a PPP Centre, an unincorporated statutory body which will be tasked with assisting the government in developing, tendering and implementing PPPs. Building on the principles outlined in the 2008 National PPP Policy, the centre is expected to provide a solid, predictable framework and process through which the private sector can partner with the government on major infrastructure projects.

PPP Progress 

The Pacific Legal Network reports that Kumul Consolidated Holding, which is responsible for overseeing major public infrastructure projects, has made good progress in developing new hydropower projects under a PPP model, most notably at the planned Ramu 2 and Karimui projects (see Energy chapter). The Sir Hubert Murray Stadium in Port Moresby was also developed under a PPP with local firm Curtain Brothers, and while the stadium has faced delays, the government announced in September 2016 that work on the 20,000-capacity facility is set to continue.

The government was seeking sponsorship and funding from private corporations in order to finance the remaining PGK40m ($12.7m) of construction costs mandated by the PPP agreement.

Transport PPPs 

PPP projects are gradually extending to the transportation sector, and in February 2017 the ADB announced that it had signed a transaction advisory services agreement with the PNG National Airports Corporation, which will see the two cooperate to develop a new international terminal at JIA. The project will be the ADB’s first PPP transaction advisory agreement in PNG and the Pacific, and is expected to be developed under a framework in which a private firm will design, build, finance, operate and maintain the new facilities. Construction works will also include an extension to JIA’s primary runway and related infrastructure enhancements, allowing it to meet rising international passenger demand (see Transport chapter).

International donors are also working to support increased private sector participation in new infrastructure projects. The East Cape Road project, for example, is part of the second tranche of the World Bank’s Road Maintenance and Rehabilitation Project, a $126.5m initiative launched in 2011 and running until 2021. It seeks to restore key national roads across the country, but also emphasises strengthening institutional arrangements for road maintenance, including the participation of the private sector.

Increased collaboration with donors and international lenders will be important to maintain momentum in PPP development. Indeed, in a February 2017 assessment of PPP development in PNG, the Pacific Legal Network urged the government to move forward on the policy by gazetting the PPP Act and launching the PPP Centre, writing that “the growth in major infrastructure projects risks stagnating while the PPP Centre remains unformed. As such, it is important to consider the impact of the PPP framework on infrastructure projects in the future and the risks that exist if the government does not move forward with its policy.”

APEC Works 

Outside of transport projects, preparations for the APEC summit will provide near-term support for the industry. APEC works are a major priority under the 2017 budget, and the government continues to invest in building and upgrading new facilities for the event. In a March 2017 analysis of APEC summit preparations, the Economist Intelligence Unit wrote that lack of transparency in public accounts, and a mix of state-owned enterprise, private and public spending has made it difficult to estimate the event’s total cost.

However, the IMF has estimated that the government will spend PGK3bn ($951m) in APEC preparations between 2015 and 2018, while the 2017 budget allocated PGK100m ($31.7m) for the APEC meeting between 2014 and 2016, and an additional PGK250m ($79.3m) of APEC-related spending in 2017 alone.

Port Moresby’s waterfront is undergoing revitalisation in preparation for the APEC summit. The PGK120m ($38m) APEC Haus, for example, is a purpose-built conference facility which will host the APEC leaders’ summit and is set to become a national landmark. The project is being developed by Oil Search through a tax credit scheme approved by the National Executive Council. Global Constructions is building the facility on reclaimed land at Ela Beach in Port Moresby, with construction expected to wrap up in July or August 2018. In March 2017 Prime Minister Peter O’Neill announced that the building would be used as a national museum following the summit. The government is also investing PGK55m ($17.4m) to redevelop the Ela Beach area, including the construction of a PGK45m ($14.3m) sea park, with construction expected to finish in mid-2018.

An anticipated surge in hotel room demand has also helped support private sector construction activities, with more than 900 new rooms under or planned for development in Port Moresby as of mid-2017, although several high-profile projects – including the mixed-used tourism city Paga Hill – have stalled and are unlikely to be completed prior to the APEC deadline (see analysis).

Outlook 

Although PNG’s construction industry is unlikely to return to the highs of the PNG LNG boom years, the sector is well-positioned to continue on a steady growth path in 2017. The country’s severe infrastructure deficit will necessitate considerable civil works in the coming years, and although government and donor funding is in decline, stakeholders have made good progress in boosting private sector participation in major infrastructure projects.

In the longer-term, ongoing expansion of the PNG LNG project will underpin growth, while new LNG development in the Elk-Antelope fields could see the industry return to robust, rapid expansion in the mid-2020s.

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The Report: Papua New Guinea 2017

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