Regional demand for minerals and resources helps to steady the ship

In Papua New Guinea’s small economy, trade and investment flows play a determining role in both growth and macro-economic stability. The economy is gradually rebalancing its traditional dependence on its southern neighbour Australia for both trade and investment, leveraging on Asia’s continued appetite for its natural resources. While lower international commodity prices are impacting the pipeline of projects in the traditionally dominant mining sector, PNG’s emergence as a major liquefied natural gas (LNG) exporter in 2014 has attracted global attention – with a second landmark LNG project moving towards a final investment decision in 2016.

Meanwhile, the authorities are pursuing a more active strategy to liberalise trade and investment flows in non-mineral sectors such as fisheries and agriculture, with partners further afield including the EU. Improving the business climate is high on the agenda, just as the government seeks to strike the right balance between attracting foreign funds and supporting growth in its domestic private sector.

Investment Trends

Bolstered by investment in its abundant natural resources, growth in the stock of foreign equity holdings has outpaced, and indeed driven, broader economic growth in the past decade. While GDP rose 138.6% to PGK32.67bn ($13.28bn) between 2004 and 2012, the stock of foreign direct investment (FDI) grew 200% to PGK9.79bn ($3.98bn), or 30% of GDP, in the same period, according to Bank of PNG (BPNG) figures. Nominal inflows of FDI received a significant boost from construction on the PNG LNG project, with inflows of $1.38bn, $554m, $1.02bn, $1.88bn and $904m from 2009 to 2013, according to the IMF. Figures for net outward capital flows however, have proven more erratic, with net inflows in 2009 of $423m, $29m each in 2010 and 2012, but net outflows of $309m in 2011, according to figures from the UN Conference on Trade and Development. These figures remain of poor quality however, “because of major deficiencies in data collection”, according to the IMF’s 2013 Article 4 consultation. Indeed, a share of FDI flows is categorised as net external liabilities, thereby under-valuing the stock of existing investment. The rapid build up in net external liabilities, from 81.6% of current account receipts in 2006 to 444.2% in 2013, according to Standard & Poor’s, reflects the financing of the PNG LNG project. These are thus expected to worsen to 193.3% by 2016, according to the global ratings agency.

Geographic Spread

Despite data inadequacies, southern neighbour Australia stands out as the single largest investor in PNG, with Australia’s Department of Foreign Affairs and Trade reporting total investment of $17.86bn in the country in 2013. Indeed, its share of inward FDI grew from 52.6% to 58.1% over this span, BPNG data show. A significant portion of this is focused in hydrocarbons and mining, with Australian firms including Santos, Highlands Pacific and Oil Search, but global multinationals have also channelled their investments through their Australian subsidiaries, including Coca-Cola Amatil, Nestlé Australia and Campbell’s Australia.

Given that BPNG figures do not reflect the ultimate beneficial investor, which explains the US’s low share of 0.5% of inward FDI stock in 2012, despite Exxon-Mobil’s large investment in PNG LNG, the Bahamas features as the fourth-largest investor, with 1.9% of the 2012 FDI stock. The fastest-growing source of investment in the past decade was from Japan however, whose share of the total FDI stock rose from 3.4% to 17.5%, driven by investments by Mitsubishi and Nippon Oil. Other top investors in 2012 included the UK with 2.1%, Singapore and Malaysia with 1.7% each, Canada with 1% and the US with 0.5%.

Figures from the Investment Promotion Authority (IPA) tracking new foreign investment commitments reveal a more balanced picture, however. The most significant sources of new commitments in 2013 came from Malaysia, Australia and China, with 24.1%, 22.7% and 20.7% of the total, respectively, while the British Virgin Islands accounted for another 10.9%. Chinese state-owned enterprises in particular have dominated the investment make-up, with China Harbour and China Railway Construction Corporation active in infrastructure construction, with the latter winning most of the contracts for the 2015 Pacific Games. China’s single largest investment in PNG, meanwhile, the $1.5bn Ramu nickel mine, was developed by the Metallurgical Corporation of China.

Sector Focus

Inward investment has increasingly been driven by the minerals sector, including oil and gas, whose share of the total stock rose from 71% to 87.4% between 2004 and 2012, according to BPNG. This has largely been at the expense of investments in agriculture, whose share fell from 6.2% to 2.2% based on just 12.4% growth in total investment, to PGK219m ($89m), over the eight years. Likewise, investment in manufacturing fell from 6.8% to 4%, while that in financial services more than halved from 3.7% to 1.4%. Statistics from the IPA reveal that the largest share of new FDI in 2013, some 24.6%, targeted the construction sector, outpacing that in financial services, manufacturing and mining, which accounted for 19.8%, 18.1% and 10.9%, respectively. Although investments in energy made up just 1% of new commitments in 2013, the announcement of a second planned LNG project will provide a boost.

In December 2013 French oil major Total announced its acquisition of a 61.3% stake in the Elk and Antelope gas fields from InterOil, although this was reduced to 41.1% after Oil Search opted to buy a 22.5% share. Total paid $613m to InterOil upon completing the deal, promising to pay an additional $112m upon a final investment decision on the LNG plant in 2016 and another $100m once LNG exports come online at decade’s end.

Although preliminary plans are for a 3.5m tonnes-per-annum (tpa) LNG facility, the consortium will invest in additional exploration up until 2016 to secure gas reserves, with Total agreeing to pay between $1.5bn and $5.3bn for certified gas reserves in excess of the current 3.5trn cu ft. A third potential LNG project, meanwhile, has seen Talisman Energy and Horizon Energy conclude a $280m strategic partnership with Mitsubishi in 2012 to conduct further exploration on several gas formations in Western Province. Estimations of proven reserves range from 2trn to 4trn cu ft for 2015, which could support a new LNG project with an initial capacity of approximately 3m tpa.

Trade Flows

Movements in PNG’s trade patterns mirror the growing diversity in the sources of inward investment. The country is the largest exporter among Pacific Island states, accounting for roughly 80% of the region’s total in 2012, according to the banking group ANZ, and has thus benefitted from a surge in the region’s external trade. Indeed, average growth in regional trade rose from the low single-digits in the 1980s and 1990s to around 15% in the decade up until 2013, according to the bank.

Riding the global upswing in commodity prices, the value of exports rose from 40% of GDP in 2002 to 51% in 2012, according to the Asian Development Bank (ADB) – well above the region’s 30% average.

The value of exports (fob) went up by 53.3% to $6.9bn between 2009 and 2011, before falling back to $6.1bn in 2012 and a forecast $6bn in 2013, according to the IMF. Given domestic production constraints the PNG LNG construction phase drove large rises in imports, which more than doubled in value (cif) from $3.3bn in 2009 to $7.4bn in 2012, before falling back to a projected $5.4bn in 2013.

Export growth was largely driven by commodities, with gold, copper and oil accounting for roughly two-thirds, according to the ADB. The Ok Tedi copper and gold mine alone accounts for 26% of export earnings, although declining production is forecast to reduce this to 4% by 2030, according to ANZ (see Mining chapter). The share of natural resources rose from 75% of total exports in 2002 to 78.2% in 2012, while that of agricultural goods rose marginally from 15.1% to 15.6%, according to BPNG figures. Exports of forestry goods, meanwhile, the third source of foreign earnings, fell from 6.5% to 4.5% in this span.

Key Partners

The lion’s share of mining and petroleum products are exported to Australia and Japan, which together account for around 75% of total exports, while forestry products comprise 65% of exports to Asia, with coffee, cocoa and fisheries accounting for the balance, according to the ADB.

While trade is still dominated by Australia this reliance is gradually decreasing, with its share of exports falling marginally from 45.7% in 2003 to 44.5% in March 2013, and that of imports from 54.8% to 42.2%, as per BPNG figures. Exports to Japan registered the sharpest increase, rising from 12.8% of the total in 2003 to 20.6% in 2012, at the expense of sales to South Korea and China, which fell from 5.4% to 1.3% and 6.7% to 4.8%, respectively, over the same period.

Meanwhile, exports to the EU, which is PNG’s second-largest trading partner, rose nearly four-fold from €264m ($359.7m) to €987m ($1.34bn) between 2002 and 2012, according to EU trade figures. Most of this growth was driven by non-mineral goods, seafood, coffee, cocoa, tea, vegetable oils, spices and rubber, particularly, according to the ADB.

Based on BPNG data, non-mineral exports, mainly coffee, cocoa and fisheries, were the main drivers of more modest growth in exports to the US, which rose from PGK181m ($73.6m) in 2004 to PGK212m ($86.2m) in 2012. In 2H 2014 however, as LNG exports ramp up, trade with Japan, China and Taiwan is likely to rise dramatically given long-term sales agreements with Osaka Power, Tokyo Electric Power, Sinopec and Taiwan’s CPC, with the IMF forecasting 20% year-onyear growth in total exports to $7.2bn in 2014.

Over the long term, a 2013 report by ANZ and Port Jackson Partners estimates commodity exports could rise four- to six-fold in value to between $23bn and $36bn annually by 2030, if current mining and hydrocarbons projects are completed. Such forecasts are based on projected investment of between $112bn and $170bn both in new natural resource projects and infrastructure required to support broader-based growth in non-mineral sectors, according to the study.

Gradual Liberalisation

Already an open economy with average most-favoured-nation tariffs of 2.5%, according to the World Trade Organisation, PNG is using a more active trade and investment policy to further lower tariffs with key partners. It will also need to complete ambitious infrastructure investments to lower non-tariff barriers.

Through the Melanesian Spearhead Group, PNG maintains duty-free trade arrangements with Fiji, Vanuatu and the Solomon Islands. It has also gradually expanded its network of dual-taxation treaties to seven countries, with New Zealand and Indonesia signing up in 2012 and 2013, respectively.

Although the region is also negotiating a broader multilateral trade and cooperation agreement with Australia and New Zealand, known as the Pacific Agreement on Closer Economic Relations Plus, progress has so far been slow. The minister for trade, commerce and industry, Richard Maru, indicated in 2013 that the main focus of trade liberalisation would be with the Pacific region rather than broader agreements. Nonetheless, in March 2014 PNG signed an economic cooperation treaty with Australia (see analysis) aimed at expanding bilateral trade and investment. The deal includes commitments for $528m in bilateral aid in 2014, alongside $420m in aid over four years to 2017 as part of a Regional Resettlement Programme of asylum seekers on Manus Island.

Setting Key Benchmarks

Further afield, PNG became the first Pacific nation to conclude an interim Economic Partnership Agreement (EPA) with the EU in 2011. Under the EPA, supported by €6m ($8.17m) in EU technical assistance, PNG has gained duty-free access to the common market, and the requirements for rules of origin were relaxed to allow for processed fish caught outside its territorial waters to enter tariff-free. With the South Pacific accounting for 60% of annual catches globally, PNG stands to gain significantly from new investments in fisheries processing, expanding exports to key European markets such as Germany, the UK and the Netherlands for canned tuna, and Spain and Italy for loin exports (see Agriculture & Fisheries chapter).

Despite power generation constraints, four new canning factories came on-line in Madang from mid-2013, adding to the three existing plants in the Lae region operated by RD Tuna of the Philippines and International Food Corporation of Malaysia. Asian investors are developing the new plants, including South Korea’s Dong Wong, China’s Hailisheng, Nambawan Seafoods, Fairwell Fishery Group of Taiwan, and a joint venture involving Thai Union Frozen and Philippines-based Century Canning. The US-based Tri Marine International is also participating in a joint venture with RD Corporation and Fairwell.

Zoning

The development of a fisheries cluster around Madang fits into a broader government strategy on special economic zones (SEZs). The authorities have already extended incentives for fisheries processors, including full, accelerated depreciation deductions for new fishing and processing equipment, and three-year corporate income tax holidays from the start of exports, with additional reductions over the subsequent four years. The International Finance Corporation has provided technical assistance since 2008 on a legislative framework for SEZs, submitting a draft to the Department of Trade, Commerce and Industry (DTCI) in 2010. Although the draft legislation, still under parliamentary consideration in 1H 2014, was originally drafted for the Pacific Marine Industrial Zone in Madang, the authorities have expanded their efforts. The zone, backed by a $72m loan from the Export-Import Bank of China, was renamed in 2013 to Madang Industrial Centre, broadening the scope of activities beyond fisheries, while other zones such as the Sepik Plains SEZ were proposed under the 2014 budget. In January 2014 AWAL Impex International of the UAE announced plans for a new free trade zone on Manus Island, with aims to invest roughly PGK2.4bn ($975.6m) in telecommunications, oil and gas, and construction and infrastructure, although details of the plan remain unclear.

Business Climate

Alongside efforts to carve out export-processing zones, the government is implementing more extensive reforms and streamlining investment procedures. Notwithstanding, the local environment remains challenging, with PNG down five places to 113th in the World Bank’s 2014 “Doing Business” report, while ranking 132nd among 178 nations measured on the Heritage Foundation’s (HF) “2014 Index of Economic Freedom”. The greatest bottlenecks are in the provision of hard infrastructure, as well as corruption and investment freedom.

The density of the road network for instance, at 0.065km per sq km of land, is much lower than in peer economies, while only a third of the road network is of ‘good quality’, according to ANZ. Congestion and low efficiency at the main ports of Lae, Port Moresby and Madang, meanwhile, which operate at capacity, is another challenge, with port turnaround times three-times longer than at Australian container ports. Air transport costs also constrain logistics, with domestic flights twice as costly per kilometre compared to within Australia, whereas international flights to Asian cities are almost 10 times more expensive. Further, with only 12% of households connected to the grid, businesses must rely on back-up generators.

Notwithstanding, PNG can improve its standing. According to ANZ, while the country ranks 73rd in a survey of global resources investors, it would rank third behind Mongolia and Canada if land use restrictions were resolved and “best practice” were implemented in key policies. Legislative efforts to reform the traditional land use system, which awards significant power to landowner groups in a country where 97% of land titles are customary, have been slow.

Yet the authorities are moving to electronic solutions for key investment and trade processes. In November 2013 the IPA launched its online business registry, providing for remote business registration and online searches of the companies registry. The Internal Revenue Commission and PNG Customs are also moving to collocate their registry with the IPA’s online platform, as part of a 2013 agreement that should reduce transaction costs. The IPA estimates that the introduction of free automated online searches will reduce the cost to the private sector by PGK3.6m ($1.46m) annually. The Customs service is also introducing e-payments, facilitated by the transition to an automated real-time gross settlement system between banks and government agencies.

Having shifted to electronic manifests in early 2010, the service is reducing the number of documents required in 2014. “The government has recognised the importance of the Customs service as a key trade facilitator by increasing our budget in 2014,” Ray Paul, a PNG Customs services commissioner, told OBG. “We are seeking to reduce the number of import documents from the more than 10 required currently and, in cooperation with the central bank, introduced e-payment in early 2014.”

Domestic Support

DTCI has also become more active in proposing legislative changes. In August 2013 Parliament revised the 1998 Takeover Code, providing for a national interest test for any merger or acquisition involving a foreign entity (see analysis). DTCI also supported revisions to the 1997 Companies Act, enacted by Parliament in February 2014 and modelled on New Zealand’s 1993 Act.

The reform simplifies the business registration and filing procedures, while moving the registration and annual reporting systems online via the IPA. There have been calls for additional reforms to further streamline reporting requirements.

“The priority should be to revise the 1992 Investment Promotion Act: since all companies who apply for approval from the IPA receive it, albeit with some delay, this means the system amounts to a formality that could be simplified,” John Leahy, a partner at Leahy Lewin Nutley Sullivan, a local legal group, told OBG. “For instance the requirement to provide a business plan at registration and six-monthly reports thereafter could conceivably be waived.”

Reforms of investment procedures are aimed at assisting local small and medium-sized enterprises (SMEs) as much as for foreign investors. Since 2013 in particular, DTCI has led efforts to protect and support indigenous SMEs. Having introduced a national interest test administered by the Securities Commission in mid-2013, DTCI will be publishing a new SME policy in 2014. The master plan will be wideranging, including a list of businesses restricted to local ownership, including in agriculture and media, national content requirements, a foreign investment review board, and a dedicated SME Act offering tax incentives. Building on a 12-point stimulus package launched in 2012, which included financial support and subsidised lending for SMEs, the new policy aims to grow the number of SMEs ten-fold, from 50,000 currently, by 2030 (see Banking chapter).

Transparency

While such measures to support private investment are an important step, the authorities are also tackling structural challenges linked to traditionally poor transparency and accountability by strengthening checks and balances.

Efforts to improve the quality of spending and public service delivery will play a key role in improving the outcome of increases in public spending (see Economy chapter). Yet in a country ranked 144th in Transparency International’s “Corruption Perceptions Index” in 2013, the significant decentralisation of public spending since 2012 through the provincial and district Service Improvement Programmes poses challenges of accountability.

In November 2013 the government announced plans for a constitutional amendment to establish an Independent Commission Against Corruption by mid-2014, replacing the existing anti-corruption Taskforce Sweep. As a key means of ensuring the transparency of SIP-level spending, the government amended the organic law on provincial and local governments in early 2014 to create district-level development authorities. Amidst broader efforts to improve public-sector accountability, PNG was admitted as a candidate country by the Extractive Industries Transparency Initiative (EITI) in March 2014, with its first audit report due within two years. “EITI membership provides a unique vehicle to demonstrate the government’s determination to improve revenue transparency and integrity, and supports the larger goals of fighting corruption, which is perceived to be pervasive and imposing significant drains on scarce public resources,” according to the IMF’s 2013 Article 4 Consultation. Although the government’s institutional capacity for implementing reforms remains limited, there is major support for greater transparency led by the Department of Treasury, which is also steering the creation of the new sovereign wealth fund in 2014 (see Economy chapter).

Outlook

Highly dependent on trade and investment for growth, PNG is exposed to movements in global commodity prices. While the pipeline of potential mining and hydrocarbons projects is significant, the authorities are using more assertive policies both to develop the non-mineral sectors and to support the growth of the fledgling domestic private sector. Striking a balance between the two priorities will require close consultation with private investors. PNG’s hosting of the Asia-Pacific Economic Cooperation summit in 2018, which Australian Prime Minister Tony Abbott described as a “coming of age”, will reflect its growing role as part of the Asian century.

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The Report: Papua New Guinea 2014

Trade & Investment chapter from The Report: Papua New Guinea 2014

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