Regulatory reforms to boost PNG tax revenues and develop non-mineral sectors

Although 2017 was another challenging year for Papua New Guinea, with subdued GDP growth against a backdrop of falling government revenues, cuts to public spending and rising fiscal challenges, economic recovery is gradually gathering steam. A steady uptick in commodity prices supported export growth and augmented the country’s trade surplus, while agriculture and mining recovered from severe drought that significantly impacted economic activity in 2016.

Maintaining growth after a boom period – which was driven by construction of the country’s first major liquefied natural gas facility (LNG), PNG LNG – has proven challenging for policymakers. However, the economic slowdown has pushed the government to implement fiscal and policy reforms aimed at fostering domestic growth and the non-extractives economy. Fiscal challenges are expected to be mitigated by efforts to boost revenue and improve public financial management practices, while loans from foreign countries and international institutions, such as the Asian Development Bank (ADB), and a planned eurobond issuance should offer relief from a chronic foreign exchange shortage.

Negotiations for PNG’s next major LNG project are being finalised, which is expected to take into consideration the lessons learnt during the first development. Although the multibillion-dollar investment has proven to be a technical success, allowing PNG to establish itself as a reliable international supplier of LNG, it has yet to provide a significant boost to state revenues or trickle-down benefits to local communities, intensifying the impetus to ensure a more beneficial and equitable deal for the country’s next big project, Papua LNG.

Headline Figures

Although PNG is one of the poorest countries in the Asia-Pacific region, it has undergone a period of rapid yet volatile economic growth since the 1990s. Data from the World Bank show that since 1990 GDP growth has fluctuated from a high of 18.2% in 1993 to a low of -3.9% in 1997. In 2007 GDP growth reached 11.1% before moderating to -0.3% in 2008 then rising to 6.8% in 2009. It surged to 10.1% in 2010, then dropped to 1.1% in 2011 before registering 4.7%, 3.8% and 15.4% in 2012, 2013 and 2014, respectively.

The PNG economy is highly susceptible to global commodity price fluctuations, which has led to a significant economic slowdown in recent years. Energy commodity prices fell by 45% between 2014 and 2015, while metals and minerals prices dropped by 15%, and agricultural commodities by 13%, according to the World Bank. The full impact of this slowdown was offset by the PNG LNG construction boom, with GDP growing at an average rate of 6.2% between 2012 and 2016. The $19bn project, led by ExxonMobil, commenced operations in May 2014, after which the country’s resource production more than doubled. Oil and gas output surged from PGK1.4bn ($437.1m) in 2013 to PGK12.5bn ($3.9bn) in 2015, making it a larger contributor to GDP than the combined exports of gold, copper, nickel, wood and palm oil. In 2017 the oil and gas segment represented 16% of GDP, according to the ADB.

However, in its December 2017 economic update for PNG, the World Bank reported that the country had not yet realised the significant benefits from its LNG project, leaving the economy vulnerable to the downturn in global commodity prices. Falling export revenues have also impacted the non-resource economy, while foreign currency shortages have impeded many sectors and businesses. GDP growth slowed significantly from 5.3% in 2015 to 1.9% in 2016 and 2.2% in 2017, according to the World Bank. The 2018 budget estimated that GDP growth hit 2.2% in 2017, however, in July 2018 the Department of Treasaury reported it might be as high as 3%. This is greater than the 2% in 2016, but well below the country’s 10-year average of 5.4%.

Extractives & Agriculture

The primary sectors of PNG’s economy include mining, petroleum and gas, and agriculture, forestry and fisheries, which together accounted for 46% of GDP and nearly all exports in 2016, according to the World Bank’s “Reinforcing Resilience” report published in December 2017. In its “Asian Development Outlook 2018” publication, the ADB reported that the agriculture, forestry and fisheries sector accounted for 18% of GDP in 2017, which was mainly supported by the production of palm oil, followed by the oil and gas industry with 16%, and the mining sector with approximately 10%.

The mining sector grew by 13.6% in 2017, as the country’s three largest mines – Lihir, Ok Tedi and Porgera – all saw an increase in output, according to the ADB. The three mines accounted for more than three-quarters of total mining revenue in 2017, as Ok Tedi returned to full-year production following an extended shutdown caused by the drought in 2016. PNG’s fourth-largest mine, Ramu NiCo, also recorded a production increase in 2017. It produced 35,000 tonnes of nickel, up 55%, while colbalt production grew by 51% to 3308 tonnes. Gold remained the country’s most important export by value, accounting for more than three-quarters of total metal revenue, followed by copper at 12%.

PNG has proven itself to be a low-cost, efficient gas producer, with PNG LNG’s output consistently higher than anticipated. Output from PNG LNG reached 7.9m tonnes in 2016 and 8.3m tonnes in 2017, both well above its 6.5m-tonne nameplate capacity. In its “When the Pieces Come Together” 2017 annual report, local firm Oil Search, a partner in the PNG LNG project, reported that oil and condensate production registered a record 30.3m barrels of oil equivalent (boe) in 2017, up from 30.2m boe in 2016 and 29.3m boe in 2015. Extractives production in the first half of 2018, however, was impacted by a severe earthquake that hit Hela Province in February that year, forcing PNG LNG to halt operations for eight weeks (see Energy chapter).

With regional LNG demand expected to exceed supply by the mid-2020s, PNG is well-positioned to attract future large-scale investment in the sector; however, the World Bank noted that LNG extraction remains capital-intensive and provides limited direct opportunities for job creation.

PNG’s other primary sector, agriculture, forestry and fisheries, saw growth moderate from 3.4% in 2016 to 2.6% in 2017. Despite the slight slowdown, the sector remains an economic mainstay for the country, providing employment for an estimated 85% of people living in rural areas. Between 2009 and 2013 the agriculture, forestry and fisheries sector was the highest contributor to GDP, averaging 20.5% over the five years, before the mining industry took the lead in 2014, when production began at the PNG LNG facility.

Trade & Investment

Although macroeconomic and fiscal challenges have stunted growth in recent years, the country’s abundant natural resources and ongoing policy reforms should help the economic recovery gain momentum in 2018. Foreign direct investment (FDI) remains concentrated in extractive industries and dominated by the PNG LNG project, with data provided by the UN Conference on Trade and Development (UNCTAD) showing that FDI inflows have dropped since 2005, from $33.5m that year to $29.1m in 2010. Continuing that trend, the country experienced foreign divestment of $39.6m in 2016 as a result of volatility in commodity markets and political uncertainties during the implementation of large-scale mining and natural gas projects (see Trade & Investment chapter).

Trade growth has skewed in the opposite direction, however, with UNCTAD reporting that exports increased from $3.3bn in 2005 to $5.7bn in 2010 and $8.2bn in 2016. Fuels accounted for 30% of total export receipts in 2016, followed by agricultural raw materials with 18% and manufactured goods with 4%, while the merchandise trade surplus climbed significantly from $1.5bn in 2005 to $5.8bn in 2016.

The Bank of Papua New Guinea (BPNG) reported in its quarterly bulletin published in December 2017 that export growth continued its upward trajectory that year, supported by a gradual recovery in global commodity prices. According to the central bank, the weighted average kina price of exports (excluding LNG) rose by 14%, supported by a 14.4% expansion on mineral prices, and a 12.6% increase on agriculture, forestry and marine product prices. As a result, the country’s balance of payments rose from PGK30m ($9.4m) to PGK350m ($109.3m) over that period.

Trade and investment growth is expected to be supported by the government’s first-ever National Trade Policy (NTP), which was released in August 2017. The 15-year plan seeks to foster the development of the domestic industry and attract new investment in the non-oil sector, creating 50,000 new jobs in the process, as well as bolstering efforts to diversify the economy and reduce extractives dependency (see analysis).

Forex Challenge

Private consumption remains constrained by an ongoing foreign exchange (forex) shortage, which has significantly impacted business confidence, particularly in the wholesale, retail and transport sectors, which each grew by 2% in 2017, according to the ADB. The shortage is a result of the BPNG exchange rate policy, whereby the central bank keeps the kina artificially inflated while a forex trading band determines the speed of kina depreciation, which has a far-reaching impact on the domestic economy.

For example, Stefan Hansen, former general manager of Tower Insurance, told OBG that reinsurers have expressed concerns regarding pricing and market competition. Due to the forex shortage, local insurers have difficulties paying in installments to foreign reinsurers. Meanwhile, investors have shied away from the Port Moresby Stock Exchange and the financial system has built up excess kina liquidity with few options for outward investment. Some stakeholders estimated the forex backlog was more than $1bn as of early 2018.

The central bank continues to manage forex imbalances through selective currency market interventions; however, according to the ADB, PNG’s current account surplus growth did not translate into higher foreign exchange reserves in 2017, as it was matched by a financial account deficit due to PNG LNG debt repayments, and the use of offshore foreign currency accounts by mining and oil and gas firms. As of October 2017, forex reserves were unchanged from 2016 at $1.7bn, which gave PNG six months of import cover.

BPNG maintained a neutral monetary policy in 2017, leaving its main kina facility rate unchanged at 6.3%; however, the ADB noted that “excess liquidity in the banking system renders monetary policy largely ineffective”, with broad money supply dropping by 0.9% in 2017.

Although the foreign exchange rate remained at a stable PGK3.2:$1 in 2017, inflation fell from 6.7% to 4.7% as seasonal produce prices moderated on the back of a recovery in the agriculture sector. The exchange rate limited import inflation, with the ADB reporting that inflation was highest for alcoholic beverages, tobacco and betel nut, at 11.5%, though this was still an improvement on the 26.1% rate in 2016.

Employment & Poverty

PNG’s economic slowdown has impacted employment, as well as put a particular strain on the financial sector. “Superannuation funds are under pressure as a result of growing unemployment,” Ian Tarutia, CEO of the National Superannuation Fund (NASFUND), told OBG. “There is no social security system in place, so if people lose their jobs, they take up their superannuation savings.”

Superannuation is a long-term savings initiative, and PNG’s two main players are NASFUND and Nambawan Super. The rise in life expectancy as a result of better health care services and awareness is also increasing dependency on retirement savings.

However, government policy-making initiatives could see the financial situation improve. PNG is a lower-middle-income country, recording unsteady, yet broadly positive gross national income per capita figures since 1990, rising from $790 that year to $1090 in 1994, according to the World Bank. It dropped to $490 in 2003, but climbed to $1450 in 2008, $1940 in 2011 and $1970 in 2013. In 2014 it peaked at $3010 before moderating to $2410 in 2017.

PNG’s unemployment rate hovered around 2-3% between 2005 and 2017, according to Moody’s Analytics, although much of the country’s workforce is employed in the informal or agricultural sectors. In the first half of 2017 formal employment dropped by 2.2%, with only the minerals and agriculture sectors recording growth, according to the central bank. Meanwhile, formal employment in the construction, transport, retail and wholesale sectors fell by 17%, 7%, 5% and 4%, respectively. By the end of 2017 the total level of formal employment had dropped by 3.9%, compared to the slight uptick of 0.3% in 2016, according to the central bank’s December 2017 bulletin.

High levels of informal employment are evidenced by low levels of financial inclusion, and the BPNG reported that nearly two-thirds of the population was considered unbanked in 2016. Low public spending on education has exacerbated the problem, limiting economic and social mobility for Papua New Guineans. “Middle-class growth can help stimulate awareness among parents and students on the importance of education,” Les Roai, interim executive director of local private education provider International Education Agency, told OBG. “Interest in private education remains high, but economic challenges have affected accessibility.”

The UN Development Programme reported that 37% of Papua New Guineans lived below the poverty line in 2016, and according to the ADB, 22.9% of the population had access to electricity in 2016.

Government Revenues

The lack of formal employment in the country has also affected tax collection realisation, which has resulted in cuts to government spending. Revenue realisation fell below government targets for four consecutive years beginning in 2014. Revenue for 2017 was projected at PGK11.5bn ($3.6bn), PGK248.4m ($77.5m) below its 2016 supplementary budget estimate. In response, the government took steps to address the rising fiscal challenges by releasing the 100-Day Economic Stimulus Plan immediately following Prime Minister Peter O’Neill’s re-election in August 2017, and moving to implement a series of public financial management reforms under the 2018 budget that is expected to boost revenue collection and help balance the budget (see analysis).

Resource Curse

While these efforts should help improve macroeconomic stability, industry observers have reported that the country’s next big LNG project, Papua LNG, offers PNG the best opportunity to address its fiscal challenges, with many hoping the project’s construction period will help kick-start lagging growth. However, in April 2018 research organisation Jubilee Australia published a controversial report titled “Double or Nothing: The Broken Promises of PNG LNG”, raising concerns as to whether the new LNG project will be yet another unrealised potential. Authors Paul Flanagan and Luke Fletched noted that PNG LNG’s proponents had billed it as a “major transformational project” for the country’s economy. However, according to the report, the model by ACIL Tasman to calculate the project’s economic impacts was flawed and “extraordinarily optimistic”, leading it to conclude that the PNG LNG project had not yet provided the expected benefits for the economy or the people. Although the economy was forecast to double in size as a result of PNG LNG activities, it only expanded by a modest 10%, most of which was concentrated within the resources sector.

The Jubilee report also argued that low global gas prices and higher-than-anticipated construction costs were not the sole cause of the unrealised predictions. It did, however, highlight severe revenue shortfalls as the main culprit, with government revenue standing at less than PGK500m ($156.1m) in 2016 compared to the predicted PGK1.4bn ($437m). Moreover, the additional costs of financing PNG’s equity share in the project, as well as direct payments to landowners, led to a budget loss of at least PGK200m ($62.4m).

Going forward, Jubilee recommended PNG establish a clear policy framework for all future works – including the upcoming Papua LNG project, to be led by French oil firm Total – arguing that no project should be approved without the production and release of transparent, verifiable and independent government economic modelling, which also includes costs to the budget.

Following the release of the Jubilee report, the government and related agencies strongly defended the economic impact of the PNG LNG project. Richard Maru, the minister of national planning and monitoring, told international press in May 2018 that investors and the government had to borrow money to pay for the project, so the initial financial returns and economic benefits would be constrained until the loans were repaid. ExxonMobil responded by saying that the project had contributed around $4.3bn to local businesses and the government through employment taxes, disbursements to state shareholder agencies, development levies, royalties and petroleum licence fees.

LNG Debates

In a June 2018 rebuttal to the Jubilee report, Australian think tank Development Policy Centre argued that the findings were based on Flanagan and Fletched’s own model comparing actual economic outcomes to those that likely would have been observed in the absence of PNG LNG, not comparisons of modelled versus actual outcomes. Furthermore, Jubilee’s conclusions were based on the assumption that without the project, PNG’s economy would have continued to grow at the rate it did between 2005 and 2009.

However, Jubilee is not the only organisation to call for more equitable terms for future LNG projects. In December 2017 the World Bank said that PNG would need to carefully consider the terms for any future LNG project to “ensure the benefits of the investment are not unnecessarily generous to foreign investors”, noting that the government had received “almost no revenue” from the existing PNG LNG project, which has exacerbated ongoing fiscal pressures and the forex shortage.

Outlook

PNG has remained resilient in the wake of a host of domestic and external challenges, and while growth has slowed since construction of PNG LNG ended, ongoing fiscal, structural and policy reforms should support domestic non-oil economic growth in 2018. The NTP is expected to provide support to local businesses by introducing new tariffs aimed at protecting the domestic industry, while loans and a planned eurobond issuance, ongoing public financial management reforms and the recovery in global commodity prices should further support a macroeconomic recovery and mitigate ongoing fiscal challenges.

The APEC Leaders’ Summit 2018, which will be hosted in Port Moresby for the first time in November, also offers the country the opportunity to showcase itself as an up-and-coming investment destination (see Trade & Investment chapter), with most stakeholders projecting it will have a positive impact on economic growth.

The World Bank forecast GDP growth to hit 2.5% in 2018 as mining operations expand output and improve efficiency, while APEC-related expenditure and an ongoing agricultural recovery will support non-oil growth, even as public spending remains constrained.

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The Report: Papua New Guinea 2018

Economy chapter from The Report: Papua New Guinea 2018

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