Regions and Countries

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p. 2 of 5 BACK | NEXT I. Summary of Strategy II. Current Development Trends and Issues III. Implementation of the Country Strategy and Program IV. Portfolio Management Issues V. Country Performance and Assistance Levels

Country Strategy and Program Update 2004-2006: Papua New Guinea

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II. Current Development Trends and Issues

A.Recent Political and Social Developments

3. The political situation in PNG remains extremely volatile. The present Government, which came to power in August 2002 after a prolonged and often violent election process, remains vulnerable, with political infighting continuing, notwithstanding new legislation— effective in all by-elections after the July 2002 elections—to strengthen the position of political parties and the introduction of limited preferential voting to induce politicians to reach out to a wider part of the electorate. The Government is exploring measures to further stabilize the political situation, including extending the period during which a new government is protected from votes of no confidence, from the current 18 months to 36 months. If the extension does not occur, a vote of no confidence is likely in February 2004 or soon after. There is considerable opposition to the extension and two attempts in November and December 2003 to pass the legislation were rejected by Parliament. The then Deputy Prime Minister, who had held the office for only a month, was demoted for not supporting the extension, an example of the prevailing political instability. Reshuffles, or threats of reshuffles, of cabinet positions within the ruling coalition are a continuing destabilizing feature, hampering implementation of reform measures. The political instability has exacerbated difficulties with corruption.

4. There is some appreciation of the need for reform and some appetite for wide-ranging reform, as evidenced by public discussions, by statements of policy and intent on the part of the Government, and even by the welcome passage of significant legislation. However, the champions of reform appear unable to translate these intentions into concrete and consistent actions on the ground. Corruption is a critical problem, and is publicly acknowledged by government leaders as well as the general public. Governance issues, and concerns over commitment to real reform, underlie recent difficulties in relations with the development partners, greatly exacerbating fiscal constraints. Release of the second tranche of the ongoing ADB Public Service Program loan, originally targeted for September 2002, has been delayed, pending stronger evidence of real commitment to reforms. The World Bank has suspended a recently approved forestry project. At the PNG Government’s request, the Australian Government is moving to install Australian civil servants in senior positions within the PNG bureaucracy and is seconding about 230 police officers to work with the PNG police.

5. General development continues to be hampered by the poor nationwide peace -andorder situation. Although the Bougainville secessionist conflict has ended, autonomy arrangements for the provincial administration are unclear and highly sensitive. The Highlands region remains unstable. Crime and violence throughout the country are serious impediments to development. Access to basic services is poor. Appendix 1, Table A1.1 indicates PNG's progress toward the Millennium Development Goals (MDGs) and targets.

B. Economic Assessment and Outlook

6. Since the mid-1990s, PNG’s growth performance has been weak, with poverty increasing. Per capita real gross domestic product (GDP) at end-2002 was about 10% lower than at the time of independence in 1975. An unfavorable external environment is partially to blame. However, in large part the poor performance is attributable to governance and peace - and-order problems, deep-seated structural impediments to growth (exacerbated by neglect of rural physical infrastructure), and inadequately focused macroeconomic policies. The development outlook in the medium term is poor. The natural gas and mineral prospects, which had provided some hope for the medium to longer term, are now less likely to eventuate. There has been a sustained decline in investment, and government spending is at unsustainable levels. The most dramatic decline has been in the quality of governance, with a negative effect on the quality of public spending, particularly on the standard of basic services.

7. After three successive years of contraction, PNG's real GDP grew by an officially estimated 2% in 2003. Output of the oil and gas and mining sectors, accounting for one quarter of GDP, increased by 3.4%. The agriculture, forestry and fishing sector grew by a modest 1.6% due to more favorable weather conditions, an early coffee harvest and generally strong commodity prices. Manufacturing and construction increased by approximately 5%, resulting from investment in a new oil refinery, a new tuna processing plant and improvements to the Highlands Highway. The trade surplus in 2003 is officially estimated to have increased substantially from 2002 as a result of strong growth in oil and gold exports and a drop in merchandise imports. The current account thus moved from a deficit of 4.6% of GDP in 2002 to an estimated surplus of 9.1% of GDP in 2003. Real GDP is forecast to grow at 2.8% in 2004 based on agriculture, forestry and fishing growing by 3%. The rebound is fragile, as it results from good weather and improved terms of trade, rather than structural changes.

8. The 2003 budget deficit is estimated to be 1.7%, slightly lower than expected due to unexpectedly high mining and petroleum tax and dividend receipts. These receipts more than compensated for a shortfall in indirect tax revenue resulting from stagnant domestic consumption and permitted the Government to retire some domestic debt and repay an outstanding advance from the central bank. Total expenditure and net lending exceeded the original budget estimate, reaching 33.4% of GDP. Development expenditure fell by even more than the budgeted cut, while recurrent expenditure exceeded the budget estimate by 6.7%. The public wage bill was relatively well controlled but still constituted 49.3% of total national department expenditure. During 2003, the Government has continued with strict expenditure constraints, imposed through cash controls over the line agencies, with severe implications for service delivery. The budget deficit is projected to fall to 1.5% of GDP in 2004 and to 0.6% of GDP by 2006.

9. With asset sales falling short of the budgeted figure and negative external financing requirement, the 2003 budget deficit was financed by short-term Government borrowing. Total public domestic debt rose to 27.3% of GDP, compared with 22.8% in 2002. However, external debt fell to 47% of GDP as the Government met some of its external loan repayment obligations.

C. Implications for Country Strategy and Program

10. The continuing political uncertainties, as well as the current economic difficulties, impede general policy dialogue, the development of an agreed medium-term strategy of assistance (beyond this CSPU), and implementation of specific projects. ADB needs to continue to support public sector reform. At the same time, however, the growth, albeit modest, in appreciation among the wider population of the need for deep-seated reform provides an opportunity for targeted assistance. ADB needs to reach beyond the government bureaucracy and communicate better with politicians and civil society. The short-term priority is to tackle fundamental governance issues. Fiscal discipline needs to be restored so that public resources can be targeted to protect existing investments in the social sectors and key infrastructure. ADB’s ongoing involvement in improving the machinery of fiscal management needs to continue. A significant fiscal adjustment will be required, implying that lending will need to be sharply focused. The very difficult country circumstances require that the objectives and expected outcomes of ADB’s strategy (and those of other funding agencies) be modest. ADB, together with the other development partners, needs to continue to explore alternative delivery channels for basic services. In this regard, the scope for private sector operations, including via public-private partnerships, will also be examined.

11. In another development, legal ambiguities have emerged that affect the negative pledge clause of ADB loan agreements. The Government has indicated that these ambiguities may require that domestic legislation be amended.

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