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p. 43 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia People’s Republic of China Southeast Asia South Asia The Pacific Cook Islands Fiji Islands Kiribati Marshall Islands Federated States of Micronesia Nauru Papua New Guinea Samoa Solomon Islands Tonga Tuvalu Vanuatu III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia

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Papua New Guinea

The economy slowed in 2000, despite the restoration of macroeconomic stability. The Government followed a tight fiscal and monetary policy during the year. Growth prospects are bright in the medium term, but depend heavily on political stability and continued government commitment to reforms.

Recent Trends and Prospects

According to official estimates, real GDP grew by 0.8 percent in 2000, though the actual figure may be lower. This contrasts with growth of 3.2 percent in 1999 following a period of recession in 1997 and 1998. The agriculture, forestry, and fisheries sector expanded by 0.9 percent in 2000, but mining production fell by 7.9 percent.

Coffee production dropped significantly in 2000 due to a reversal of the traditional wet and dry weather pattern and weak export prices. Copra and copra oil output also declined in response to weak prices. However, cocoa production increased due to renewed production on Bougainville island and better management practices. Logging production improved and prices rose from the 1999 levels, and while palm oil production strengthened, prices weakened significantly. The fall in mining production reflected the ongoing depletion of oil reserves and the impact of a landslide at the important Moran field.

The trade balance improved to $1,155 million in 2000 as exports increased by 7.9 percent and imports declined by 5.5 percent from the 1999 levels. This led to a substantial surplus on the current account of nearly 12 percent of GDP. The capital account was characterized by a significant increase in external aid and a very large rise in private outflows, reflecting, respectively, the drawdown of the first tranche of a structural adjustment loan from the World Bank, and both higher loan repayments and purchases of short-term securities by mining companies. Foreign direct investment was lower. The overall impact on the capital account was to increase the deficit from about 2 percent of GDP in 1999 to over 6 percent in 2000. However, given the sizable current account surplus, the overall balance-of-payments surplus stood at 5.7 percent of GDP. In mid-2000, foreign reserves were equivalent to 2.7 months of total import cover and 3.7 months of nonmineral import cover, considerably higher than a year earlier. Foreign reserves were estimated to have increased to adequate levels in the second half of the year.

The budget deficit in 2000 is estimated to have been about 1.8 percent of GDP, compared with a deficit of 2.6 percent of GDP in the previous year. Both revenues and expenditures were higher than forecast at the time of the 2000 budget: increased tax revenues reflected the impact of higher inflation on incomes and profits, and of higher oil prices; greater expenditure was mainly related to increases in teachers’ salaries and higher interest payments.

The improvement in government finances and macroeconomic performance follows a period of lax fiscal conditions and widespread governance problems. With the formation of a new Government in July 1999, fiscal responsibility was restored and a wide-ranging reform program, focusing on improving governance, was formulated and is being implemented.

With no new domestic borrowing and with proposals to retire significant amounts of domestic debt as important features of the fiscal strategy, the authorities expect that the improvement in government finances will facilitate lower nominal interest rates. However, this strategy depends on the generation of significant revenues from the current privatization program and further external concessional financing of at least $45 million— which at the end of 2000 had still not been secured.

Total public debt in 2000 amounted to 60.8 percent of GDP compared with corresponding figures of 63.1 percent in 1999 and 65.8 percent in 1998. External debt rose sharply in 1999, on the basis of both an expanding deficit and the impact of currency depreciation on kina-denominated debt. The servicing of public debt absorbed 18.8 percent of total government revenue in 2000.

The money supply (M2) contracted in 2000, reflecting weaker economic growth and tighter monetary policy. By end-June 2000, credit to the private sector had grown by 5.4 percent over the previous 12 months, while net credit growth to the Government had declined by 8.4 percent over the same period (see Figure 2.24). This decline followed several years of significant growth associated with a period of fiscal difficulties and borrowing from the central bank in excess of statutory limits. In January 2000, the authorities reacted to the buildup in liquidity by selling treasury bills to commercial banks. Despite the tight monetary stance, interest rates moved lower through the year with the treasury bill rate falling from an average of 23.3 percent in 1999 to an average of 18 percent in 2000. To some extent, the reduction in nominal rates reflected lower inflationary expectations and ample liquidity in the banking system.

For 2000 as a whole, the kina weakened by 8 percent against the US dollar, following a substantial depreciation of 19 percent in 1999. The weakness in 1999 reflected problems in securing finance for a growing budget deficit and the impact of political instability on confidence. The slower depreciation in 2000 reflected the impact of a higher trade surplus, international financial assistance, and improved sentiment in the foreign exchange markets. However, the exchange rate varied considerably over the year: in the first half, the kina appreciated strongly against most major currencies, but in the second half it weakened from around $0.40 at the end of July to $0.34 at the end of October. Weakness in this latter period appears to have been related to lower than normal coffee export revenues and the continued strength of imports. A further negative factor may have been the expectation among importers of an even weaker kina. Papua New Guinea does not operate a normal forward currency market and, therefore, when importers seek to obtain forward cover, the effect is felt on the foreign exchange market straightaway as banks purchase the required foreign currency immediately and place it on deposit.

Inflation has been high and rising in recent years, largely reflecting the impact of a general weakening of the kina over the past two years and drought-induced local price increases. For 2000, year-on-year inflation was 17.9 percent. The major factors were the medium-term weakening of the kina, the introduction of value-added tax and increases in other excise taxes, and the flow-on impact of rises in civil servants’ wages in 1999.

Real GDP is forecast to increase by about 3 percent in 2001 and nearly 6 percent in 2002. The agriculture, forestry, and fisheries sector is expected to be the major contributor to growth, with coffee exports likely to grow strongly and other agricultural exports to record solid growth. Preliminary work on a nickel mining development in Ramu and a gas pipeline to Queensland, Australia will boost the construction sector. Average consumer price inflation is forecast to fall to below 12 percent in 2001 and to just over 6 percent in 2002 as the kina stabilizes further.

The trade balance is expected to record surpluses of over K2 billion in both 2001 and 2002. These surpluses are considerably lower than the K3.1 billion in 2000 largely because of stronger imports. Import values are expected to increase substantially as the Ramu nickel and Queensland gas pipeline projects get under way. The current account is expected to move to a deficit of around 3.5 percent of GDP in 2001 and 2002, largely reflecting stronger invisibles payments associated with the mining and petroleum sectors. The transfer position is projected to record a modest deficit in 2001 and 2002 as Australian budgetary support is phased out.

Capital flows are forecast to more than offset the current account position, leading to small surpluses on the balance of payments in 2001 and 2002 averaging around 2 percent of GDP. Capital flows in this period will be dominated by finance for new mining projects. Net aid flows are projected to turn negative as receipts decline and repayments increase. The net impact is expected to contribute to a buildup of foreign reserves to $363 million by end-2001, sufficient to provide cover for seven months of nonmineral imports.

The 2001 budget aims, in fiscal terms, to continue the trend toward a balanced budget with the deficit for 2001 projected to be 1.3 percent of GDP. It includes the following priority sectors targeted for expenditure: health; education; transport; agriculture, forestry, and fisheries; police and key legal institutions; and the Internal Revenue Commission. It also provides for a large increase in public salaries, which, however, is dependent on savings derived from retrenchments of around 1,400 public servants.

Following a major taxation review completed in October 2000, the 2001 budget is to implement a new personal income tax schedule with a higher tax-free threshold, wider tax bands, and other income and value-added tax simplifications. The overall effect of the income tax changes is revenue neutral, and progressive in terms of income distribution impacts.

Under the 2001 budget, the Government is carrying out a package of reforms for the mining sector, designed to provide a more internationally competitive fiscal regime with greater transparency and improved administration. It has also proposed a draft for a new law guaranteeing stability of fiscal terms in major resource projects and the publication of model fiscal terms for inclusion in agreements made under the law.

Issues in Economic Management

Macroeconomic stability is an important precondition for facilitating broad-based economic growth. In the past, the central bank has normally responded to macroeconomic instability by tightening monetary policy, mainly via higher interest rates. However, the resultant interest-rate volatility is costly for investment and general business activity. To avoid such volatility, the Government needs to prevent fiscal imbalances from emerging in the first place. Its fiscal strategy is, therefore, aimed at reducing debt over time and should thereby contribute to the stability required. It is harder though to select the correct mix of responses in dealing with exogenous shocks, such as the Asian financial crisis, drought, or other natural disasters, due to their very unpredictability.

Policy and Development Issues

The Government has addressed a range of fiscal and governance problems that were contributing to macroeconomic instability and ineffectiveness of public institutions under the old administration. It has restored macroeconomic stability in a fairly short time and is implementing a comprehensive structural reform program, the key objectives of which are to improve governance, sustain macroeconomic stability, improve public sector performance, and remove barriers to investment and economic growth. In 2000, the Government gained endorsement and financial support for its structural reform program from the World Bank via a structural adjustment loan, the International Monetary Fund, and Friends of Papua New Guinea.

This reform program is important for laying the foundations of an effective development strategy which, however, also entails the setting of development expenditure priorities. These priorities, contained principally in the National Charter on Reconstruction and Development, are elementary and primary education, primary health care, transport infrastructure maintenance, law and order, and private sector development in rural areas. The 2000 and 2001 budgets increased the allocations to these sectors. The key initiative in the development budget for 2001 is the introduction of the Development Charter Program, which aims to significantly increase the delivery of basic services in rural regions. The program targets health, education, roads, and capacity building. The emphasis on rural regions should help address the incidence of poverty.

The country has wide disparities in income both among social groups and across the country, and a high incidence of poverty. The vast majority of poor people live in rural areas, and nearly two thirds of the poor rely on agriculture as their main source of income. There is consequently a need to diversify production, particularly in the nonmining sector.

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