Loi M Bakani: PNG Economic Survey - "From Boom to Gloom"
Commentary by Mr Loi M Bakani, Deputy Governor of the Bank of Papua New Guinea, on
the PNG Economic Survey: "From Boom to Gloom", at the 2009 Papua New Guinea Update,
Port Moresby, 16 April 2009.
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The survey is focused on: (1) the likely end of macroeconomic stability and economic growth
that the PNG economy has enjoyed in the period 2003 to 2007/08, driven by high commodity
prices and prudent management of macroeconomic policies - fiscal and monetary, although
the survey does not explicitly give credit to the sound management of fiscal and monetary
policies; (2) the start of turbulent times arising from the adverse impact of lower commodity
prices caused by lower demand for PNG's export commodities, itself the consequence of the
downturn in global economy; and (3) a comparison of the National Government's
management of the revenue windfalls of the 2000s and 1990s.
The primary common factor that is analyzed extensively in the survey is international prices
of primary export commodities, and the secondary but also important factor is government
policies, both macro (fiscal and monetary) and micro economic policies.
In the boom period, high international export commodity prices gave rise to increased foreign
exchange reserves, Government revenue, steady appreciation of the kina exchange rates,
and low and stable inflation rates. Government expenditure was within its means. Whether
there was enough productive government expenditure as opposed to consumption
expenditure is another issue. On paper, there was promotion of capital, infrastructure, and
other productive expenditures. Actual effective spending of this was below budgeted levels.
The survey did not explicitly give credit to prudent fiscal (balanced budget) and monetary
policy management. These contributed to improved business confidence and
macroeconomic stability and growth that the economy enjoyed. Government spending and
private sector credit growth supported the expansion in the economy. The survey gives
evidence of these; 6.5 percent real GDP growth in 2007 and 7.3 percent in 2008 quoted from
the 2009 National Budget, and employment growth, using the Bank of PNG's employment
index.
In the start of the gloom period, especially the second half of 2008, the declines in prices of
PNG's major export commodities will be the telling factor behind reduced Government
revenue, foreign exchange inflows, potential depreciation of the kina and high inflation rate.
Already, total government revenue was lower than budgeted in 2008 while expenditure was
within budget but higher than the revenue, which resulted in a larger budget deficit compared
to a projected budget surplus.
While the Bank acknowledges that its reaction in adjusting monetary policy in 2008 to market
conditions was a little late it has to be pointed out that (i) the link between monetary
aggregates (money supply) and inflation is weak and not as strong as in other economies,
and that (ii) the most influential variables/factors of inflation are the exchange rate and
imported (foreign) inflation of PNG's major trading partners. With these in mind, while
monetary expansion in the form of credit growth contributed to an extent to aggregate
demand and therefore to inflation, the most influential factors on inflation in 2008 were the
increased food and fuel prices in 2007 and the first half of 2008 and their lag effect, and
strong domestic demand. With respect to the high credit growth, the Bank continued to
closely monitor the quality of loans and as evident, there was no increase in non-performing
loans by banks. It is also important to appreciate that the Bank viewed the credit growth
necessary to stimulate economic growth after low growth rates of real GDP were recorded
prior to 2007. Indeed, the Bank stood ready to tighten monetary policy in the event evidence
of inflationary pressures emerged in the economy. Relying on the release of actual inflation
data had a part in the slow response of the Bank.
Within domestic demand, monetary policy was picked on by the survey as being responsible
but increased government spending and public consumption from the export earnings, both
important factors contributing to strong domestic demand, were not clearly emphasized.
Also, very importantly, the kina appreciated against the US and Australian dollars and the
prices of fuel and food declined in the second half of 2008. These would have some positive
flow on effects to domestic prices, but we have not seen business houses passed on the
benefits of reduced import costs to consumers. This is something that the survey missed.
BPNG hopes that there is still a lag effect of the appreciation, that is, goods bought under the
appreciated rates will be sold at lower price. Firms must be fair and pass on the benefits to
consumers. However, the latest (2009) depreciation of the kina against the key
currenciesUS and Australian dollars may give them an excuse not to reduce prices of goods and
services or delay further any downward adjustment to domestic prices.
Coinciding with the declining commodity prices in 2008 was an increase in total government
spending in excess of total revenue. Experience of the 1990s show that when there is
excessive Government spending there can be downward pressure on the exchange rate and
high inflation. And monetary policy is burdened with the task of restoring macroeconomic
stability. That is, monetary policy could become preoccupied with the Government's debt
management. We have to avoid this. We may be going through this cycle again. In this
respect, the survey then makes some comparison of the revenue windfall and its
management in the 1990s with that of the 2000s.
In the 1991 to 1994 period the main growth area in expenditure were salaries and benefits
and current transfers or simply - recurrent expenditure which were financed by substantial
amounts of domestic debt.
In the 2000's, there was restraint on public sector salaries and current transfers, especially in
2003, although revenue had already increased substantially. Also starting in 2003, the
reduction in public debt took place. By 2007, the public debt/GDP ratio had been reduced to
around 33 percent from 63 percent in 2003. This decline reflected the increase in nominal
GDP and also a deliberate and prudent debt management policy to prepay expensive
overseas loans using the windfall revenue. But then recurrent expenditure started increasing
and by 2007, salaries and benefits increased by 40% from 2002. This is unproductive
expenditure and I agree with the survey that it would be difficult to reduce it under a situation
where budget revenue is declining, unless drastic reforms in the public service to achieve
efficiency are undertaken.
We hope to avoid the experience of the 1990s where monetary policy became burdened with
Government's debt management. The difference now is that the Central Banking Act 2000
safeguards monetary policy from any political interference and influence. But to achieve
macroeconomic stability and growth, it requires close coordination between fiscal and
monetary policies.
Overall, the survey pointed out that the Government managed the revenue windfalls of the
2000s better than in the 1990s. But we have to be mindful that some of the windfall revenue
are kept in trust accounts with commercial banks and Bank of PNG. Whether these funds will
be effectively spent for the intended purposes remains to be seen. More time will lapse
before we know. Good management of the windfall revenue and effective spending for
improvement in the delivery of goods and services also requires good governance and micro
reforms. While the Government should be acknowledged in the survey for putting aside in
trust accounts some of the windfall revenue, and also coming up with long term development
plans (National Strategic Plan 2010-2050), which should be supported with resources.
Prudent management of the windfall revenue held in the trust accounts is a challenge for
Government to ensure that it is used efficiently and for areas that will enhance revenue
generation in future. But a closer assessment of most of these trust accounts show that they
are likely to end up as recurrent expenditure, and not of investment type. The issue of
efficiency in delivery of services requires micro reforms.
This is where the survey also deliberated on some areas of micro reform necessary to
sustain economic growth in future. They are: (i) competition in mobile telecommunications,
about which the survey acknowledges the gains in the competition between Telikom and
Dicigel, (ii) competition in air transportation, about which the survey pointed out benefits for
travelers on certain travel routes (e.g., Brisbane-Port Moresby-Brisbane) served Qantas/Air
Niugini and Virgin Blue/Airlines PNG (iii) business regulations (iv) dealing with construction
permits (v) reducing costs of trade (vi) streamlining contract enforcement. These reforms
should be pursued as the benefits for the economy are substantial. The Bank has
consistently called for these reforms in its six-monthly monetary policy statements.
In concluding, the survey focused on the appropriate theme that is relevant today for the
Government as it is already experiencing the effects of low commodity prices on its budgeted
revenue for 2009. It is a challenge not to repeat the experiences of previous years where
expenditure is not adjusted whenever there is a shortfall in revenue. The Government should
not resort to debt financing but take a strong stand to cut expenditure in non essential areas.
The effective use of the trust funds has to be undertaken in an orderly manner so that it does
not exert pressure on liquidity and inflation. This is a form of Government's fiscal stimulus
required to keep the economic momentum going. Close coordination between fiscal and
monetary policies is therefore necessary in order to achieve long term macroeconomic
stability and sustainable growth.
In terms of the timing of the survey, it is early to assess the full impact of the decline in export
commodity prices on the economy. It is desirable thus to assess this impact later and how
the Government had reacted to such impact. This could be looked at in the next survey of the
economy. But raising these issues now as the Government is starting to experience the
effects of lower commodity prices is important, and the authors should be commended for
undertaking this survey at this time. Lessons drawn from the past commodity boom and
gloom should be used as a guide as we face the challenge of a commodity gloom in 2009.
Thank you.