Loi M Bakani: The LNG project and Papua New Guinea's economy
Presentation by Mr Loi M Bakani, Governor of the Bank of Papua New Guinea, at the
Consultative Implementation and Monitoring Council (CIMC) Workshop on "The LNG project
and Papua New Guinea's economy", Port Moresby, 31 March 2011.
* * *
Acknowledgement
Honourable Ano Pala, Minister for Agriculture and Livestock
Honourable Mr. Warren Dutton, Chairman of CIMC Agriculture Sectoral Committee
Mr. Anthony Yauieb, Deputy Secretary, Treasury Department
Mr. Paul Barker, Director, Institute of National Affairs
Ms. Marjorie Andrew, Executive Officer, CIMC
Ms. Laura Bailey, World Bank Country Manager
Ladies and gentlemen
I am pleased to have been invited to make a presentation at this forum. The topic of
discussion is an important one at this juncture of developments in the country. It is timely to
discuss it. I take serious note of the focus on the implications on agriculture sector of the
LNG project.
My paper draws on the findings of a study done in 2010 jointly by the Bank of PNG and the
Monash University (Melbourne) on the impact of the PNG LNG project, as well as the latest
policy issues that have emerged amongst relevant Government bodies and authorities,
including issues raised in the Bank's Monetary Policy Statement of March 2011 (about which
I made a breakfast presentation this morning, hosted by the PNGID, and to be released
through the media tomorrow.)
Introduction
During the construction phase of the PNG LNG project, the sectors of the PNG economy that
supply material inputs and will be involved in activities directly and indirectly with the project
will benefit. These sectors include manufacturing, building and construction, transportation
and communications, commerce (wholesale & retail - especially equipments and vehicles)
and service industries such as hoteling. There are other sectors such as the
agriculture/forestry/fisheries that will not benefit directly from the project. The project has the
potential to significantly raise standards of living in PNG. However, it will generate structural
adjustment pressures. How the rest of the country, including the agriculture/forestry/fisheries
sector where majority of our people live, benefit will depend on: (i) macroeconomic
management of the Government, specifically how the Government manages the windfall
revenue from the project during the production stage; and (ii) monetary policy stance in
reaction to movements in liquidity, inflation, exchange rates, and interest rates.
There is a lot of hype about the size of the project and the huge money, involved -
A$12 billion for construction-phase expenditure in 2010-2012 and annual exports averaging
A$4.0 billion (in 2010 prices) (taken from the study done by BPNG and Monash University,
2010, based on ExxonMobil funded 2008 ACIL Tasman study and information supplied by
ExxonMobil in 2010). However, it has to be understood that the bulk of the setup expenditure
will be on imported inputs and short term foreign labour. The joint paper by Monash and
BPNG argues that what is important for the PNG economy is the expenditure out of that total
amount on domestic supplies, by firms households and labour, which will total around
A$1.8 billion (K4.5 billion) over the three years of construction (BPNG & Monash, 2010).
Similarly, the project will generate substantial export revenue for PNG and have an
enormous effect on Gross Domestic Product (GDP). Again, from the point of view of the PNG
economy, this is largely irrelevant. The LNG exports receipts will be owned by overseas
based entities. What is relevant for PNG is the taxes, dividends and royalties that will accrue
to PNG Government, and landowners which will be in the range of a low of K2.0 billion a year
to a peak of K14.0 billion a year (ibid). Another way of putting this point is to recall that
welfare in a country depends on its GNP (a measure of its income), not GDP (a measure of
quantity of output that takes place within its borders). What matters most after receiving the
revenue, is how the Government manages it to benefit the rest of the country, without
creating an economic environment in which growth in liquidity of the banking system and in
inflation do not spiral out of control.
What Can the Government Do for the LNG Proceeds to Benefit the Agriculture Sector
and Mitigate the "Dutch Disease" Effect?
The means through which the LNG project can benefit the rest of the country, including the
agriculture/forestry/fisheries sector, is the expenditure of the LNG induced Government
revenue through the National Budget process. But it has to be prudent fiscal management
with emphasis on development and productive expenditure through a fiscal strategy that
ensures investment and consumption expenditures grow steadily (conservative approach)
over the years of the project life span. The fiscal strategy should not be one where there is
aggressive spending over and above the revenue with the Government borrowing against
future revenue or one that the Government spends all it gets in a year each year over the life
span of the LNG project. The prudent conservative spending approach will see some savings
and accumulation of assets by the Government over time while allowing for welfare of the
people to improve through improvement of infrastructures of transport, education, health and
law and order.
Real exchange rate
Let me first define a couple of economic terms that matter for the topic of the forum. Real
exchange rate refers to movements in the nominal exchange rate adjusted for differences in
the rate of inflation in PNG and the rates of inflation in PNG's principal trading partners.
Movements in the real exchange rate facilitate changes in exports and imports. Real
appreciation decreases the rate of growth of exports and increases the rate of growth of
imports. Real depreciation has the opposite effect. "Dutch Disease" refers to an economic
condition where a mineral boom leads to an appreciation of the real exchange rate, which in
turn depresses output in the tradeable sector. The real exchange rate appreciation can occur
in two ways. First, a surge in export from the mineral sector leads to an appreciation of the
nominal exchange rate, resulting in a rise in the domestic prices of tradeables and a
reduction in exports of other tradeables, non-tradeables being unaffected. Or second, the
increase in income may lead to an increase in demand for domestic non-traded goods and a
consequent increase their prices.
Having given the above definitions, let me now move onto why the concepts matter. In the
construction phase of the LNG project, real exchange rate appreciation is likely under all
three Government fiscal scenarios - conservative, aggressive and passive spending. Then in
the production phase, the study by BPNG and Monash shows that real exchange rate
appreciation will be more pronounced under the aggressive spending (over spending) and
passive (spend all as you get it) scenarios than under a careful conservative spending
approach. Real exchange rate and inflationary pressures will be significantly lower under the
conservative spending approach. So the effects of Dutch Disease can be mitigated by careful
and prioritized Government budget expenditure. Thus, the importance of the Sovereign
Wealth Fund (SWF). The decision by the Government to establish an SWF is therefore
welcomed.
Sectoral implications of the LNG project
Construction, manufacturing, transportation, service oriented industries and commerce
(wholesale and retail) sectors will benefit directly or indirectly in the short run through the
provision of inputs during the construction phase. Then in the operational phase, sectors
such as manufacturing will face considerable competition from imports and will be harmed by
the appreciation of the real exchange rate. Traditional agriculture (food, fruits and vegetable)
sub-sector will fare well under increased aggregate income and demand.
The export agriculture sector (coffee, cocoa, palm oil, copra, forestry) will be harmed by the
real appreciation (Dutch Disease). Our exports will be less competitive and so there will be a
decline in the export of these commodities. This adverse effect can be more pronounced
under the aggressive Government spending scenario because excessive Government
spending will add to the real exchange rate appreciation through increased liquidity and high
inflation. This adverse effect can be mitigated or minimised through the conservative
Government expenditure approach.
Apart from a strategic careful and prioritized spending, the Government can also mitigate the
"Dutch Disease" effect on the tradeable agriculture sector by maintaining and reconstructing
the existing road network as well as all the social sector infrastructure of health and
education and law and order. This will aid the producers get their produces to buying points
and sustain production and export. In other words, the resource curse scenario can be
addressed through better and improved infrastructure network.
What Can the bank of PNG Do to Minimize or Mitigate the "Dutch Disease" Effect to
Assist the Agriculture/Forestry/Fisheries Sector?
On its part, the Bank of PNG can mitigate or minimize the "Dutch Disease" effect through its
management of the Kina exchange rate. While the exchange rate regime is a floating one, it
can use the build-up in international reserves to support the Kina at an exchange rate that is
favourable for agricultural export growth while not completely going against the market trend,
under a real exchange rate appreciation scenario. But this will be done in joint consideration
of the objective of monetary policy, which is price stability. The desired outcome of having
competitive prices for our agricultural exports through the Central Bank supporting the Kina
at a desired exchange rate will be best achieved with the conservative fiscal expenditure
approach described above, under a close coordination of monetary policy and fiscal policies.
Apart from the direct influence of exchange rate on the agriculture sector, the Bank considers
macroeconomic stability as an important foundation for microeconomic development and
improvement. When there is price stability - entailing stable inflation, stable exchange and
stable interest rates - businesses, the general public and the international community will
have confidence in the economy and economic activity can prosper. The Bank plays a major
role in influencing macroeconomic conditions through its monetary policy and management
of the exchange rate policy. Given a condition of macroeconomic stability, it is up to the other
Government agents to do their part to improve things at the micro level.
Overall macroeconomic management
During the construction phase of the LNG project, the Government should adhere to the
parameters of its annual budgets, and prioritise its expenditure so as not to compete with the
private sector on the limited resources within the country, especially in areas of construction,
civil works, earthmoving and other infrastructure developments. It should instead concentrate
on maintaining existing transportation and social sector infrastructure that have deteriorated
in many parts of the country, in order to improve health, education, and law and order status.
The Government should increase capacity of the workforce by providing appropriate training
in schools and colleges and improve the performance of implementing agencies. This would
also allow for the utilization of the expertise, physical and human resources that are built up
by the LNG project development, to be efficiently and productively used as and when they
are released from the project.
Over the life span of the LNG project, the Government should then follow a strategic
expenditure plan which relates to its medium term development plans, containing specified
programs and projects that aim to improve infrastructure and bring services to the rural
population. The drawing down of funds from the SWF should tie in with the annual National
Budgets, which should reflect the year to year programs of the medium term plans so that it
serves its purpose of enabling the Government to better manage the revenue flows -
including dividends, royalties and tax from the LNG project, and expend it on priority areas in
a sustainable, efficient, and productive way, that will benefit the great majority of the
population and care for future generations.
All these are part of prudent macroeconomic management that will aim to (1) contain inflation
rate at an acceptable or tolerable level and (2) minimise the effects of "Dutch Disease" on
industries that will not directly benefit from the LNG project.
Prudent Macroeconomic management encompassing what the key Central Governments
and the Bank can do as described above has to be accompanied by micro level initiatives
and programs. This is where the National Agriculture Development Plan and other medium
term development plans of the Government come in. These plans must enable the
development of the traditional as well as value-adding industries.
Ladies and gentlemen, the whole approach for policy decisions at the macro and micro
levels, and developmental programs and projects in areas that matter for our people, have to
be done in an integrated and coordinated approach by all responsible agents in line with the
Government's Vision 2050 for the country to move towards realising the Vision 2050
objectives.
Thank you.
References
Dixon, P.B, Kauzi, G. and Rimmer, M.T (2010), Effects on the PNG Economy of a Major LNG
Project, Economic Papers, Vol. 29, No. 2, June 2010, the Economic Society of Australia.
Monetary Policy Statement 31st March
BPNG (2011), - 2011, BPNG, Port Moresby.