. today is another such meeting outside of port moresby. we have covered all the regions of papua new guinea – highlands, islands, southern and momase in our visitation. the last time we had a board meeting were in mt. hagen was in the 1980s. as the central bank is a national institution that belongs to all the people of png, we will continue to go out to them in this manner. these visits are important as they provide an opportunity for the board members and senior bank officials to meet with community leaders and our business liaison and other business contacts, make educational presentations to provincial high schools and present school materials, mainly books. these are opportunities by which the central bank also gets to spend some money in the outside centres. i also hope the board members and officials will spend some money in the fresh food and craft markets so that i can confidentially reflect on our contribution to the tourism industry in mount hagen. over these years in which the board has met in port moresby and around the country, we have seen the economy turned around from a depressed state some three years ago. the economy has recovered and there is renewed confidence in the market. however, much of the fundamentals still have to be continuously nurtured, including that of transportation and other physical infrastructure. we therefore have to remain vigilant and work towards ensuring these gains are sustained. 2. current economic conditions the central bank, in its march 2005 quarterly economic bulletin, released on 31st may 2005, noted improvements in the main economic indicators, and i shall not spend too much time on these developments. the board has been brief on this. in brief : • domestic economic conditions : economic activity continued to improve in 2004, led by the export sector with higher production and prices of most mineral and non - mineral commodities, and increased employment. • inflation : the annual inflation rate continues to trend downwards in the march quarter of 2005, to negative 1. 2 percent. over the year to march 2005, inflation was 0. 1 percent, compared to 2. 9 percent in march 2004. this reflected the positive impact of the stability in the exchange rate and fiscal restraint by the government. in 2005, we expect inflation to remain low, if current stability in macroeconomic conditions, particularly exchange rate prevails. • exchange rate : the positive developments in the foreign exchange market since the second half of 2003 with stable inflows from both the mineral and agricultural sectors has resulted in the appreciation of the kina. the exchange rate

07 jun - 07 mar - 07 dec - 06 jun - 06 sep - 06 mar - 06 dec - 05 - 4 source : national statistics office, bank of png staff calculations, world bank. other factors affecting inflation in png while food prices contributed to 60 percent of png ’ s inflation between march 2008 and june 2009, over the last year, they have only contributed about 35 percent. therefore, increasingly, additional pressures are contributing to inflation. after years of strong revenues, government spending has increased dramatically, contributing to strong domestic demand. additionally, png ’ s macroeconomic stability of recent years has led to increased business activity and foreign investment, most notably the png liquefied natural gas project which is currently under construction. moreover, due to the length of this boom in business activity, domestic demand pressures have consistently exceeded the ability of domestic supply to increase, and inflation expectations have increasingly become a factor in price setting and wage negotiations. with data collected from our business liaison surveys, we can see that wage expectations increased with the food and fuel price surge in 2008. but starting at the end of 2009 – even before the current food price surge began – we have seen wage expectations increase to their highest sustained levels since our survey began. when expectations of higher inflation are built into business costs, higher inflation can become entrenched, and monetary policy must then also decrease these expectations to reduce inflation. expected average employee wage change over the next year ( percent ) trimmed mean ( 50 % ) survey response q4 2010 q2 2010 q4 2009 q2 2009 q4 2008 q2 2008 q4 2007 q2 2007 q4 2006 q2 2006 q4 2005 q2 2005 q4 2004 q2 2004 q4 2003 source : bank of png staff calculations. bis central bankers ’ speeches thus, since 2007, inflation in png has been affected mainly by these factors : 1 ) external food and fuel prices ; 2 ) increased domestic demand due to high government spending, business activity, and lng project construction ; and, increasingly, 3 ) inflation expectations. role of monetary policy the bank of png has some tools to affect these inflation developments, but when it comes to externally driven factors such as food prices, png is a price taker, and the main challenge is for the bank to limit these prices passing on to other prices. moreover, with much of the current business boom driven by the lng project, the bank of png can only have a limited effect on demand