The good
Things are not all doom and gloom. Many domestic policy makers are even talking positively about the affects of the crisis.
The positive interpretation is partly justified by the huge volumes of foreign exchange reserves built up over the past 6 years meaning that the economy is unlikely to suffer a repeat of the foreign exchange shortages of the 1990s. It is also widely thought that a slowdown in the global economy may help to cool off Government revenue growth, which has been increasing at a dramatic rate since 2002. This would require the Government to consolidate on its recent revenue gains and also help to dampen inflation which has recently reached double digit levels. PNG is also much less dependent on both remittances and tourism revenue than other countries in the region. These two ‘advantages’ mean that it is unlikely to feel any significant pain from a drop in earnings from both activities.
In terms of the stock market, the initial phase of the crisis also left the POMEX relatively unaffected – despite some sensationalist headlines in local newspapers. The small decline which did occur during August and early October resulted mainly from those stocks which are double listed on both the POMEX and ASX markets, and the corresponding falls in their Australian listing.
A significant Kina appreciation against most of PNG’s major trading partners over the last two months will also help to curb rising domestic inflation a large portion of which has been from imported sources. The Kina has appreciated against the Australian Dollar by as much as 45 per cent since August this year. This change will also help lower the Governments foreign debt repayment obligations.
And the global drop in oil and gas prices will be warmly received by many in PNG who have been struggling with higher fuel and energy costs.
The bad
But the argument that PNG is immune from the current crisis overrates the resilience of the economy. The exchange rate appreciation has dramatically reduced the competitiveness of PNG exports; particularly exports of labour-intensive products from manufacturing and agriculture (coffee, copra and oil palm). Stagnation in these sectors will dampen the already minimal employment creation from the recent commodity boom.
If global oil and gas prices continue to remain low, or decline further, question marks may begin to emerge on the viability of the PNG gas pipeline project. The project entails over US$1 billion of investment by the Government, and a cancellation or delay in the project would be a disaster for current fiscal policy and future revenue growth.
Perhaps the most important impact of the crisis however relates to PNG’s ever fluctuating foreign exchange reserves. Concerns about falling foreign exchange earnings have been dismissed on the basis of current earning levels and the large stock of reserves which have been built up since 2002. This is certainly true. PNG currently has record levels of foreign exchange and any drop in earnings would have to be large and sustained for any negative side effects to emerge. But this underestimates how quickly circumstances can change in the land of the unexpected.
A large portion of PNG’s foreign exchange reserves are currently invested by a number of international investment firms. A portion of these asset values have declined substantially over the past months both from exchange rate revaluation and share price losses. Central Bank Governor, Wilson Kamit, has also highlighted the potential impact that the crisis may have on the earnings of PNG’s superannuation funds. Both Nambawan Super and Nasfund have approximately 20 per cent of their assets invested in off-shore equities. The affects of this on their balance sheets will also be combined with a loss in value of many of PNG’s dual listed companies, which have recently begun to fall prey to the crisis.
Potentially, the biggest risk to reserve levels will be if, over the longer term, PNG’s key export markets, Asia in particular, begin to implode. As the ADB recently announced in its latest Pacific studies series, ‘PNG’s commodity price boom is over’. Profits for a number of major mining companies are expected to decline substantially this financial year and this will have obvious consequences on both government revenue and export earnings. The true extent of these effects will be difficult to tell until the BPNG releases its Annual Monetary Policy Statement at the end of the year.
The ugly
Even more worryingly, despite its initial resilience, in the last week the PNG stock market has begun to feel the fallout from the global turmoil. In one week the share market dropped 13 per cent as Oil Search shares plummeted by K3.40 (34 per cent) amidst expectations of a slowing global economy. While share prices recovered in the following week, this volatility demonstrates that PNG is not immune from the crisis and almost certainly reflects the markets’ increased understanding of the consequences of a sustained downtown in the global economy.
Liquidity is not a major issue in the region at present, though the Bank South Pacific with a credit rating of B+ (S&P) could in future face a ‘run to quality’ given the AA (S&P) ratings of its major competitors, ANZ and Westpac. The recent deposit guarantee provided by the Australian PM to the latter two may exacerbate these pressures with a flow of funds out of the Pacific towards safer Australian shores.
Tighter global and regional credit markets will also increase the cost of obtaining international finance and are likely to reduce private investment flows to PNG. Higher borrowing costs in turn will limit potential funding for new projects. The fall in global commodity prices will make many commodity-based projects appear less profitable, further restricting growth across a number of sectors of the PNG economy.
Easily the biggest threat to PNG’s continued economic expansion, however, is that the regulatory and institutional environment raises costs prohibitively, in particular for small scale investments. PNG now ranks second last out of ten Pacific Island countries in the World Bank’s 2009 Cost of Doing Business index, sliding back from position 89 to 95 in the world over the last year. For the most part, medium to large scale investment activities have overcome the high costs of operating in PNG’s regulatory and institutional environment by obtaining tax concessions and operating subsidies from the Government. These options are generally not accessible to smaller scale entrepreneurs who face the full cost of the PNG business environment. This has dramatically limited the flow on or ‘trickle down’ effects of PNG’s post 2002 economic boom which has been driven by large scale enclave development in mining and resource extraction. Without broad based growth and a diversification of export and government revenue sources away from mining and resource extraction PNG will continue to remain highly vulnerable to external shocks to the global economy.
Conclusion
PNG has made significant gains in its macroeconomic and fiscal position over recent years, and the risks to macroeconomic stability in the short to medium term are in all likelihood not that large, provided Asia holds up. But a sustained slow down in the global economy is a large longer term risk for PNG and the brunt of the current crisis is likely to be felt most heavily by rural and agricultural workers who find that they are no longer competitive in international export markets. The impact of a global slowdown will be on the poor. Those at the margins risk falling into poverty. The plight for the already poor will get a lot worse.
A reduction in commodity prices will significantly cut government revenues and Secretary Tosali’s concern about the potential impact of the crisis on PNG’s fiscal position is real. Fiscal belt tightening, and more importantly, prioritization of expenditures towards productivity enhancing sectors will be required to help lessen adverse impacts of the global slowdown.
Until the PNG Government addresses the structural constraints on growth by reducing the formidable costs of doing business in PNG the gains from episodic resource booms will continue to remain fragile. This is one reason why the much talked about macroeconomic improvement has failed to translate into improvement in the wellbeing of the population at large.