The spirit of good governance
This month the Spirit of Hela left from Papua New Guinea to deliver its first shipment of LNG to Japan, now the world’s hungriest consumer of natural gas. PNG’s USD 19 billion LNG project -more than 190 million work hours in the making with investments spanning five provinces- has been sold as an opportunity to independently finance an ambitious development agenda.
This LNG production will soon launch PNG to the list of the top producers in the world. Yet it was more than two years ago that the O’Neill government began enthusiastically driving funds towards ‘development enablers’ such as fee-free education and free primary healthcare. While this milestone should be a time for celebration, excitement has fallen away to concerns over debt burdens and unclear behind-the-scenes financial agreements. Port Moresby is flush with speculation about the risks of rapidly unwinding ten years of fiscal prudence.
Details of PNG’s public finances only trickle out during the year but signs are of a government storing up problems for itself. With concerns about the state of the economy heightened, vague reassurances are unlikely to assuage fears. It is in government’s own interest to begin communicating the evidence.
Once burnt
For many it is no surprise that an air of skepticism hangs over the start of PNG’s largest ever resource project.
Late last year, one of Papua New Guinea’s founding fathers, Sir Julius Chan, boldly stated that all of the major resource extraction efforts of the last 40 years had ‘failed’. This was not because the resources had failed to be extracted, he said, but because they created no improvement in the lives of the people. In fact, the 1990s economic crisis and Bougainville conflict (both resulting directly from resource extraction), suggest that he was understating the situation.
In this latest instalment in PNG’s natural resource saga, there has been ample advice from development partners, academics and international financial institutions to ensure this time was different: that revenues are carefully managed and help to foster broad-based development.
Yet, this week we saw the Ombudsman step in to block the first interest payment of the controversial (and perhaps illegal) $1.2 billion UBS loan agreement used to finance the government’s shareholdings in Oil Search. Two days later, PNG’s foreign exchange dealers began discussing rumours of foreign exchange shortages and the Bank of Papua New Guinea once more intervened to support a weakening Kina.
There is a genuine fear that clear-headed thinking may have been lost in the scramble surrounding natural resource extraction. Economists are increasingly concerned that an overly excited government has loosened its grip on the purse strings, borrowed too much and inadvertently left the country vulnerable to economic instability.
This would not be a first for PNG. If we cast our eyes back to the early 1990s to a time when the country was eagerly awaiting revenues from Kutubu Oil project and Porgera Gold Mine, we see a government, drunk on the anticipation of this windfall, that ran its public finances off the road. Ill-equipped to deal with an economic shock, PNG fell into a currency crisis and was forced to manage the distress of an IMF Structural Adjustment Programme whose legacy lasted for the better part of ten years.
Unfortunately the government is all too tempted to dismiss worries and quash expressions of concern. The removal of high-profile officials and Ministers, failure to adhere to parliamentary and judicial processes, and threats of deportation for dissenting voices, have served merely to inflame these worries and fuel speculation about incipient signs of the resource curse.
The growing list of concerns
The situation is finely balanced. The government, in their recent spree of deficit spending, has ignored advice from the IMF as well as their own previously announced strategies, and taken the government finances beyond the legal benchmarks of responsibility. This is only likely to get worse in 2014.
In the formation of a government budget it is often said that wars on public waste are the last refuge of politicians who can’t make their sums add up. In PNG’s 2014 budget refuge was also found in uncertain compliance measures and assets sales.
More recently we heard news of poorly performing mining and petroleum taxes to add to this list of revenue sources likely to fall short. Given this, it seems increasingly likely that the required revenue growth of 30% in 2014 – ten times faster than growth in revenue seen over 2013 – will be missed. Even before March all indications pointed toward the likelihood that the budget deficit will open up further and the limits in the Fiscal Responsibility Act breached again.
Then in March came the mammoth UBS loan agreement that led to the ousting of the Treasury Minister Don Polye and Petroleum and Energy Minster William Duma – the former continues to dispute the agreement’s legality. But whether or not this loan agreement is legal, it means that in two years we have seen the country committed to two multi-billion Kina loans without serious oversight.
While the Ombudsman and lawyers pore over the legislation, analysts should be debating the implications of adding to the debt pile. The government has prevented this conversation. While willing to fight the legality of this deal, the economic logic remains a discussion that only a few are privy. We do not know the implications for government revenues or for official foreign exchange reserves, which are already heading southward with the Kina. Neither do we know the implications for the Sovereign Wealth Fund.
Unfortunately the ‘wait and see if we were right’ response to critics of the UBS loan agreement that financed the government’s interests in Oil Search is unlikely to ease the discontent. Recent Oil Search share price increases are unrealised paper gains and not, as reported, a ‘windfall’ for the government. More importantly these gains do not tell us whether the decision was in the public interest or value for money. We know that this was a good deal for Oil Search, who used the capital to expand interests in the Elk and Antelope gas fields, but the public interest is less clear.
The tide coming in
In between budgets, the PNG treasury only provides limited information on the state of public finances. This makes it a challenge to understand whether an already large deficit will get larger or whether huge loan agreements are likely to become too difficult to manage. Yet, the indicators available already suggest that the consequences of deficit spending may be creeping up behind the government.
With commercial banks edging closer to the limit of their ability to lend to government, the rollover risk alarm bells have begun to ring. The government is finding it harder to borrow to cover repayments, increasingly eating into those vital cash reserves necessary to pay bills and salaries.
This is the stuff that keeps treasury officials up at night.
A glance at the recent string of hugely undersubscribed government bond auctions and the rapidly increasing cost of short-term credit reminds us of a mounting pressure that the government must carefully manage. Over the past year interest rates on one-year Treasury Bills have rocketed from 2% to 6%. At the same time commercial banks desire to lend is waning- the government’s 30th May request for K200 million is a good example of this pressure, it took just K44 million in accepted bids.
Storing up troubles: the government’s rapidly increasing short-term debt costs
Source: Bank of Papua New Guinea
The government has one more card to play if commercial banks lose interests. It can go cap-in-hand to the only institution that has the ability to ‘create Kina’, the Bank of Papua New Guinea (BPNG). A glance at BPNG’s balance sheet and data on recent stock auctions shows that the government is increasingly doing this – over the past two years, lending to government has more than doubled, reaching historically high levels and worryingly they have also stepped in to the short-term bond market. This is also a sign of the tightening environment for the government.
Government’s increasing reliance on the central bank printing press: BPNG holding of government debt
Source: Bank of Papua New Guinea
For the better part of a year the BPNG has been concerned with a rapidly falling Kina, whose depreciation has been worse than expected. While there is no doubt that this is partly driven by the gap between the construction and production phase of the LNG project, injecting liquidity into the banking system to fund the government’s deficit at best could be considered out of line with their policy, at worst could have contributed to the Kina’s weakening.
Leaning on a central bank can quickly undermine the goal of maintaining financial stability with low and stable inflation. In an ideal world a central bank governor in this situation would be making firm statements that the currency printing press should not become politically captured. Instead, the BPNG avoids discussing its own policies and limits around government lending in its latest policy statement, while reversing their advice from six months prior by telling the government ‘it should not be constrained by the limits on its total debt’. Not a line heard often from an independent central bank governor.
Finding a route out
Since the 2013 budget the government has been accused of spending LNG revenues before they arrive. There is some truth to this, but given the slump caused by the conclusion of the LNG construction phase, controlled deficit spending can be justified by economic logic.
Yet, as is all too often the case in the formation of government budgets, economic logic is used retrospectively. The increase in MP’s funds (through the District Services Improvement Program) that helped open up the hole in the budget was driven more by politics than a thought-out stimulus package. Nevertheless, the litmus test of interventionist fiscal policy will come when government needs to cut back.
Foreseeing this challenge, in the 2014 budget government officials made commitments for stringent real spending cuts for 2015 to pull the deficit back to manageable levels. Longer-term fiscal projections tend to be light on political buy-in, but they can shape discussions as we move closer to the end of the year. But while we might hope that O’Neill’s government has given itself some breathing space behind the integrity laws to heed this advice, they are more than aware that a 30-month grace period is only as strong as their ability to hold enough members on side.
Spending promises are still integral to holding together the government. But with debt financing challenges nipping at the government’s heels, there may be little choice left.
Down the line nobody wants to be looking back at another missed opportunity. With the stakes so high, the government would benefit from fronting up and engaging these issues rather than relying on reassurances or closing down discussion. As the sustainability of deficit spending comes into question and strains on the economy take their toll, the desire to know the government’s direction only increases.
For the government of Papua New Guinea, credibility has become the most important commodity of all.
