New light on Papua New Guinea’s fiscal frailty

Over recent months, a few morsels of information have come to light suggesting that the financial situation is tightening around the government of Papua New Guinea. Now with the benefit of the Treasury’s mid-year report we have a much clearer picture.

As expected, it’s not a pretty one.

What we see is a government struggling to play by its own fiscal rules or to deliver on its own budget plans. It’s not obvious how long the country can safely continue down this path.

Missed targets high and low

The report confirms that low commodity prices have caused revenues to undershoot expectations. Dwindling mining and petroleum tax revenues are the main cause. By the end of the year, Treasury expects to receive close to PGK 400 million less than it had forecast in the budget.

With spending reportedly proceeding as planned, they now believe the government will be left with a deficit just under PGK 400 million larger than planned –and roughly PGK 50 million more than last year.

The upshot of these revisions is that targets for the debt to GDP ratio, as set out in the Fiscal Responsibility Act, will be broken for a second year running. At the end of 2013, the legal debt limit was 30% of GDP; by the end of this year, parliament will be asked to revise the target up to 40%. The government is struggling to stick to its rules. Clearly, they realise that the Fiscal Responsibility Act is only as strong as the will to defend it. In practice, amendments like this go through with little discussion or pushback.

Rules such as these are enshrined in law to avoid the risks associated with over-borrowing. In this latest report, the Treasury admits that ‘interest rate and refinancing risks’ are building. This road can lead to a place where the government is unable to pay its bills, where it’s forced to default on its debt or even to suffer externally imposed austerity.

PNG might not get to this point, but the longer it takes to correct the deficit, the more painful it will be. Previous plans for 2015 suggested the need to hold spending increases at less than the rate of inflation – that is, a ‘real’ cut in spending. To put the country back on the track set last year, nominal cuts would now be required. This is likely to be distasteful to cabinet.

Missing from the report is a discussion of LNG revenues. No insight is given into the AUD 1.2 billion UBS loan agreement used to purchase the government’s shareholding in Oil Search.

Treasury does offer a hint: ‘the challenge for the government going forward… is the possibility of the initial LNG exports having minimal impact on Government Budgets in 2014 to 2023 if LNG dividends are diverted away from the budget’. From this, one might read that the Treasury is also concerned that unclear processes and closed-door dealings have overridden sensible management of LNG revenues.

Looking ahead

A mid-year report is based on forecasts for the end of the year. A lot can happen in 6 months. But even after these latest revisions, the government is still banking on quite rapid increases in revenue that will in all likelihood prove just as unrealistic as the ones that in the 2014 budget.

The report offers a much more comprehensive summary of the compliance efforts of the government and suggest they have already raised an extra PGK 200 million. This figure is highly uncertain, but if true, is very impressive. Nonetheless, it is unclear whether they will reach the budget target of PGK 600 million by the end of the year.

The report further notes continued uncertainty around revenues from State Own Enterprise dividends (PGK 287 million) and assets sales (PGK 600 million). A lot hinges on not much – in their absence, the budget deficit would be fully a third larger than the deficit in 2013.

It increasingly clear that had the government used its revenue forecasts presented in September’s 2014 Budget Strategy Paper it would be much better placed. However, this is less a forecasting problem than a reflection of the divergence in outcomes of the technocrat-driven Budget Strategy Paper process and the politically driven budget. This is by no means a challenge unique to Papua New Guinea.

Questions will (or should) be asked about the faith placed in some of the more uncertain revenue sources that were not discussed only three month’s before in the Budget Strategy Paper. This was either a mistake in the budget’s formulation, or these revenue sources were merely stuffing, used to lend legitimacy to the high spending levels. Papua New Guinea would not be the first to pull revenues out of the ether to maintain respectability, nor will it be the last.

Revenue worries notwithstanding, there are still plenty of risks on the spending side that may yet emerge before year end. The report points to some challenges:

Risks have emerged from political commitments and National Executive Council decisions which were made outside of the 2014 Budget process and from overspends for projects agreed in the 2014 Budget which did not have robust business plans and costing at the time of the 2014 Budget.

This suggests that we would be foolish to take the government’s new spending projections as given. In an unstable political environment, keeping a lid on spending pressures is no mean feat.

Overall it is now clear that the government overstretched itself in its last budget. Central bank financing of the deficit continues to provide the government life support- hopefully not at the expense of the Bank of Papua New Guinea’s own objectives of financial stability and low inflation. Unfortunately, those who hope to see LNG revenues come charging in at the eleventh hour are likely to be disappointed.

Inap long tumbuna stori nau

Back in 2012, with the construction phase of the PNG LNG project nearing completion, economic activity tailing off, and pots of gold still far off on the horizon, the government stepped on the accelerator and rapidly expanded spending. Admittedly, there was a certain logic to this: it provided needed economic stimulus, and fed efforts to drive change in Papua New Guinea’s ailing public services.

Yet here we find a lesson for future advocates of fiscal stimulus: if a government presses the accelerator, it better make sure the brakes are functioning. In Papua New Guinea, we have seen time and time again that, although necessary, unwinding such a stimulus is politically nearly impossible.

The government knows that it has to reel in the budget deficit before financing challenges become too large to manage. It is for this reason that September’s 2015 Budget Strategy Paper will tell the same story as last year and plan a clear-headed effort at reducing the budget deficit.

PNG’s new Minister for Treasury, Patrick Pruaitch, has demonstrated his ability to identify and deal with similar challenges. However, he will be weighing his actions against a desire to maintain National Alliance’s standing within the coalition government. This will partly be a balancing act, partly a test of resolve.

The first test will come in the careful formation of the next budget and second in sticking to it. Six months into 2014, the government appears to have fallen short in both.