Papua New Guinea

Country Report

Papua New Guinea

Papua New Guinea at a glance: 2002-03

OVERVIEW Papua New Guinea (PNG) will benefit from a sustained period of relative political stability, as the prime minister, Sir Michael Somare, is ensured a full five-year term, barring extraordinary circumstances. However, there is little prospect of his government being any more capable than its predecessors in overcoming PNG’s immense social and economic problems. The government’s finances are in disarray and it is in dire need of international financial support. Sir Michael will therefore be under pressure to implement domestically unpopular economic reforms. The economy will remain depressed in 2003, but the construction of a gas pipeline will provide a fillip to the economy from 2004, assuming that there are no further delays.

Key changes from last month Political outlook • The security situation in the Southern Highlands has calmed recently, but the prospect of fresh elections, and the likely re-occurrence of violence that marred the first polling attempt in June, looms large. Repeat elections in the region—where polling results for six constituencies were declared void owing to blatant voter intimidation, violence and destruction of ballot papers—are now expected to take place in April 2003. Economic policy outlook • The finance and treasury minister, Bart Philemon, has indicated that the 2003 budget, which will be announced in late November, will aim for a deficit of only 1% of GDP. In the current economic climate this appears unfeasible. Economic forecast • The depreciation of the exchange rate has increased—the kina plummeted to record lows of Kina4.35:US$1 in early November. The Bank of Papua New Guinea (the central bank) has raised its benchmark interest rate, in an effort to stem the depreciation of the kina and the consequent imported inflationary pressures, but this will only have a limited impact.

November 2002

The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 15 Regent St The Economist Building 60/F, Central Plaza London 111 West 57th Street 18 Harbour Road SW1Y 4LR New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: Error! Not a valid link. Tel: Error! Not a valid link. Tel: Error! Not a valid link. Fax: Error! Not a valid link. Fax: Error! Not a valid link. Fax: Error! Not a valid link. E-mail: Error! Not a valid E-mail: Error! Not a valid E-mail: Error! Not a valid link. link. link.

Website: Error! Not a valid link.

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2002 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN 1478-1719

Symbols for tables “n/a” means not available; “–” means not applicable

Error! Not a valid link. Papua New Guinea 3

Outlook for 2003-04 Political outlook

Domestic politics Papua New Guinea (PNG) will benefit from a sustained period of relative political stability, as the prime minister, Sir Michael Somare, is ensured of a full five-year term, barring extraordinary circumstances. Sir Michael is the first prime minister to serve under a new political integrity law, which prevents the MPs who supported him (88 out of 103) from voting against him in no-confidence motions. The government’s unwieldy coalition (of 13 political parties and a number of independent MPs) will, however, limit its political effectiveness. There is, therefore, little prospect of Sir Michael’s administration being any more capable than its predecessors in overcoming the country’s immense social and economic problems. In a positive start to his current tenure (his third in 25 years), Sir Michael used his new-found security of office to choose a cabinet based more on merit than cronyism or compliance to his wishes. The senior cabinet members, such as the new finance minister, Bart Philemon, and the minister for welfare and social development, Lady Carol Kidu, are well-respected and have proven capabilities. A total of 19 cabinet members are first-time MPs, a positive change from previous administrations full of old hands tainted by corruption and nepotism. There are, however, some areas of concern. Sir Michael will have direct control over the privatisation programme after given himself the privatisation portfolio. He has in the past been a vocal opponent of privatisation, and the future of the programme is unclear. Sir Michael has also handed a former prime minister, Sir Rabbie Namaliu, the post of foreign minister. Sir Rabbie has been a critic of what he calls Australia’s “big brother approach” to dealing with PNG, and he will be a strong supporter of Sir Michael’s nationalistic policies. The security situation in the Southern Highlands has calmed recently, but the prospect of fresh elections, and the likely re-occurrence of the violence that marred the first polling attempt in June looms large. Fresh elections in the region—where polling results for six constituencies were declared void owing to blatant voter intimidation, violence and destruction of ballot papers—are now expected to take place in April 2003. Sir Michael had initially planned for the elections to go ahead before February, but representatives from the region raised concerns about rushing the process to bring voters back to the polls. The Election Commission is also struggling to raise the Kina4.2m (US$1m) needed to fund the process. Progress has been made in attempting to stabilise the region and restore provincial services that were damaged during polling, but the situation will remain volatile until people in the region are fully represented in parliament. (The new parliament commenced on August 5th with only 103 of the 109 seats filled.)

International relations Sir Michael is expected to struggle to build up as strong a reputation in the international arena as his predecessor, Sir Mekere Morauta. However, given the current state of the government’s finances, it is vital that Sir Michael maintains strong relations with the country’s donors, particularly Australia. The government has agreed to continue to participate in Australia’s ill-defined and

Country Report November 2002 www.eiu.com © The Economist Intelligence Unit Limited 2002 4 Papua New Guinea

controversial “Pacific solution” to its problem of asylum seekers, despite its initial opposition to participating further in the programme. China and Taiwan are both important sources of aid and investment, and the new administration will find it difficult to appease both sides, while remaining committed to its “One China” policy. The government upset China in October when three cabinet members attended Taiwan’s national day celebrations in the capital, Port Moresby, even though the Chinese government had requested the non-attendance of PNG officials.

Economic policy outlook

Policy trends Sir Michael’s administration is under increasing pressure to devise a range of policies that will adequately address the country’s economic malaise. Attempts by the previous administration (under Sir Mekere Morauta) to implement reforms and stabilise the economy under the guidance and support of the World Bank and the IMF had limited success, partly because of the strong domestic opposition to such reforms. Sir Michael will, however, have little choice but to proceed along this line and compromise on his initial proposals to steer a course away from the reform agenda followed by Sir Mekere. Support from international donors will be a vital component of any recovery strategy, and financial assistance, particularly from the multilateral donors, will be linked to the progress of reforms. Sir Michael’s main policy agenda will centre on an ambitious five-year “recovery and development” plan, which incorporates an export-driven strategy for the agricultural, fisheries and forestry sectors.

Fiscal policy The finance and treasury minister, Bart Philemon, has indicated that the 2003 budget, which will be announced in late November, will aim for a deficit of only 1% of GDP. In the current economic climate this appears unfeasible. The full-year budget deficit in 2002 will be around 3.7% of GDP (higher than the deficit of around 3.4% projected in the supplementary budget in August), and financing this deficit will impose greater pressure on the government’s finances in 2003. Furthermore, the government is likely to struggle to keep to its spending targets if, as expected, economic and social conditions deteriorate further. Tax revenue will also contract further in line with the current downturn in economic activity, particularly in the mining sector. On a positive note, the government has now managed to avoid a possible fiscal crisis owing to a legal challenge to its taxation policy. In late September the Supreme Court had ruled that the value-added tax (VAT) system was illegal, thereby throwing the government’s budget preparations into turmoil. However, the court granted a stay of the ruling and the government agreed on a compromise with the complainant, the Morobe governor, Luther Wenge. The VAT system will be replaced in 2004 with a new goods and services tax, with provincial governments receiving 80% of the proceeds, up from the 30% they receive from the current VAT.

Monetary policy In a surprising move in early November, the Bank of Papua New Guinea (BPNG, the central bank) raised its benchmark kina facility rate (KFR) to 14% from 12.5%. With the economy in its current depressed state and consumer confidence and spending low, the decision has led to consternation in PNG’s business community. The central bank opted to increase interest rates in an attempt to

Country Report November 2002 www.eiu.com © The Economist Intelligence Unit Limited 2002 Papua New Guinea 5

strengthen the kina and curtail the consequent upward pressure on domestic prices. However, the correlation between interest rate movements and the exchange rate in PNG is far from exact. Furthermore, there is a concern that the rate rise will hurt business and consumer confidence, which will put further downward pressure on the kina—the reverse of what was intended. Lending to the private sector has declined and is not expected to pick up while the economy remains in its depressed state. Commercial banks are likely to widen their interest rate spreads further to improve profitability.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2001 2002 2003 2004 Real GDP growth World 2.0 2.7 3.6 4.0 OECD 0.7 1.6 2.2 2.7 EU 1.5 0.9 1.7 2.2 Exchange rates ¥:US$ 121.5 125.8 128.8 130.5 US$:€ 0.896 0.948 1.070 1.053 SDR:US$ 0.785 0.772 0.737 0.745 Financial indicators ¥ 2-month private bill rate 0.17 0.10 0.10 0.35 US$ 3-month commercial paper rate 3.61 1.70 1.38 3.88 Commodity prices Oil (Brent; US$/b) 24.5 25.3 24.7 19.7 Gold (US$/troy oz) 271.1 307.0 315.0 320.0 Food, feedstuffs & beverages (% change in US$ terms) -1.9 14.6 13.6 0.4 Industrial raw materials (% change in US$ terms) -9.8 0.2 6.1 9.7 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. The global economic recovery has started to lose steam, and we have revised down the estimates of growth in both the US and Japan in 2003. The US economy is forecast to grow by 2.6% and 3.3% in 2003 and 2004 respectively. GDP growth in Japan is estimated to contract by 1% this year, and will grow by only 1% in 2003 and 1.3% in 2004. In Australia, which is PNG’s largest trading partner, economic growth has also been revised down, to 3.7% in 2002 and 3.4% in 2003, owing to the sluggish global economic recovery. In line with the ever-increasing risk of a US-led attack on Iraq, world oil prices (dated Brent Blend) are estimated to have risen by 3.2% in 2002 to US$25.3/barrel, but are forecast to fall to US$24.7/b in 2003 and US$19.7/b in 2004. Prices for most of PNG’s other export commodities, particularly gold, have strengthened this year (gold prices have jumped by over 13%). In 2003-04 prices for copper, rubber and palm oil will rise, but coffee prices will remain at historical lows.

Economic growth PNG’s economy has suffered another year of contraction; real GDP is estimated to have declined by 3.3% in 2002, after an estimated 2.6% contraction in 2001. Lower production and export volumes of all major agricultural and mining commodities in the first half of the year severely restrained domestic demand,

thus limiting growth in the manufacturing and services sectors. Agricultural and mining activity since then has been curtailed by election-related disruptions, and deteriorating infrastructure. A period of drought related to the El Niño weather pattern also created further problems in these sectors in the second half of the year. Assuming that plans for the long-awaited US$3.5bn PNG-Queensland gas pipeline project move forward in early 2003, a small degree of confidence in the economy will return. However, the deteriorating law and order situation and the country’s overwhelming infrastructure deficiencies will ensure that the economy remains depressed. Construction and investment inflows for the gas pipeline will provide a fillip to the economy in 2004, but further delays in the project cannot be ruled out. If it fails to proceed, PNG’s economy will remain in the doldrums for the next few years at least.

Inflation Annual average consumer price inflation in PNG is expected to have risen to around 9.9% in 2002, from 9.3% in 2001. Inflationary pressures have been building up in the economy in line with rising food prices and the depreciating exchange rate; inflation reached 9.4% year on year in the second quarter of 2002 (latest available data) with food prices rising by over 17%. The weakening trend in the exchange rate and expected supply disruptions will ensure that inflationary pressures remain strong in 2003-04. The central bank has raised its benchmark interest rate in an effort to stem the depreciation of the kina and consequent imported inflationary pressures, but this will only have a limited impact.

Exchange rates The rate of depreciation of the exchange rate has picked up, and the kina plummeted to record lows of Kina4.35:US$1 in early November. The central bank governor, Wilson Kamit, has ruled out imposing exchange-rate controls, but has raised interest rates and will continue to intervene in the currency market in an attempt to maintain a relatively stable exchange rate. However, the bank’s ability to stabilise the exchange rate is limited and will decline as it runs down its scarce reserves of foreign exchange. The deterioration in the current account and the general lack of confidence in the economy will ensure that the downward trend persists. The kina is therefore forecast to drop to an average of Kina4.66:US$1 in 2003 and Kina4.90:US$1 in 2004. Against the Australian dollar, the kina will fall to Kina2.79:A$1 and Kina2.97:A$1 in 2003 and 2004 respectively.

External sector The improvement in prices for most of PNG’s export commodities has not been sufficient to offset the downturn in overall export volumes in 2002. Shrinking export revenue from crude oil, in particular, has resulted in an estimated contraction of 2.3% in total exports (in US dollar terms). Although oil revenue will continue to decline, overall export revenue is forecast to grow by over 2% annually in 2003-04, as prices for most commodities strengthen. Import demand in the non-mineral sector has risen steadily in 2002. Assuming that construction of the gas pipeline gets under way in late 2003, associated imports of capital goods and services will expand, particularly in 2004. Services debits will also rise in line with the increase in imports. The current-account deficit will therefore expand from US$109m (4.3% of GDP) in 2003 to US$214m (8.1% of GDP) in 2004. The relatively large deficit in 2004 will be covered by capital inflows, namely commercial borrowings by PNG-based mining companies and foreign direct investment to finance the development of the projects.

Forecast summary (% unless otherwise indicated) 2001a 2002a 2003b 2004b Real GDP growth -2.6 -3.3 -0.5 1.7 Gross agricultural production growth 0.9 -4.2 0.3 1.7 Consumer price inflation (av) 9.3c 9.9c 9.2 9.0 Consumer price inflation (year-end) 10.4c 9.5c 8.7 9.2 Short-term interbank rate 16.2c 14.2c 13.0 11.5 Government balance (% of GDP) -3.5 -3.8 -2.8 -2.7 Exports of goods fob (US$ bn) 1.8 1.8 1.8 1.9 Imports of goods fob (US$ bn) 0.9 1.1 1.2 1.3 Current-account balance (US$ bn) 0.3 -0.1 -0.1 -0.2 Current-account balance (% of GDP) 9.2 -2.3 -4.3 -8.1 External debt (year-end; US$ bn) 2.5 2.7 2.9 3.4 Exchange rate Kina:US$ (av) 3.39c 3.93c 4.66 4.90 Exchange rate Kina:¥100 (av) 2.788 3.125 3.616 3.755 Exchange rate Kina:€ (year-end) 3.32 4.68 5.13 5.17 Exchange rate Kina:SDR (year-end) 4.73 6.09 6.51 6.63 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

Editors: Danny Richards (editor); Graham Richardson (consulting editor) Editorial closing date: November 11th 2002 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule