Papua New Guinea

Country Report July 2003

Papua New Guinea

Papua New Guinea at a glance: 2003-04

OVERVIEW Papua New Guinea (PNG) will benefit from a sustained period of relative political stability, as the prime minister, Sir Michael Somare, is assured of a full five-year term, barring extraordinary circumstances. However, there is little prospect that his government will prove any more capable than its predecessors of 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 there will be some positive developments in agriculture and mining that will contribute to economic growth in 2004.

Key changes from last month Political outlook • Sir Michael maintains that his leadership is not under threat and that he will lead the governing coalition until the next general election in 2007. However, he plans to make controversial amendments to the constitution to protect further his tenure of office. Economic policy outlook • The government is struggling with a shortage of funds and has resorted to borrowing from domestic sources, which has pushed up Treasury bill rates to more than 20%, compared with around 10% in early 2002. However, a mini-budget is unlikely to be introduced. Economic forecast • According to preliminary data from the central bank, consumer prices increased by more than 20.7% year on year in the first quarter of 2003. The central bank has raised its benchmark interest rate in an effort to ease inflationary pressures. Year-on-year inflation is therefore forecast to rise to an average of 18.4% in 2003, before easing slightly to around 14.6% in 2004.

July 2003

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.

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Contents

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2003-04 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

16 Economic policy

20 The domestic economy 20 Economic trends 21 Oil and gas 23 Mining 24 Agriculture, fisheries and forestry 26 Infrastructure 26 Financial and other services

27 Foreign trade and payments

List of tables

9 International assumptions summary 11 Forecast summary 17 Central government finances 20 Money supply 21 Quarterly inflation 24 Mineral exports by volume 26 Agricultural exports by volume 27 Exports 28 World commodity price forecasts 28 Balance of payments 29 Exchange rates 30 Public debt outstanding

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List of figures

12 Gross domestic product 12 Consumer price inflation 20 Interest rates 24 Mineral exports 29 Exchange rate 29 Foreign-exchange reserves 30 Public debt outstanding

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Summary July 2003

Outlook for 2003-04 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. 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 there will be some positive developments in agriculture and mining that will contribute to economic growth in 2004.

The political scene Sir Michael has moved to prevent a no-confidence vote. His predecessor, Sir Mekere Morauta, has questioned his motives. Constitutional amendments have been proposed to prepare for the 2007 election. Parliament is suffering a cash crisis and has yet to reach its full complement of sitting ministers. Some efforts have been made to counter corruption. The second draft of the Bougainville constitution has been circulated for comment, and Bougainville peacekeepers have been replaced by a civilian transition team. Delegations from Indonesia and Australia have helped to strengthen ties with PNG.

Economic policy The government is suffering from a cash-flow crisis, despite recording a rare budget surplus in the first quarter of 2003. A mini-budget is unlikely to be introduced. The government’s revised mining policy has reaped some rewards, and similar wide-ranging measures may be offered in the agricultural sector. Changes in fisheries policy, however, may put future investment at risk. The government’s revised privatisation policy has been publicly outlined, but the poor state of state assets has hindered sell-off plans. The Bank of Papua New Guinea (the central bank) has tightened its monetary policy stance by raising the kina facility rate to 16%.

The domestic economy Real GDP remains weak, and consumer price inflation has accelerated. However, private-sector employment has grown. Oil exports have picked up strongly. The future of the PNG-Queensland gas pipeline project has brightened. Mining policy changes have boosted activity, and gold and copper exports have risen. Ramu Sugar has begun a large palm oil development. Tuna fisheries have driven growth in the fisheries sector. Log exports have increased rapidly.

Foreign trade and payments The value of exports (in kina terms) expanded by 44% year on year on the first quarter, supported by rising prices. The current account has recorded a robust surplus, but the level of international reserves has declined. The kina has strengthened against the US dollar, but not against the Australian dollar. External debt has fallen. Editors: Danny Richards (editor); Graham Richardson (consulting editor) Editorial closing date: July 14th 2003 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Political structure

Official name Independent State of Papua New Guinea

Form of state Constitutional monarchy

Head of state Queen Elizabeth II, represented by the governor-general, who is nominated by the national parliament (currently Sir Silas Atopare)

The executive The National Executive Council, presided over by the prime minister, has executive powers; the prime minister is proposed by parliament and appointed by the head of state

National legislature Unicameral national parliament of 109 members elected for a period of five years (currently comprises 103 members, with elections having been declared void in six seats); of the total, 89 members represent “open” constituencies, and the remainder represent 19 provincial constituencies and the capital district

Provincial government Each of the 19 provinces has its own government, which may levy taxes to supplement grants received from the national government

Legal system A series of regional and magistrates’ courts leading to a Supreme Court at the apex

National elections June-July 2002

National government Sir Michael Somare, the leader of the National Alliance (NA), was elected prime minister by parliament in August 2002.

Main political organisations National Alliance (NA); People’s Democratic Movement (PDM); People’s National Alliance (PNA); United Resources Party (URP); People’s Progress Party (PPP); Pangu Pati (PP); Advance PNG Party (APP); People’s National Congress (PNC)

Main members of the National Prime minister & minister for finance Sir Michael Somare Executive Council Deputy prime minister & minister for trade & industry Allan Marat

Key ministers Agriculture Moses Maladina Defence Ya rka Ka p pa Education Michael Laimo Environment Sasa Zibe Finance & treasury Bart Philemon Foreign affairs Rabbie Namaliu Health Melchior Pep Lands & physical planning Robert Kopaol Justice Mark Maipakai Mining Sam Akoitai Petroleum & energy Moi Avei Transport & works Alfred Pogo

Central bank governor Wilson Kamit

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Economic structure

Annual indicators 1998a 1999a 2000a 2001a 2002b GDP at market prices (Kina bn) 7.8 8.8 9.7b 10.2b 11.0 GDP (US$ bn) 3.8 3.4 3.5b 3.0b 2.8 Real GDP growth (%) -3.8 7.5 -1.2b -3.4 b -3.3 Consumer price inflation (av; %) 13.6 14.9 15.6 9.3 11.7a Population (m) 4.6 4.7 4.8 4.9b 5.1 Exports of goods fob (US$ m) 1,773.3 1,927.4 2,094.1 1,812.9 1,660.2 Imports of goods fob (US$ m) 1,078.3 1,071.4 998.8 932.4 998.5 Current-account balance (US$ m) -28.8 94.7 345.3 282.0 -53.1 Foreign-exchange reserves excl gold (US$ m) 192.9 205.1 286.9 422.6 321.5a Total external debt (US$ bn) 2.7 2.7 2.6 2.5 2.7 Debt-service ratio, paid (%) 14.8 9.7 12.9 12.7 17.2 Exchange rate (av) Kina:US$ 2.07 2.57 2.78 3.39 3.90a a Actual. b Economist Intelligence Unit estimates.

Main origins of gross domestic product 2001 % of total Components of gross domestic product 2001 % of total Agriculture 32.2 Private consumption 74.4 Industry 38.2 Government consumption 18.7 Mining 26.0 Investment 13.1 Services 29.6 Exports of goods & services 49.5 Imports of goods & services -55.7

Principal exports fob 2002 US$ m Principal imports cif 1994 US$ m Gold 578 Machinery & transport equipment 552 Crude oil 367 Manufactured goods 313 Copper 211 Food & live animals 216 Palm oil 101 Chemicals 92

Main destinations of exports 2001 % of total Main origins of imports 2001 % of total Australia 23.9 Australia 50.4 Japan 10.6 Singapore 18.7 China 7.6 Japan 4.6 Germany 3.9 New Zealand 3.9 South Korea 2.9 Indonesia 3.2 Thailand 2.4 Malaysia 3.0

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Quarterly indicators 2001 2002 2003 2 Qtr 3 Qtr 4Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Prices Consumer prices (1995=100) 188.7 196.0 198.3 201.7 206.5 220.0 227.6 243.5 Consumer prices (% change, year on year) 7.8 10.1 10.4 10.5 9.4 12.3 14.8 20.7 Financial indicators Exchange rate Kina:US$ (av) 3.15 3.44 3.71 3.69 3.75 3.99 4.14 3.79 Exchange rate Kina:US$ (end-period) 3.33 3.57 3.76 3.75 3.98 4.02 4.02 3.66 M1 (end-period; Kina m) 1,262 1,286 1,417 1,532 1,619 1,571 1,645 n/a M1 (% change, year on year) 0.8 2.1 3.2 21.8 28.3 22.2 16.1 n/a M2 (end-period; Kina m) 3,108 3,092 3,183 3,221 3,295 3,220 3,306 n/a M2 (% change, year on year) 4.0 2.1 1.6 4.4 6.0 4.1 3.9 n/a Sectoral trends, exports Copra ('000 tonnes) 10.8 8.2 19.8 5.6 4.7 4.8 0.7 1.4 Copra oil ('000 tonnes) 9.9 4.7 4.4 6.1 4.0 6.5 11.6 9.3 Cocoa ('000 tonnes) 10.0 9.4 6.9 5.8 9.7 8.9 10.5 8.0 Coffee ('000 tonnes) 15.3 16.5 8.5 6.7 12.7 25.9 17.8 7.9 Logs ('000 cu metres) 347 248 279 381 423 409 621 543 Gold (tonnes) 18.8 17.8 14.0 15.5 15.6 11.9 16.1 16.7 Fish ('000 tonnes) 1.1 1.0 2.8 9.0 2.5 1.4 2.7 0.9 Oil, crude ('000 barrels) 4,069 6,190 4,582 3,916 4,215 3,607 3,632 3,745 Foreign trade & reserves Exports fob (Kina m)a 1,491 1,659 1,342 1,359 1,677 1,571 1,780 1,954 Gold 524 563 496 480 584 494 737 665 Oil, crude 359 562 359 278 379 371 404 473 Imports fob (Kina m)a -657 -822 -880 -843 -907 -1,009 -979 -480 Trade balance (Kina m) 834 837 462 516 770 562 801 1,474 Balance of payments (US$ m) Merchandise trade balance fob-fob 264.4 243.5 124.5 n/a n/a n/a n/a n/a Services balance -99.6 -89.7 -85.8 n/a n/a n/a n/a n/a Income balance -84.9 -65.2 -38.9 n/a n/a n/a n/a n/a Net transfer payments 6.9 1.5 6.8 n/a n/a n/a n/a n/a Current-account balance 86.6 89.9 6.5 n/a n/a n/a n/a n/a Reserves excl gold (end-period) 317.7 367.8 422.7 400.7 439.7 362.0 321.5 313.7 a Balance-of-payments basis. Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; IMF, International Financial Statistics.

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Outlook for 2003-04

Political outlook

Domestic politics The prime minister, Sir Michael Somare, maintains that his leadership is not under threat and that he will lead the governing coalition until the next general election in 2007. However, he has shown his intent to make controversial amendments to the constitution to reduce the appeal and effectiveness of no- confidence motions, in an effort to protect further his tenure of office. (Political integrity laws, enacted in 2001, already provide him with a near-guarantee that he will not be ousted by a no-confidence motion.) The recently proposed constitutional amendments centred on the stipulation that a successful no- confidence motion would automatically trigger the dissolution of parliament and immediate fresh elections. As general elections in Papua New Guinea (PNG) are characterised by a high turnover of members of parliament (MPs), there would certainly be less enthusiasm among sitting MPs for any no- confidence motion that might cut short their parliamentary terms. After consulting coalition partners in early July Sir Michael shifted the focus of the proposed constitutional amendments away from the automatic triggering of fresh elections, and towards extending the grace period following the formation of a new government during which a no-confidence debate is not permitted; the proposal is to extend the period to 36 months from the present 18. The forthcoming vote on these constitutional amendments will test the general level of support for Sir Michael’s leadership, which appears to have weakened recently. Sir Michael’s party, National Alliance (NA), has lost ground in parliament to the opposition, led by the People’s Democratic Party (PDM), and some of its coalition members. (The NA failed to gain any seats at the supplementary election in Southern Highlands, and has lost parliamentary representation because of successful appeals against individual constituency elections.) Given the financial burden imposed by elections, and their potential for causing further social and economic instability, it appears that the proposal that a successful no-confidence motion would automatically result in a fresh election was not well thought out. This is even more the case given the disruption that marred the 2002 election and the subsequent need for a supplementary election in Southern Highlands. The supplementary election has only recently been completed, fortunately without a repeat of the violence and voter intimidation encountered during the original, invalid vote. One of the main short-term threats to political stability has thus passed, and a degree of confidence in the central and local authorities has been restored. However, there remain other outstanding issues relating to the July 2002 general election: for example, the court of disputed returns has declared that the vote for the seat of Moresby North-East was invalid and has ordered a by-election. Aside from such political tests, Sir Michael’s administration will have to overcome a number of economic and social challenges in the next few years. There is little evidence to suggest that it will prove itself any more capable than its predecessors in dealing with such problems. However, the parliamentary

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opposition is weak and unable to provide an effective check on government policy or present itself as a capable alternative to the current administration.

International relations Sir Michael will endeavour to maintain strong relations with Australia, PNG’s largest bilateral donor, in an effort to secure much-needed financial support. Despite recent debate in Australia on the government’s aid policy towards PNG, the amount of aid committed to PNG in the Australian government’s fiscal year 2003/04 (July-June) budget is similar to that of recent years. Relations with PNG’s other close neighbour, Indonesia, will be tested if the Indonesian government decides to embark on a sustained campaign to crack down on the separatist movement in Papua (formerly Irian Jaya), which borders PNG. Tension along the border is high following a spate of attacks towards the end of 2002, allegedly launched by members of a separatist group, Papua Freedom Fighters (OPM), from the PNG side of the border. The government has so far shown its willingness to co-operate with Indonesia in attempting to secure the joint border area, and both sides have agreed to co-operate in security operations to rid the area of OPM operatives and their training camps.

Economic policy outlook

Policy trends The government is experiencing mixed fortunes in implementing its export-led recovery strategy. However, the enhanced fiscal regime for mining and oil contained in the 2003 budget is starting to pay off, and grassroots mineral exploration is picking up from negligible levels after a decade of decline. The government hopes to repeat this success with similar incentives for agriculture. However, in fisheries a collision between nationalistic aspirations and the need for massive investment could retard the export-led recovery. In order to secure much-needed financial assistance, particularly from the multilateral lending institutions, Sir Michael will have to demonstrate a much stronger commitment to economic reform, in addition to raising counterpart funding. Although stating that the government will continue to pursue the sale of selected state-owned enterprises (SOEs), in early July Sir Michael indicated that some of the largest SOEs!the national telecommunications firm, Telikom, the national airline, Air Niugini, and the PNG Harbours Board!would remain in state hands, as he was confident that they would earn vital funds for the state coffers.

Fiscal policy The government is struggling with a shortage of funds, and it has reportedly had to delay payments. The cash-flow crisis is a result of the lack of progress in the sale of non-core state assets (budgeted to bring in Kina200m, or US$52m) in addition to the delay in the disbursement of around Kina140m in funding from the Asian Development Bank (ADB). The ADB decided to withhold the funds because of concerns over the government’s interference in the management of the National Fisheries Authority. The government has therefore resorted to borrowing from domestic sources, which has pushed up Treasury bill rates to more than 20%, compared with around 10% in early 2002. In an effort to rein in the deficit inherited from the previous administration, Sir Michael proposed a range of expenditure-cutting measures in the 2003 budget, including the abolition of education subsidies, cuts in recurrent and development budgets,

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and a freeze on wages and public-sector recruitment. However, the government will find it difficult to keep to its spending targets if, as expected, economic and social conditions deteriorate further. Tax revenue will be disappointing, as the government had based its budget of the optimistic assumption that the economy would grow by 1.8% in 2003. The government’s 2003 budget deficit target of Kina274m (equivalent to 2.3% of GDP according to government estimates) will therefore prove difficult to achieve. The Economist Intelligence Unit forecasts a budget deficit of around 3.2% of GDP in 2003 and 3% in 2004.

Monetary policy The Bank of Papua New Guinea (BPNG, the central bank) has formally advised the government of the need for co-ordinated fiscal and monetary policies in managing the risks facing the economy. For its part, the BPNG will maintain a tight monetary policy stance owing to its concerns about the build-up of inflationary pressures in the economy. The BPNG increased the kina facility rate (KFR)!which was introduced in February 2001 as an official rate to indicate the BPNG’s monetary policy stance!by 100 basis points, to 16%. This was the fourth increase since November 2002, when the BPNG increased the KFR from 12.5% to 14%. The problems facing private businesses will thus be further compounded in 2003 as the commercial banks’ minimum indicator lending rate rises in line with the KFR.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2001 2002 2003 2004 Real GDP growth World 2.1 2.9 3.0 3.7 OECD 0.9 1.8 1.6 2.2 EU 1.5 1.0 0.8 1.8 Exchange rates ¥:US$ 121.5 125.3 116.2 115.5 US$:€ 0.896 0.945 1.150 1.183 SDR:US$ 0.785 0.772 0.710 0.702 Financial indicators ¥ 2-month private bill rate 0.17 0.10 0.10 0.10 US$ 3-month commercial paper rate 3.61 1.70 1.04 1.75 Commodity prices Oil (Brent; US$/b) 24.5 25.0 25.5 18.3 Gold (US$/troy oz) 271.1 310.3 335.0 315.0 Food, feedstuffs & beverages (% change in US$ terms) -1.9 12.7 2.1 1.8 Industrial raw materials (% change in US$ terms) -9.7 2.2 10.2 3.5 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. The global economy has weakened dramatically for the second time in just two years. In the opening half of 2003 growth in the OECD countries almost ground to a halt, with some of the largest economies experiencing a contraction. We expect the world economy to remain sluggish until late 2003. The situation will then start to improve, but only gradually. The US economy is forecast to expand by only 2.2% in 2003, before accelerating to 3.1% in 2004. In

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Australia, which is PNG’s largest trading partner, economic growth will fall to 3% in 2003 before picking up to 3.4% in 2004. The outbreak of Severe Acute Respiratory Syndrome (SARS) in Asia has had a damaging effect on many economies in the region. However, by early July the outbreak was on the wane. Owing to the slower than anticipated resumption of Iraqi oil production and the low level of US oil stocks, world oil prices will rise by an annual average of 2.3% to US$25.54/barrel in 2003, before falling to US$18.31/b in 2004. Prices for most of PNG’s other export commodities will remain firm in 2003, but in 2004 prices for key exports, such as gold and coffee, will decline.

Economic growth Real GDP is forecast to contract again slightly in 2003, after suffering a third consecutive year of contraction in 2002. Despite recently admitting that the economy would not escape recession this year, the finance minister, Bart Philemon, has since offered a more upbeat assessment of the prospects for growth this year on the basis of a recent pick-up in agricultural productivity and the positive effect that the revised mining tax policy is having on the sector. However, the full impact of such measures will not be felt strongly in 2003. Furthermore, domestic demand remains weak, constraining growth in the manufacturing and services sectors, and overwhelming deficiencies in infrastructure continue to hamper the delivery of agricultural commodities. We therefore forecast a slight contraction of real GDP in 2003. The economy is forecast to return to growth in 2004, albeit of only 0.9% year on year, owing to some positive developments. The Moran oilfield, which will come into full production this year, will provide some temporary relief from effects of the natural decline in oil production at the Kutubu and Gobe oilfields. The Kainantu gold mine will also provide a boost to the mining sector when it comes on stream in 2004. The future development of the long-awaited US$3.5bn PNG-Queensland gas pipeline project (now known as the Highlands Gas Project) looks more promising after the recent signing of a major customer (see The domestic economy: Oil and gas). However, even if the project goes ahead soon, aside from boosting investor confidence the project will have little impact on the economy in 2003-04.

Inflation According to preliminary central bank data, consumer prices increased by more than 20.7% year on year in the first quarter of 2003. This represents a rapid acceleration from year-on-year average consumer price inflation of 9.3% in 2001 and 11.7% in 2002. Inflationary pressures have built up in line with rising food and fuel prices and the depreciating exchange rate against the Australian dollar, in which more than 50% of PNG’s imports are denominated. The BPNG has raised its benchmark interest rate in an effort to ease inflationary pressures. However, the impact of this will be offset by the government’s failure to tighten adequately its fiscal operations. Year-on-year inflation is forecast to average 18.4% in 2003, before easing slightly to 14.6% in 2004.

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Exchange rates By early July the kina had appreciated by more than 13% against the US dollar since the beginning of the year. The BPNG has recently attempted to prevent a damaging spike in the currency’s value by selling kina in the foreign-exchange market!a reversal of the supporting role it played earlier in the year, when it ran down international reserves in an effort to prop up the kina. (Foreign- exchange reserves stood at US$314m at the end of March, according to the latest available data, down from US$400m at the end of March 2002.) The kina, however, remains weak against the Australian dollar. The general lack of confidence in the economy suggests that the recent upward trend in the value of the kina against the US dollar will not be prolonged, and the kina is forecast to depreciate from an annual average of Kina3.73:US$1 in 2003 to Kina4.10:US$1 in 2004. Against the strong Australian dollar, the kina will fall to Kina2.41:A$1 in 2003 and Kina2.72:A$1 in 2004.

External sector Rising prices for most of PNG’s export commodities will contribute to overall growth in export revenues of around 3.6% year on year in 2003. Gold prices are forecast to rise by 8%, copper prices by 9.4%, crude oil prices by 2.3% and coffee prices by 4.8%. But this upturn in export revenue will be short-lived, as a 28.3% drop in oil prices and 6% decline in gold prices in 2004 will offset volume gains and drive down overall revenue by around 4.4%. The merchandise trade balance, however, will not deteriorate markedly, as the import bill will remain fairly stable. General import demand will not pick up much in 2003-04 because of weak aggregate demand, and with little prospect of any development in key mining and energy projects, the demand for imported construction machinery and materials will remain low. The services and income accounts will remain in deficit, together totalling more than US$700m, thereby offsetting the positive trade balance and contributing to current-account deficits in 2003 and 2004.

Forecast summary (% unless otherwise indicated) 2001a 2002b 2003c 2004c Real GDP growth -3.4b -3.3 -0.3 0.9 Gross agricultural production growth -5.4 1.0 1.5 2.0 Consumer price inflation (av) 9.3 11.7a 18.4 14.6 Consumer price inflation (year-end) 10.4 14.8a 17.0 14.5 Short-term interbank rate 16.2 13.9a 17.4 14.0 Government balance (% of GDP) -3.5b -4.1 -3.2 -3.0 Exports of goods fob (US$ bn) 1.8 1.7 1.7 1.6 Imports of goods fob (US$ bn) 0.9 1.0 1.0 1.0 Current-account balance (US$ bn) 0.3 -0.1 -0.1 -0.1 Current-account balance (% of GDP) 9.3b -1.9 -1.5 -2.8 External debt (year-end; US$ bn) 2.5 2.7 2.8 2.8 Exchange rate Kina:US$ (av) 3.39 3.90a 3.73 4.10 Exchange rate Kina:¥100 (av) 2.788 3.107a 3.210 3.550 Exchange rate Kina:€ (year-end) 3.32 4.22a 4.60 4.93 Exchange rate Kina:SDR (year-end) 4.73 5.46a 5.51 6.01 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

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The political scene

The National Alliance loses Since forming the government in August 2002 the National Alliance (NA), led ground by the prime minister, Sir Michael Somare, has lost ground to both the opposition People’s Democratic Movement (PDM) and to some of its own government coalition members. The NA has lost parliamentary seats to electoral petitions, and failed to gain any seats in the recent supplementary elections in the Southern Highlands province. Support has also been lost in other areas. The parliamentary speaker, Bill Skate, has controversially resigned as chairman of the government coalition, and members of parliament (MPs) have complained that the treasurer, Bart Philemon, an NA regional deputy to Sir Michael, does not understand “money politics”. All of this has fuelled media speculation that pressure will be put on Sir Michael to step down in August, as he told the NA’s pre-election convention he would do 12 months after leading the party in the election. However, he is unlikely to do so. It would be anomalous for the prime minister not to be the party leader; and Sir Michael is not expected to relinquish the premiership that he won so handsomely a year ago. Two major coalition members, the People’s Progress Party (PPP) and the People’s Action Party (PAP), signed a declaration of partnership in late June to support Sir Michael and his party.

Sir Michael moves to prevent a In the current climate of intensifying speculation over the future of no-confidence vote Sir Michael’s administration, it is of little surprise that Sir Michael is pursuing further protection for the executive arm of the government from parliamentary votes of no-confidence. Sir Michael is using his mandate to amend the constitution to reduce the appeal of, and the opportunity for, no-confidence motions. After consulting his coalition partners in early July he withdrew at the last minute a proposal for changes that would have required a successful no- confidence motion automatically to trigger the dissolution of parliament and immediate fresh general elections, including local government elections. He has replaced this proposal with one that extends the grace period after the formation of a new administration during which a no-confidence motion is not permitted. The period currently stands at 18 months (having been increased from six months in 1991); Sir Michael is hoping to extend it to 36 months. He

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also proposes to change the requirement for a successful no-confidence motion from a simple majority of 37 votes to an absolute majority of 55 votes. MPs who voted for Sir Michael as prime minister following the general election in 2002 may not vote against the motion, but they may abstain by absenting themselves from the chamber when the vote is taken. Although Sir Michael will know in advance how many members will vote against the changes, the number absenting themselves will be unknown. A test of his leadership strength will therefore be his ability to ensure that few members adopt this course of action.

Sir Mekere questions The leader of the opposition, Sir Mekere Morauta (who, while prime minister in Sir Michael’s motives 2001, introduced the law on integrity of political parties and candidates that provides protection against no-confidence motions), has questioned Sir Michael’s motives. He has also pressed Sir Michael on the consultation methods he has adopted for the recently proposed constitutional amendments: Sir Michael did not consult the Constitutional Development Commission, claiming that its term had expired. A similar proposal to Sir Michael’s idea of linking any successful no-confidence motion with the automatic dissolution of parliament was mooted in the early 1990s, but was rejected as unfeasible in view of the high turnover of MPs during general elections. (If anything, the turnover rate has increased since then.) The alternative proposal at that time was to lengthen the grace period following the formation of a new government before a no-confidence motion could be permitted from six to 18 months. A modified procedure for a no-confidence vote, considered earlier this year, seems to have been discarded. It would have required the submission to parliament of a report to the effect that the country was in financial and economic crisis or showing that the prime minister was corrupt or incapable of running the country. The report would then have been debated and voted on.

Constitutional changes are The parliamentary agenda for the June-July parliamentary session has centred proposed for the 2007 election on Sir Michael’s proposed constitutional changes in relation to no-confidence motions. However, other constitutional amendments have been proposed to prepare for a preferential system of voting in 2007. Such proposals include an amendment to ensure that a political party can endorse only one candidate in a constituency and cannot support an independent candidate in any way. In a situation where two or more political parties secured equal numbers of successful candidates, the party whose candidates attained the highest number of formally declared votes would be invited to form the government. After an election, successful independent MPs must decide, before the election of the speaker, either to join a political party or to remain independent for the term of the parliament A political party would forfeit the Kina10,000 (US$2,850) otherwise payable from the central fund if any of its members were to fail to submit financial returns to the registrar within the prescribed time.

Parliament has yet to reach its Parliament has yet to achieve its full complement of members. Although the full complement of MPs last of the Southern Highlands representatives, Imbonggu MP-elect Timothy Tala, has been sworn in, a number of seats await by-elections as a result of decisions of the court of disputed returns or of leadership tribunals. Of the six

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Southern Highlands seats contested in the supplementary elections in March 2003, the governing coalition won four and the PDM two. Within the coalition, the PPP won two seats, and the PAP and the People’s Labour Party gained one seat each. The NA, despite its disappointing performance (particularly given Sir Michael’s personal, week-long local campaigning), and despite the loss of seats to the courts, remains dominant in the numbers game. Sir Michael seems in no hurry to replace ministers who have been ousted as a result of electoral petitions. The ministerial posts in the tourism, public service, information and communication, and science and technology ministries therefore remain vacant.

The parliament is suffering The house speaker, Mr Skate, opened the June-July parliamentary session on from a cash crunch June 24th by announcing that parliament would not have the cash to pay wages for members and staff and pensions for former members if the Treasury did not transfer Kina2m (US$570,000) by the following morning. The electricity supply was cut off on June 23rd owing to the non-payment of the outstanding bill of Kina120,000 but was reconnected on the first day of parliament following a personal assurance of payment given by the clerk of parliament. Mr Philemon responded to Mr Skate’s announcement by pointing to the consistent overspending by parliament; whereupon he was reminded by Mr Skate that the law allows parliament to spend up to its original budgetary request!presumably to establish the supremacy of the legislature over the executive. A similar cash crunch on the eve of the previous parliamentary session drew attention to Mr Skate’s unbudgeted engagement of a foreign consultant and lavish hosting of a foreign delegation.

Some effort is being made to In early 2003 a prominent media commentator and director of the Institute of counter corruption National parliamentary privileges committee following the release of a co- authored Australian Affairs in Papua New Guinea (PNG), Mike Manning, was called before the report suggesting that a corrupt and complacent elite had mis- appropriated much of the Australian aid that was intended for the general development of the country and its people. Confirming the thesis, and also that something is being done about it, the New Ireland governor, Ian Ling- Stuckey, is gaining support for following up on a probe by the national government in 2002 into alleged fraud and misuse and theft of public funds in the province. Ten senior provincial government officers have been referred to the police for prosecution, and a similar number face disciplinary action under public service regulations.

Bougainville constitution is The second draft of the constitution for the Autonomous Region of circulated Bougainville, has been circulated for comment and will be subject to final approval by the national parliament. The constitution stipulates that only a Bougainvillean may: own customary land; be a candidate in any election; vote in any such election; and possess additional rights as provided for by a Bougainvillean law. The constitution provides for an upper house consisting of representatives of traditional chiefs and other traditional leaders, and a lower house, the House of Representatives. The lower house will comprise a president of the Autonomous Region of Bougainville, 43 elected members, three

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women members representing North, Central and South Bougainville, and three former combatants representing the same areas. The constitution proclaims that traditional systems of government will be utilised and developed by all levels of government. It provides for the adoption of the human rights and freedoms and the criminal code contained in the PNG constitution. East New Britain province has presented the prime minister with its first consultative report seeking a greater degree of autonomy!although, unlike Bougainville, firmly within the PNG state. Sir Michael is known to be committed to fostering decentralisation.

Bougainville peacekeepers are A 17-member Bougainville transition team has replaced the peace monitoring replaced group (PMG) after the latter completed its five years of duty on June 30th. Comprising both women and men, all unarmed and led by a civilian, the team will oversee the completion of weapons disposal, including the decision on the final fate of the weapons. Australia and New Zealand have agreed to contribute personnel to the new group. The continuity provided by the arrangement addresses concerns highlighted by the UN Observer Mission on Bougainville about the possibility that containerised weapons might be stolen following the PMG’s withdrawal. The arrangement follows representations made by the president of the Bougainville interim government, Joseph Kabui, in Canberra, Australia. Mr Kabui would like the arrangement to stay in place until the inaugural elections that he says could take place in early 2004. In mid-April the PMG stated that about 80 weapons in the hands of a dozen or so people remained unaccounted for, and that around 1,800 had been surrendered.

PNG assists in Solomon PNG has indicated its willingness to contribute police and defence force Islands task force personnel to a regional task force to assist in the restoration of security in the Solomon Islands following that country’s formal request to the Pacific Islands Forum for help. The forum’s secretariat, in collaboration with Australia and New Zealand, convened a meeting for member countries in Sydney, Australia, on June 30th to discuss the security and economic concerns of the Solomon Islands. Bougainville’s 10-year insurrection is thought to have contributed to its close neighbour’s destabilisation. PNG assisted with direct military intervention in the suppression of an uprising in Vanuatu a generation ago.

Delegations from Indonesia Following the updating in March of the joint border agreement, in June an and Australia strengthen ties Indonesian delegation visited the capital of PNG, Port Moresby, to promote stronger trade ties between the two countries. In addition, an Australian Senate delegation recently visited PNG as a follow-up to an Australian multi- departmental review of aid. The review heard from various sources that aid appeared not to be achieving its aims in the Pacific, including PNG. The Australian delegation heard that Papua New Guinea feels discriminated against, relative to other Pacific island countries, in respect of access to labour and food (taro, root vegetable) markets in Australia.

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Economic policy

The government is suffering The government has not yet realised any of the Kina200m (US$57m) from asset from a cashflow crisis sales on which the 2003 budget was based. The draw-down of the Kina140m loan from the Asian Development Bank (ADB) has also been delayed. More- over, the 2% economic growth that was a central assumption in the 2003 budget is failing to materialise, despite the government’s recent assertion that the economy is picking up. (The treasurer, Bart Philemon, had previously told a business meeting that he expected the economy to contract again this year!the fourth annual contraction in a row.) The consequent need for domestic borrowing has forced up interest rates on Treasury bills to 20%, double the level a year earlier, as the government has resorted to unbudgeted financing from commercial banks (totalling Kina156m) and from the public (Kina178m). Mr Philemon has said that he still expects the sale of the state’s share of a palm oil company, Hargy, as well as commercial office buildings in downtown Port Moresby and a controlling share in the national telecommunications firm, Telikom PNG, to proceed and bring in the budgeted Kina200m. He also expects the ADB to release its loan by August. Fisheries appointment annoys The ADB has sought an explanation for the deviation from recently legislated ADB policy in the appointment of the chief executive of the National Fisheries Authority. The ADB is a lender to both the fisheries authority and to a public- sector reform programme. Under the arrangement with the fishing authority, an ADB consultant was appointed as chief executive in an acting capacity. At the expiry of his term, the board wished to renew it. However, the fisheries minister, Andrew Baing, intervened and appointed a retrenched former officer in the authority. In doing so, he did not follow procedures required under the public-sector reform programme, for which parliament had previously legislated. He also violated the retrenchment policy, which does not allow the re-employment of retrenched officers. The government’s explanation!that the appointment was in an acting capacity only and was not governed by the new procedures!fell short of satisfying the ADB’s visiting investigative team.

A mini-budget is unlikely to be Despite the present cash-flow problems, Mr Philemon has ruled out the introduced introduction of a mini-budget as called for by the opposition leader, Sir Mekere Morauta. Even if Mr Philemon were to pass a mini-budget, it is not obvious what effective policy measures might be available to him: an economy in endemic recession does not invite increased tax rates or new taxes. As for expenditure, the government has little option in the short term but to cut development expenditure first, and then to reduce expenditure on the goods and services its employees need to do their work. A permanent solution to the recurring fiscal crises depends on the government’s completion of the expenditure review foreshadowed in the 2003 budget, and on switching expenditure from recurrent wages and salaries to goods and services and development projects. However, to do this quickly will require the assistance of multilateral and bilateral agencies in funding the substantial associated retrenchment payments.

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The government records a In the first quarter of 2003 the national government recorded a rare surplus of quarterly budget surplus Kina25.4m, compared with a deficit of Kina120m in the year-earlier period. Both receipts and expenditure were proportionately low, representing 16.6% and 14.9% of the annual budget respectively. The government spent 19.7% of its recurrent budget for the year and 4.7% of its development budget, but received 22% of budgeted tax receipts for the year and 19.1% of budgeted non-tax receipts. It received no foreign grants in the first quarter. Receipts from import and excise duties and value-added tax (VAT) in the first quarter of 2003 were slightly behind budget, but personal tax receipts were ahead. Export tax receipts were strong, representing nearly 40% of the annual budget, but company tax receipts accounted for just 6% of the annual budgeted amount.

Central government finances (Kina m) 2001 2002 2003 2003 Outturn Outturn Budget Qtr 1a Total receipts 3,184.8 3,214.3 3,489.0 580.0 Tax revenue 2,294.2 2,370.3 2,465.1 542.4 Personal tax 598.8 689.9 713.9 202.1 Company tax 686.8 570.2 588.4 34.6 Value-added tax 198.3 289.6 327.2 71.1 Non-tax revenue 171.5 153.2 196.5 37.6 Foreign grants 719.1 690.8 827.4 0.0 Expenditure 3,544.2 3,668.6 3,733.0 554.6 Recurrent expenditure 2,424.9 2,572.3 2,532.7 498.6 National departmental 1,242.4 1,357.3 1,191.7 209.8 Provincial governments 588.6 587.1 593.3 89.1 Interest payments 433.2 467.7 579.2 153.9 Foreign 180.5 192.6 215.7 33.7 Domestic 252.7 275.1 363.5 120.2 Other grants & expenditure 164.7 165.0 172.5 45.8 Net lending & investments -4.0 -4.8 -4.0 0.0 Development expenditure 1,119.3 1,096.3 1,200.3 56.0 Overall balance -359.4 -454.3 -244.0 25.4 a Preliminary data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Mining policy is reaping Various investment incentives for mining were contained in the 2003 budget. rewards The recent measures included removing the additional profits tax (APT) and double tax deductions for exploration expenditure. The move is believed to have directly influenced the decision by Lihir Gold to expand throughput with the construction of two autoclaves, at a cost of US$200m-250m, which could be in production by the middle of 2006. The government is still considering the phasing out of the levy on mining production imposed in 1999 in the face of a fiscal crisis, as well as the issue of the government’s option to take up (at cost) a share of up to 30% of a mining development. The levy, currently 1.9% of turnover, is particularly galling to the industry because as a tax on production it directly reduces profitability and reserves. The jury is still out on the issue of government equity in mining ventures: investors view it both as a deterrent and as a way of spreading risk, while policymakers see it as enhancing total returns to the country from exploitation of its natural resources but also as

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diverting scarce funds from priority expenditure on economic and social capital. Investors are more sensitive to the pricing of the government’s share of equity: the government buys its stake at cost after the private investors have carried all the risk in finding the resource and proving it.

Wide-ranging agricultural The government is hoping to replicate in the agricultural sector its apparent incentives may be offered success with the mining incentives. The agricultural incentives foreshadowed for inclusion in the 2004 budget include:

• a double tax deduction for agricultural research and extension expenses. This will allow continued support for smallholders through the nucleus estates without the need for government funding; • an increase in the tax credit rate for agricultural companies to allow them to maintain rural infrastructure; • the provision of rural development incentives to new agricultural investment projects (a 10% corporate tax would be applicable for a minimum 10-year period, increasing to 20% for the second 10-year period); • allowing all machinery and vehicles for agricultural companies to be imported duty-free; • the removal of foreign-exchange controls that deter foreign investors in agriculture; • the reduction of excise and duty rates on diesel fuel; and • the removal of all taxation on dividend payments to shareholders in agricultural companies.

Fisheries policy puts future Fisheries investment, which has increased in recent years, may stall if Mr Baing investment at risk succeeds in mandating local ownership. Mr Baing appears keen on replicating a structure in the fisheries industry that he implemented in stevedoring (when he headed the transport ministry in a previous government), in which national companies own 51% of operations in the main ports. Stevedoring, however, is a mature industry and is not an appropriate model to apply to fisheries, which has enormous potential and a commensurate need for investment. Moreover, Mr Baing seems to be pursuing his objectives without regard to the bigger picture, and his attempt to short-circuit newly legislated procedures for appointments to statutory bodies has delayed the draw-down of vital foreign- currency loans.

A revised privatisation strategy In a recent address to the Institute of Engineers of PNG the chairman of the is outlined Independent Public Business Corporation, Dr Moseley Moramoro, took the opportunity to outline progress in preparing state-owned enterprises (SOEs) for partial privatisation under the government’s revised strategy. This strategy comprises the rehabilitation of core state assets, private-sector partnership arrangements for core state assets, and selling non-core assets, which would be more appropriately owned and run by the private sector. Core state assets include the national airline, Air Niugini, the state-owned power company, PNG Power, the Harbours Board, Eda Ranu (the body responsible for water and

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sewerage services in the capital, Port Moresby), the state-owned telecoms company, Telikom, and PostPNG. Some non-core assets are subject to claim by others. In early July Sir Michael, who is also the privatisation minister, advised parliament that Telikom, Air Niugini and the Harbours Board would remain in state hands, as he believed that these companies could generate much-needed funds for the state. The PNG Banking Corporation (PNGBC) was the only state asset sold under the previous strategy. The report of the commission of inquiry into the sale of PNGBC recently concluded that haste in completing the sale before the general election in July 2002 probably resulted in the government failing to realise full asset value.

Poor state of national assets Some of the SOEs intended for sale are either insolvent or can barely meet their hinders sell-off plans operating costs, let alone fund maintenance and capital expansion, while some are monopolies that continue to be regulated using unsuitable models. Most have large debt exposures, including foreign-currency exposures, which are not managed at all and have caused their profits to fall substantially as the kina has depreciated over the past ten years. Reporting and accountability mechanisms are still poor, although considerable improvements have been made in this respect. All have extremely poor corporate governance structures, opening the door to inappropriate political intervention. Dr Moramoro said that these were some of the reasons why there had been little interest shown in Air Niugini, PNG Power, Water Board and Eda Ranu, and only one bidder for Telikom.

The business watchdog’s The business watchdog, the Independent Consumer and Competition mandate is broadened Commission (ICCC), has taken over the functions of the former Consumer Affairs Council, the price control branch of the Treasury, together with the economic regulatory functions of the PNG Telecommunication Authority. The latter body will now regulate only in the areas of technology, standards and service quality in the telecoms industry. The ICCC will regulate certain specified industries, including those involving Telikom, PNG Power, Post PNG, and PNG Harbours. It will also regulate the prices of a number of key goods (including rice and sugar) and services (including coastal shipping and automotive service stations). The commission also has responsibility for the government’s competition policy. It comprises a full-time commissioner, who is also the chief executive officer, and two part-time associate commissioners, all appointed by a panel comprising the prime minister as chairman, the minister for finance and treasury, the opposition leader and the central bank governor.

The central bank raises its key The Bank of Papua New Guinea (BPNG, the central bank) has again raised its interest rate kina facility rate (KFR, an official rate that indicates the bank’s monetary policy stance). The central bank began raising the KFR in August 2002; the rate had been stable at 12% since the previous September. The latest increase in the KFR came in June 2003, when it was raised by 100 basis points from 15% to 16%. The BPNG stated that its decision was based on its assessment of the prevailing economic fundamentals and the inflationary environment. This tightening of monetary policy in an economy in endemic recession has greatly perplexed the business community. The government’s monetary policy has been hostage to

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fiscal policy, and although higher interest rates mitigate the impact of the government’s budget deficit on the exchange rate, inflation and demand, they also hurt business operations.

Money supply growth is slow Private-sector credit grew hardly at all in the 12 months to end-March 2003, although total money supply (M3) grew by 3%. A 26% increase in net credit to the government more than offset a 12.4% decline in net foreign assets. Narrow money grew by 9% over the same period. In April 2003 the annual rates of growth in government credit and both measures of the money supply increased, as did the rate of decline in net foreign assets.

Money supply (Kina m; end-period) Qtr1 2001 2002 2003 % changea Domestic credit 2,367.0 2,850.3 3,018.5 10.7 Non-government 1,670.1 1,593.8 1,612.9 0.1 Central government 696.9 1,256.5 1,405.6 26.0 Net foreign assets 1,537.6 1,419.4 1,195.6 -12.4 Total money supply (M3) 3,904.6 4,269.7 4,214.1 3.0 a First quarter of 2003 compared with year–earlier period. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The domestic economy

Economic trends

Real GDP declines further The treasury and finance minister, Bart Philemon, recently told the Business Council of PNG that the economy would suffer its fourth successive annual contraction in 2003. However, he has since offered a more upbeat assessment of the prospects for growth this year. The reason for Mr Philemon’s about-turn is the evidence of a pick-up in agricultural productivity in the first quarter, together with the positive effect that the revised mining tax policy is having on the sector. However, both the mining and non-mining sectors of the economy

remain weak, despite strong prices for gold, crude oil and cocoa, and the full impact of budgeted incentives will not be felt strongly in 2003. The 2003 budget envisaged that the economy would grow by 1.8 % in 2003, but this is not likely to be realised. Real GDP is now about the size it was in 1993, but the population has grown by around 2.7% a year!an increase of about 1m in the past ten years.

Inflation is accelerating Driven by the depreciation of the kina against the Australian dollar (more than 50% of PNG’s imports are sourced from Australia), the quarterly and annual rates of inflation doubled in the first quarter of 2003, to 6.9% and 20.7% respectively. A 23.7% year-on-year increase in food prices and a 22.2% rise in the drinks, tobacco and betelnut category led the acceleration in overall consumer prices. Prices in other categories also increased rapidly, up by more than 19% in the transport and communication group and the household equipment and operations group. Prices in Port Moresby rose by slightly less than the national average. Underlying inflation, which excludes the prices of betelnut, fruits and vegetables and the effects of government policy decisions on prices of consumer goods, accelerated to 21.6% in the first quarter compared with the year-earlier period.

Quarterly inflation (1977=100) 2001 2002 2003 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1Qtr Consumer price index 611.2 618.3 629.0 644.1 686.1 709.9 758.9 % change, year on year 10.0 10.4 10.5 9.4 12.3 14.8 20.7 Underlying inflationa 375.8 384.9 393.0 405.0 433.5 451.3 477.9 % change, year on year 6.6 8.2 8.4 10.3 15.4 17.3 21.6 a Revised series. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Private-sector employment Employment growth in the formal sector has been stagnant over the past ten grows years, and according to the Institute of National Affairs, a private think-tank in PNG, 80,000 people are joining for the labour force every year with no hope of getting a job. Other estimates put the figure as high as 100,000. However, according to the central bank’s revised business liaison survey, formal private- sector employment increased by 5.3% in the first quarter of 2003 compared with the year-earlier period. Employment in building and construction grew most strongly, up by 22% year on year, while in manufacturing, agriculture and finance and business services it grew by 6-8%. The transport sector experienced a 3% gain in employment, but employment in the retail and wholesale trades contracted year on year.

Oil and gas

Oil exports pick up strongly Crude oil exports in the first quarter of 2003 totalled 3.75m barrels, a decline of in April 4.3% year on year, but up by 3.2% quarter on quarter as Moran production contributed to a temporary halt in the overall sharp downward trend. According to preliminary data the country recorded its best monthly oil export performance in almost a year in April: oil exports totalled 1.87m barrels,

marginally ahead of the previous month and the best export figure since 1.9m barrels were exported in May 2002. The increase in exports came out of crude oil stockpiles, since total production in January-April reportedly fell by around 500,000 barrels compared with the year-earlier period. Oil industry sources indicate that oil production and export levels are likely to remain at current levels or to increase slightly before a sharp decline is felt once again owing to the depletion of reserves at the Kutubu, Moran and Gobe oilfields.

Oil Search will take over as A PNG-based Australian exploration and production company, Oil Search, will operator of PNG’s oil projects take over as operator of PNG’s existing oil-producing projects in October, when a US-based energy company, ChevronTexaco, departs after almost 20 years in the country. Oil Search currently owns 50-60% of the fields in PNG following its takeover of the partly government-owned Orogen Minerals in 2002. Industry analysts suggested that an Australian energy company, Santos, was the logical buyer for ChevronTexaco’s PNG portfolio, which was put on the market in April and valued at A$300m-500m, or US$200m-330m (this includes a 19.4% stake in the Kutubu oil project and other interests in Gobe and Moran oilfields in the Southern Highlands region, which are currently producing an aggregate of 53,000 barrels per day). However, the minister of petroleum and energy, Sir Moi Avei, although conceding that the government had no say in the matter, expressed a preference for Oil Search (in which the government has an 18% interest). He rejected a suggestion by the parliamentary opposition that an Asian operator should be invited to form a joint venture with the government to bid for the entire portfolio.

Oil refinery completion date is The largest shipment of equipment from Houston, USA, for the construction of put back an oil refinery at Napa Napa is scheduled to reach PNG in mid-July. The oil refinery, which is owned by a Canadian company, InterOil, will be capable of processing around 32,500 b/d when it is completed. The schedule completion date has been put back, however, owing to a delay in the shipment of the main refinery column. The decision by InterOil’s contractors, Clough Engineering, to modify the column at the last minute means that the mechanical completion of the refinery will not be reached until March 2004, instead of December 2003 as originally planned. The majority of product from the refinery is secured by contracts with Shell PNG, and BP Singapore is the exclusive agent for all crude oil supplied to the refinery.

The future of the gas pipeline In June, soon after an Australian bauxite and aluminium operation, Alcan, had project brightens committed itself to purchasing gas from the Timor Sea, reports emerged that another aluminium refinery, Comalco, which is owned by Rio Tinto and based in Gladstone, Queensland, would finally make a decision on its future source of power. Comalco decided in favour of the Highlands Gas Project, the new name for the PNG-Queensland gas project. In early July the Australian state- owned utility company, Energex, signed a conditional agreement to buy up to 1,200 petajoules of gas pumped through the PNG-Queensland pipeline from 2007 over a 20-year period; Energex would sell the gas on to Comalco. The signing of Energex (and Comalco indirectly) as a customer, coupled with a reduction in project costs, could be sufficient for the for the 3,500-km pipeline project’s front-end engineering and design to start. Sir Moi was confident that a

sufficient customer based would be achieved by September. The revised cost concept for the gas pipeline project involves simultaneous development of gas from the Hides and Kutubu fields; the initial strategy was to tap gas reserves from proven oilfields such as Kutubu and Moran prior to development of the big Hides field. Processing facilities will also be simplified by building most of them onshore, instead of offshore as originally envisaged. All interested parties converged in Port Moresby in late June. Representatives from a US oil company, ExxonMobil, which is managing the project, were there at the government’s request to report on progress and to hear that the government had its finance in place. Another project participant, Itochu Corporation of Japan, also attended the gathering.

Mining

Mining policy changes boost In response to new policies favourable to the mining sector (see Economic activity in the sector policy), construction is expected to commence in the coming year on three small- and medium-sized mining projects in Morobe, Eastern Highlands and New Ireland provinces. However, a communication breakdown between the new owners of the Morobe project and the landowners could delay construction there. Grassroots exploration is also experiencing solid gains this year after going almost into extinction over the past decade. Two n ew exploration licences have been issued to an Australian exploration company, Kanon Resources Limited, to explore Kamadoudou and Mapamoiwa in Milne Bay Province, and Silubata, which is located 60 km west of Kimbe in the West New Britain Province. Another Australian energy company, Pac-Rim Energy, was granted a licence to explore the hinterland of Manus Province. A further six applications are being processed.

Gold exports rise in the first Gold export volume in the first quarter of 2003 was up by 8% year on year to quarter 16.7 tonnes. The Porgera mine in Enga province in the Highlands region produced more than 6 tonnes of gold during this period, and at Lihir gold production reached 131,050 oz. Tolukuma mine has produced over 431,500 oz of gold since the start of production in 1995, and output in the first quarter of 2003 was 509 kg. The life of the Tolukuma mine was initially estimated at five years; however, exploration in areas immediately surrounding the known mineable reserves continues to be positive, and the potential exists to extend the mine’s life by several more years. At the end of December 2002 there was estimated to be approximately 300,000 oz of gold remaining to be mined. Most non- operational activities on Misima currently relate to mine closure issues and rehabilitation. Misima had approximately 243,000 0z of gold and 2.2m oz of silver in its stockpiled reserve base at the start of the year. Operations will cease in 2004.

Copper exports pick up Low river levels caused by the El Niño-related drought had adversely affected the shipping of copper concentrate from the Ok Tedi mine in September- December 2002. More than 258,000 tonnes of copper concentrate were shipped out from the mine during the first quarter of 2003, containing 75,450 tonnes of copper and 5,807 kg of gold. The poor export performance in the fourth quarter

of 2002 and the catch-up process in the first quarter are clearly reflected in the quarter-on-quarter increase of more than 170% in total copper exports. The year-on-year increase was slightly less impressive, at 28.5%.

Mineral exports by volume 2001 2002 2003 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1Qtra Crude oil (’000 barrels) 4,582 3,916 4,215 3,607 3,632 3,748 Copper (’000 tonnes) 33.5 50.2 54.4 41.8 23.7 64.5 Gold (tonnes) 14.0 15.5 15.6 11.9 16.1 16.7 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Agriculture, fisheries and forestry

Palm oil capacity is set to In line with the government’s export-driven strategy for employment growth increase and economic recovery, Ramu Sugar (in which the government has recently sold its stake by way of a float on the local stock exchange) has embarked on the development of a 2,000 ha palm oil plantation. Development of this small- scale plantation, which will be operational by 2007, will initially be financed internally on land already owned by the company at Gusap. The company has also identified a much larger US$40m project at Walium in Madang’s hinterland, and is looking to the government for help in accessing international finance to develop it. Ramu Sugar is the country’s monopoly sugar producer and operates behind a 70% tariff, which must be lowered by 2010 in accordance with the government’s Asia Pacific Economic Cooperation (APEC) commitments. Another major palm oil development is being planned as a joint venture between the East Sepik provincial government and New Britain Oil Palm, the industry’s pioneering investor. Palm oil has recently surpassed coffee as the largest agricultural export earner.

Coffee body plans to Owing to the government’s inability to provide sufficient funding, the Coffee restructure the sector Industry Corporation (CIC) has reduced its operations to be consistent with the

revenue it receives from the 8 toea (2 US cents) per kilo that it levies on exports. (The CIC has been struggling, owing to the lack of research grants over the past five years and the non-delivery of the government’s price support facility, promised in the 2001 budget.) CIC has eliminated two of its four divisions and retrenched more than one-half of its staff (from 300); it has also cut back on research work and abolished the stabilisation levy. The CIC wants to restructure the industry, organising smallholders into co- operatives to process and export their green beans directly to international markets, thereby cutting out the middle man. Smallholders accounted for 86% of PNG’s total production of just over 1m bags (around 64,000 tonnes, a decline of 5.2% year on year) in 2002. The plantations’ share of production has halved over the past decade or so. The CIC also plans to recruit retired public servants to be trained to deliver extension services, including education and awareness programmes, to village farmers. Another feature of the planned restructuring, a kina-for-kina airfreight subsidy scheme with the national government, is thought by the World Bank to be unsustainable.

Tuna fisheries drive sector The National Fisheries Authority has projected that the annual export value of expansion fisheries products will reach Kina1bn by the end of the decade owing to continued growth in tuna processed for export. PNG’s extended economic zone, 2.4m sq km in total, is one of the most productive in the world, accounting in some years for 10% of world production of tuna (a migratory species), with around 300,000 tonnes of skipjack, yellowfin and bigeye tuna. Total sustain- able fisheries potential in PNG waters (not including aquaculture) may be close to 500,000 tonnes per year of marine products, conservatively valued at Kina2bn unprocessed. According to the fisheries authority, existing and planned capacity would process only one-half of the tuna available to be caught sustainably in PNG waters. Onshore processing of tuna started in 1997 with RD Cannery in Madang. A loining (preparation and cooking) plant is currently under construction in Wewak. Planned projects include a second processing factory in Madang and loining plants in Lae, Madang, Lombrum and Kavieng.

Log exports increase rapidly Log exports have risen rapidly, owing to favourable weather conditions. In the first five months of the year exports jumped by 45% in value terms to Kina176m (US$50m), and by 38% in volume terms to nearly 930,000 cu metres. In the year-earlier period revenue totalled Kina121m and volume only 670,000 cu meters. The expansion of logging output has been driven by the government’s high-tax regime, which has forced producers to ramp up their activities in order to maintain operating margins. However, prices have remained fairly stable, with exports reaching an average price of Kina190 (US$51) per cu metre compared with Kina180 per cu metre in the year-earlier period. Export volumes for most other agricultural commodities in the first quarter of 2003 were up year on year. Copra oil volume rose by more than 50%, cocoa rose by 38%, tea by 27%, coffee by 18% and palm oil by 14%. However, copra and rubber export volumes fell by 75% and 10% respectively.

Agricultural exports by volume (’000 tonnes unless otherwise indicated) 2001 2002 2003 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Cocoa 10.0 9.4 6.9 5.8 9.7 8.9 10.5 8.0 Coffee 15.3 16.5 8.5 6.7 12.7 25.9 17.8 7.9 Tea 2.4 1.2 2.7 1.6 1.4 1.0 1.2 1.9 Copra 10.8 8.2 19.8 5.6 4.7 4.8 0.7 1.4 Copra oil 9.9 4.7 4.4 6.1 4.0 6.5 11.6 9.3 Palm oil 100.0 94.5 67.9 80.5 91.4 76.5 75.5 92.1 Rubber 0.9 1.0 0.4 1.0 0.9 1.1 0.8 0.9 Logs (’000 cu metres) 346.6 248.1 279.3 381.0 423.0 409.0 621.0 543.0 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Infrastructure

Road upgrade commences in Work on upgrading a 21-km stretch of road between Kokopo and Rabaul in East East New Britain New Britain province commenced in late June. The work is being financed by the Australian government’s aid agency, AusAID, at a cost of around Kina22m, and will take ten months to complete. AusAID has also provided funds to improve important road links within the province. The dire state of the road network in PNG hampers economic activity, particularly in terms of the delivery of agricultural commodities.

PNG Power is insolvent The Independent Public Business Corporation has called for expressions of interest to manage the nation’s state-owned electricity supplier, PNG Power. This follows a report, compiled by an accounting firm, PricewaterhouseCooper, that disclosed that the company was technically insolvent, the government being the main creditor. The investigative report was critical of the “build, operate and transfer” arrangement with a South Korean company, Hanjung, for a diesel-powered plant in Port Moresby. At the time, this was seen as a way to obtain much-needed extra capacity without direct investment. The contract is denominated in US dollars. The investigative report recommended a 7% tariff increase from July 1st 2003.

Financial and other services

The stock exchange is The chairman of the Port Moresby Stock Exchange (POMSoX), Anthony promoted Siaguru, has tried to encourage more firms to list on the exchange and raise capital domestically. Mr Siaguru attempted to raise interest in the exchange on the first day of the two-day 2003 Money Show in Port Moresby in late June. The general aims of the show were to promote investment by educating people as to the benefits of investing in public companies, and also to give listed companies an opportunity to raise their corporate profiles. There are currently only 11 companies listed on the POMSoX, which opened in 1999; they include Oil Search, Lihir Gold and Ramu Sugar.

Telikom launches digital The analogue mobile telecommunications era came to an end in late April with system the launch by the state-owned national telecoms provider, Telikom, of the global system mobile (GSM) network, which will provide coverage in National Capital District, Lae, Madang, Goroka and Mount Hagen. The network is the country’s first digital mobile telephone system and replaces the analogue network that has been is use for the past decade.

Foreign trade and payments

Value of exports rises by 44% The value of commodity exports in the first quarter of 2003 reached Kina1.9bn year on year in kina terms (US$540m), 44% more than in the year-earlier period and 10% more than in the fourth quarter of 2002. Mineral exports, which accounted for around 80% of the total, were up by 48% year on year and 19% quarter on quarter. Gold was the main export earner, accounting for more than 34% of the total, with gold export receipts increasing by 40% year on year. Crude oil exports accounted for 24% of the quarterly total and were up by a healthy 70% compared with the year-earlier period, reflecting higher prices associated with international security concerns. Copper, which contributed 20% of total export value, was up by 40% year on year and 165% quarter on quarter, the latter result reflecting the adverse impact of low river levels on Ok Tedi’s copper shipments during the last quarter of 2002. Agricultural exports accounted for 14.5% of the total in the first quarter of 2003. Forestry exports, which contributed 6% of the export total in the first quarter, rose by 30% year on year. The export value of marine products was lower in the first quarter of 2003, declining by more than 70% year on year. Palm oil contributed 47% of total agricultural export value in the first quarter of 2003.

Exports (Kina m) 1 Qtr 1 Qtr 2000 2001 2002 2002 2003a Agricultural products 955.5 801.1 1,084.9 184.8 283.3 Forestry products 308.8 272.9 414.1 89.2 115.8 Logs 283.5 234.3 365.5 68.4 104.2 Marine products 33.7 77.2 94.1 38.3 11.0 Minerals (incl silver) 4,494.6 4,895.6 4,774.0 1,041.9 1,538.9 Gold 1,950.8 2,115.1 2,294.8 479.5 665.2 Copper 595.4 859.1 1,018.7 279.0 390.6 Crude oil 1,921.7 1,889.4 1,431.2 277.0 472.6 Total 5,792.6 6,084.8 6,367.1 1,354.2 1,949.0 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Rising commodity prices PNG’s export sector benefited from rising world export prices in kina terms for support exporters most commodities. Prices for cocoa, copra oil and rubber were up by 70-80% year on year in the first quarter of 2003. Palm oil exports prices were 48% higher, coffee prices were 17% higher and copra prices were up by 12%. Crude oil prices in the first quarter of 2003 were 75% higher than in the year-earlier period and 26% higher than in the preceding quarter. Copper and gold prices were also up, by 8% and 27% respectively.

World commodity price forecasts (US$/tonne unless otherwise indicated) 2001 % change 2002 % change 2003 % change 2004 % change Cocoa (US cents/lb) 49.4 22.6 80.9 63.7 79.0 -2.3 63.0 -20.3 Coffee (US cents/lb; Arabica) 62.3 -28.5 61.5 -1.2 64.5 4.8 60.9 -5.6 Tea (US$/kg) 1.6 -15.8 1.5 -4.0 1.5 -2.5 1.4 -4.3 Copra 202.0 -33.7 266.0 31.7 306.8 15.3 330.0 7.6 Palm oil 285.8 -7.9 390.0 36.5 394.0 1.0 364.8 -7.4 Rubber 746.8 -10.2 907.0 21.5 1,060.0 16.9 1,200.0 13.2 Crude oil (US$/barrel; Brent) 24.5 -14.1 25.0 2.0 25.5 2.3 18.3 -28.3 Gold (US$/troy oz) 271.1 -2.9 310.3 14.5 335.0 8.0 315.0 -6.0 Copper (US cents/lb) 71.5 -11.9 70.4 -1.6 77.0 9.4 83.0 7.8 Note. Percentage changes are on a year-on-year basis. Source: Economist Intelligence Unit, World Commodity Forecasts.

The current account records a Merchandise imports in the first quarter dropped by 43% year on year, thereby robust surplus contributing to a large merchandise trade surplus of Kina1.5bn (US$400m). The trade balance was partly offset by an overall invisibles deficit of Kina556m. The services and income accounts recorded deficits of Kina370m and Kina186m respectively. Net transfers deteriorated from a surplus of Kina28m in the first quarter of 2002 to a deficit of Kina22m in the first quarter of 2003. The capital and financial account plunged into a deficit of Kina1bn in line with outflows of Kina117m in portfolio investment and Kina918m in other investment (not including direct investment or financial derivatives). The overall balance of payments in the first quarter of 2003 thus recorded a deficit of Kina156m compared with a deficit of Kina53m in the year-earlier period.

Balance of payments (Kina m) 2002 2003 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 a Merchandise exports 1,359 1,677 1,571 1,780 1,954 Merchandise imports -843 -907 -1,009 -979 -480 Trade balance 516 770 562 801 1,474 Invisible credits 152 270 170 144 138 Invisible debits -749 -982 -940 -781 -694 Net transfers 28 69 20 -11 -22 Current-account balance -53 -127 -167 162 895 Net direct investment 12 31 16 15 -15 Portfolio investment -96 231 -176 36 -117 Financial derivatives 0 0 0 0 13 Other investment 98 -144 64 -309 -918 Capital & financial account balance 14 118 -96 -257 -1,037 Net errors & omissions -14 19 -8 -53 -14 Overall balance -53 264 -292 -168 -156 International reserve levelb 1,491.5 1,828.1 1,536.2 1,378.1 1,222.6 a Provisional data. b End-period. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The kina strengthens against The central bank has attempted to maintain a fairly stable exchange rate in the US dollar recent months and has had to account for tight liquidity conditions, increasingly favourable export prices and a slowdown in import orders. The kina has appreciated against the US dollar in recent months, and in early July stood around Kina3.5:US$1, reflecting a 3.6% year-on-year appreciation and a 13% appreciation since the beginning of the year. Reflecting changes between the US dollar and other major currencies, particularly the Australian dollar and the yen, the kina has generally remained weak. In early July the kina dropped to Kina2.34:A$1, reflecting a depreciation of more than 10% year on year and around of 4% since the beginning of the year.

Exchange rates (Kina per unit of foreign currency; annual averages) Jul 7th 1998 1999 2000 2001 2002 2003 A$ 1.297 1.659 1.613 1.753 2.110 2.340 US$ 2.059 2.55 2.76 3.36 3.89 3.45 ¥ 0.016 0.022 0.026 0.028 0.031 0.029

Source: IMF, International Financial Statistics; Bank of Papua New Guinea, Quarterly Economic Bulletin.

The level of international International reserves at the end of March 2003 were sufficient to cover reserves declines 5.7 months of total imports or 8.1 months of non-mining imports. These ratios were improvements on the situation at the end of March 2002. However, the improvement also reflects the lower demand for imports in line with the contracting domestic economy. At the end of March 2003 international reserves stood at Kina1.2bn, 18% lower than in March 2002 and 11% lower than at the end of 2002. In US-dollar terms the level of reserves at the end of March 2003 was down by 16% year on year to US$314m, according to the IMF.

External debt level drops The government either under-budgeted its foreign debt repayment or accelerated repayment in the first quarter of 2003. Total foreign debt repayments during this period accounted for over 60% of the amount budgeted for the year. In addition, the government reduced its debt to domestic trade creditors by Kina273m in the first quarter, compared with a budgeted increase for the year of Kina179m. External public debt outstanding therefore stood at Kina5bn at the end of March 2003. This was 3.3% more than a year earlier but 10% less than at the end of December 2002. The reduction also reflects unrealised exchange-rate gains. In US-dollar terms PNG’s external debt fell by around 1.5% compared with the total at end-2002.

Public debt outstanding (Kina m; end-period) Qtr 1 1999 2000 2001 2002 2003a Domestic 2,021.3 1,783.3 2,115.1 2,530.5 2,762.6 Treasury bills 1,775.2 1,577.2 1,748.8 2,169.1 2,397.3 Inscribed stock 246.1 206.1 366.3 283.8 271.4 External 3,812.8 3,838.3 4,982.1 5,597.4 5,011.8 International agencies 3,650.4 3,683.5 4,822.0 5,464.1 4,814.8 Commercial loans 144.6 137.5 140.3 107.4 174.8 Other loans 17.9 17.3 19.8 23.1 22.4 Total public debt 5,834.2 5,621.6 7,097.3 8,128.9 7,774.4 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.