Papua New Guinea

Country Report

Papua New Guinea

Papua New Guinea at a glance: 2005-06

OVERVIEW The prime minister, Sir Michael Somare, is likely to see out his full term in office, defeating any no-confidence vote. The political scene nevertheless remains unsettled, with a number of parties suffering internal splits. By contrast, the economic outlook is fairly good. The government has maintained control of its fiscal position, inflation has eased sharply, and improvements in agricultural and mining output should contribute to steady real GDP growth in 2005-06. However, the current-account balance will deteriorate steadily in 2005-06, in line with rising imports related to mining activity and infrastructure projects.

Key changes from last month Political outlook • A new autonomous government on the island of Bougainville has been established, marking a milestone in the development of Papua New Guinea (PNG). The newly elected government was inaugurated in mid-June, with Joseph Kabui, the leader of the Bougainville People’s Congress securing the presidency. Economic policy outlook • Although the government has succeeded in maintaining a tight grip on expenditure, leading to an improvement in the budget balance, it has failed to utilise its development expenditure budget to support sustainable economic growth. In the first quarter of 2005 the government spent only around 3% of its full-year development budget. Economic forecast • The Economic Intelligence Unit has revised upwards its forecast for global crude oil prices, one of PNG’s leading export commodities. Oil prices will increase by 31% year on year in 2005 to an average of US50.5/barrel (dated Brent Blend), before dipping to US$46.5/b in 2006.

July 2005

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Contents

Papua New Guinea

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2005-06 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

16 Economic policy

19 The domestic economy 19 Economic trends 21 Oil and gas 22 Mining 23 Agriculture, fisheries and forestry 25 Financial and other services

26 Foreign trade and payments

List of tables

9 International assumptions summary 11 Forecast summary 16 Central government finances 18 Money supply 20 Quarterly inflation 23 Mineral exports by volume 24 Agricultural exports by volume 26 Exports 28 Balance of payments 29 Public-sector external debt

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List of figures

12 Papua New Guinea: gross domestic product 12 Papua New Guinea: consumer price inflation 18 Papua New Guinea: interest rates 21 Papua New Guinea: exchange rates 22 Papua New Guinea: Kutubu oil prices 28 Papua New Guinea: foreign-exchange reserves

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Papua New Guinea July 2005 Summary

Outlook for 2005-06 The prime minister, Sir Michael Somare, is likely to see out his full term in office, defeating any no-confidence vote. The political scene nevertheless remains unsettled, with a number of parties suffering internal splits. The economic outlook remains fairly positive. The government has maintained control of its fiscal position, inflation has eased sharply, and improvements in agricultural and mining output should contribute to steady real GDP growth in 2005-06. However, the current-account balance will deteriorate in 2005-06, in line with rising imports related to mining activity and infrastructure projects.

The political scene Sir Michael has appointed Sir Moi Avei as his deputy, in a move that has created regional balance among the most senior positions in the government. There has been little progress made in resolving internal splits in a number of political parties. An autonomous government in Bougainville has been established, with Joseph Kabui, the leader of the Bougainville People’s Congress, securing the presidency. The Enhanced Co-operation Programme (ECP) with Australia has come to a premature end, complicating bilateral ties, but relations with China have strengthened.

Economic policy The government continues to record a healthy budget surplus, but spending, particularly of the development budget, has been slow. The government has not made any progress with its privatisation programme. Monetary policy has remained neutral, with the Bank of Papua New Guinea (BPNG, the central bank) keeping its kina facility rate unchanged in recent months. The government has planned to make some legislative changes in key sectors.

The domestic economy Employment and nominal sales have risen steadily. Consumer price inflation has slowed markedly, partly because the kina has appreciated against the currencies of most major trading partners. Prospects for the eventual go-ahead for the long-delayed PNG Gas project continue to improve, with the recent signing of another two sales contracts. Crude oil production has fallen, owing to temporary repair works on a loading terminal. Export volumes of most agricultural commodities have declined.

Foreign trade and payments Export growth has lagged that of imports. International reserves have fallen in line with the deficits recorded in the current and financial accounts. Public- sector external debt has fallen. Editors: Danny Richards (editor); Robert Ward (consulting editor) Editorial closing date: July 14th 2005 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. Sir Silas Atopare vacated the position in October 2003, and Sir Paulius Matane was sworn in on June 29th 2004

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; the next elections will be in 2007

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); PNG Party; Advance PNG Party (APP); People's National Congress (PNC)

Main members of the National Prime minister Sir Michael Somare Executive Council Deputy prime minister Sir Moi Avei

Key ministers Agriculture Mathew Siune Defence Mathew Gubag Education Michael Laimo Environment William Duma Finance & treasury Bart Philemon Foreign affairs Sir Rabbie Namaliu Forestry Patrick Pruaitch Health Melchior Pep Inter-government relations Sir Peter Barter Internal security Bire Kimisopa Justice Mark Maipakai Mining Sam Akoitai Petroleum & energy Sir Moi Avei Tourism & culture David Basua Trade & industry Paul Tiensten Works Gabriel Kapris

Central bank governor Wilson Kamit

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Economic structure

Annual indicators 2000a 2001a 2002a 2003b 2004b GDP at market prices (Kina bn) 10.8 11.8 13.4 15.5 16.0 GDP (US$ bn) 3.9 3.5 3.4 4.4 5.0 Real GDP growth (%) 0.0 2.7 2.0 1.8 0.7 Consumer price inflation (av; %) 15.6 9.3 11.8 14.7a 2.1a Population (m) 5.3 5.5 5.6 5.7a 5.8 Exports of goods fob (US$ m) 2,094.1 1,812.9 1,639.7 2,200.7 2,529.4 Imports of goods fob (US$ m) 998.8 932.4 1,077.5 1,187.3 1,459.4 Current-account balance (US$ m) 345.3 282.0 -129.1 139.2 96.2 Foreign-exchange reserves excl gold (US$ m) 286.9 422.6 321.5 494.2a 632.6a Total external debt (US$ bn) 2.6 2.5 2.5 2.5a 2.2 Debt-service ratio, paid (%) 12.9 12.8 15.2 12.0a 17.7 Exchange rate (av) Kina:US$ 2.78 3.39 3.90 3.56a 3.22a a Actual. b Economist Intelligence Unit estimates.

Main origins of gross domestic product 2002 % of total Components of gross domestic product 1999 % of total Agriculture 34.6 Private consumption 73.9 Industry 37 Government consumption 14.4 Mining 16.8 Investment 19.8 Services 28.4 Exports of goods & services 38.8 Imports of goods & services 46.9

Principal exports fob 2004 US$ m Principal imports cif 1994 US$ m Gold 855.2 Machinery & transport equipment 552 Crude oil 504.3 Manufactured goods 313 Copper 479.2 Food & live animals 216 Palm oil 136.1 Chemicals 92

Main destinations of exports 2003 % of total Main origins of imports 2003 % of total Australia 25.3 Australia 51.5 Japan 7.1 Singapore 20.1 China 5.9 New Zealand 7.5 Germany 3.5 China 4.8 UK 2.5 Japan 3.7 Indonesia 1.9 Malaysia 3.1

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Quarterly indicators 2003 2004 2005 2 Qtr 3 Qtr 4Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Prices Consumer prices (2000=100) 140.3 140.4 141.0 143.0 143.0 142.5 144.3 142.6 Consumer prices (% change, year on year) 18.9 11.8 8.5 2.9 1.9 1.5 2.3 -0.3 Financial indicators Exchange rate Kina:US$ (av) 3.66 3.44 3.36 3.30 3.21 3.21 3.17 3.12 Exchange rate Kina:US$ (end-period) 3.55 3.38 3.33 3.25 3.22 3.21 3.13 3.11 M1 (end-period; Kina m) 1,678 1,759 1,897 1,774 2,006 2,056 2,331 2,398 M1 (% change, year on year) 3.6 11.9 16.4 7.4 19.6 16.90 22.9 35.2 M2 (end-period; Kina m) 3,147 3,196 3,299 3,111 3,354 3,469 3,704 3,718 M2 (% change, year on year) -4.5 -0.8 -0.4 -4.5 6.6 8.6 12.3 19.5 Sectoral trends, exports Copra ('000 tonnes) 2.4 1.3 2.8 5.3 4.6 5.6 3.7 6.4 Copra oil ('000 tonnes) 14.4 12.8 11.2 7.6 14.4 8.2 14.9 11.6 Cocoa ('000 tonnes) 13.6 10.1 8.5 10.4 9.1 10.5 11.5 8.6 Coffee ('000 tonnes) 14.5 28.3 18.1 8.2 17.3 23.7 13.8 6.0 Logs ('000 cu metres) 478 488 507 495 433 442 642 608 Gold (tonnes) 14.6 17.9 18.8 17.7 17.3 14.7 17.6 13.8 Fish ('000 tonnes) 6.8 4.1 0.5 2.7 1.0 2.9 1.3 0.8 Oil, crude ('000 barrels) 4,107 4,272 2,857 3,268 3,791 2,331 3,175 2,104 Foreign trade & reserves Exports fob (Kina m)a 1,875 1,922 2,007 1,972 2,143 1,826 2,292 2,086 Gold 585 726 784 726 699 613 742 563 Oil, crude 441 419 300 352 473 318 509 261 Imports fob (Kina m)a -1,072 -1,001 -1,075 -1,034 -1,245 -1,322 -1,102 -1,320 Trade balance (Kina m) 803 921 932 938 898 504 1,190 766 Foreign reserves (US$ m) Reserves excl gold (end-period) 340.4 400.9 494.2 487.6 519.8 555.5 632.6 554.1 a Balance-of-payments basis. Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; IMF, International Financial Statistics.

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Outlook for 2005-06

Political outlook

Domestic politics It is becoming increasingly likely that the prime minister of Papua New Guinea (PNG), Sir Michael Somare, will see out his full term in office, which ends in 2007, making him the first PNG leader to do so. However, the political scene continues to suffer a degree of instability, owing to the tendency for members of parliament (MPs) to shift their allegiance between the government and the opposition. A number of parties remain split, with members on both sides of parliament. The parliamentary speaker, Jeffery Nape, has raised the opposition’s ire on a number of occasions in recent months, partly because of his rulings to order some opposition MPs to join their parties on the government’s benches. The parliamentary opposition leader, Peter O’Neill, has since claimed that the suppression of the opposition has placed the country’s democracy under threat. Throughout 2004 the opposition failed in its efforts to launch a motion of no confidence in Sir Michael, partly because of the government’s timely adjournment of parliament. In view of the fact that the operating environment for the opposition is becoming increasingly difficult, it is unlikely that the opposition will have the appetite for continuing its efforts to push for a no-confidence motion. Sir Michael, who leads the National Alliance (NA), managed to avoid disrupting the stability of his governing coalition when recently forced to name a deputy prime minister, which was potentially a divisive issue. His eventual choice, Sir Moi Avei, appears to have been welcomed by leaders of other parties in the governing coalition, despite the fact that Sir Moi’s party, Melanesian Alliance, is one of the smallest in the coalition. However, Sir Michael’s recent decisions to place key allies on the board of the Independent Public Business Corporation (the government’s privatisation agency), and the appointment of his son, Sana Somare, to the board of PNG Power (the state-owned electricity utility), have drawn criticism, both from the opposition and some members of his own party. Sir Michael is expected soon to declare his intentions for the 2007 election. It is possible that he will announce his support for another son, Arthur Somare, the national planning and rural development minister, to succeed him as the NA’s parliamentary leader. However, such a move, which would be interpreted as Sir Michael’s attempt to prolong his family’s political legacy, is unlikely to be welcomed by all party members. Away from the political intrigue that often plagues the national government, a new autonomous government on the island of Bougainville, which suffered a decade-long violent insurgency from the late 1980s, has been established successfully, marking a milestone in PNG’s development. The newly elected government was inaugurated in mid-June, with Joseph Kabui, the leader of the Bougainville People’s Congress (BPC), securing the presidency. The autonomous government will have full responsibility for the island’s financial affairs, from revenue collection to allocation of grants. The PNG national government, however, will maintain full control of defence and foreign affairs. Meanwhile, the proposal of East New Britain province that it should be given increased

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autonomy is under examination by the Constitutional Development Committee.

International relations PNG’s ties with Australia continue to fray. The Kina2bn (US$625m) Enhanced Co-operation Programme (ECP) between the two countries, which began in June 2004 and marked a significant improvement in relations, came to an abrupt end in mid-May 2005. This followed the ruling by PNG’s Supreme Court that the ECP was unconstitutional, owing to the provision in it that offered immunity from prosecution to Australian police and officials operating in PNG under the programme. Both sides appear keen to resolve the ECP issue, with the foreign minister, Sir Rabbie Namaliu, visiting his Australian counterpart, Alexander Downer, in late May. A resolution is unlikely in the near future, however, partly because of domestic opposition to moves to amend the constitution and the Australian government’s unwillingness to send police officers to PNG without immunity from prosecution. The latest breakdown in ties with Australia may prompt PNG to make further efforts to move away from its traditional dependence on that country. The government has been making progress in improving diplomatic and economic ties with China, and a Chinese government delegation visited in late May. PNG will also seek to bolster its regional standing later this year when it hosts the 36th annual leadership summit of the 16-member Pacific Islands Forum.

Economic policy outlook

Policy trends The government has been fairly successful in maintaining economic stability, partly through its fiscal prudence, which has enabled the Bank of Papua New Guinea (BPNG, the central bank) to adopt a neutral monetary policy stance. There are concerns, however, in other areas of economic policy. For example, the government has made little progress in meeting its commitments to structural reform, particularly in terms of privatising state-owned firms. A failure to do so during the next few years could lead to problems in attracting international financial assistance. The government’s chances of receiving such assistance have also been limited by the sometimes prickly ties with key donors, particularly the World Bank, which recently cancelled its forestry conservation project owing to ongoing disagreements. In other policy areas, Sir Michael recently stated that his government was reviewing land laws with a view to amending them to make it easier for land rights to be acquired from traditional owners. It is widely viewed that economic development since independence has been hampered because of PNG’s communal land ownership laws. The issue, however, remains controversial, and little progress is expected to be made in reforming land law in the near future.

Fiscal policy The government is aiming to run small budget deficits in 2005-06 in an attempt to maintain sound fiscal management. Its target for 2005 is to run a budget deficit of Kina137.7m (US$44m), equal to around 1% of GDP. In the first quarter of the year, however, the government recorded a surplus of Kina127.1m, owing to continued expansion in revenue and slow spending. Although the government has succeeded in maintaining a tight grip on expenditure, which led to an improvement in the budget balance in 2004, it has failed to utilise its develop-

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ment budget to support sustainable economic growth. In 2004 it executed only 70% of its full-year development budget, and in the first quarter of 2005 it spent only Kina58.8m out of a full-year budget of around Kina1.9bn (US$610m). In order to secure budgeted foreign grants, the government will be called upon to execute its budget more effectively during the remainder of the year.

Monetary policy The BPNG is expected to maintain a neutral monetary policy stance throughout 2005 and into 2006, and will also seek to smooth volatility in kina exchange- rate movements. In recent monthly monetary policy commentaries, the latest of which was released in June, the BPNG has been advising that its assessment of macroeconomic conditions warranted no change in monetary policy. This partly reflects the fact that in 2004 the central bank cut interest rates aggressively. The BPNG was able to adopt looser monetary policy for most of 2004 owing to the lower inflation environment, the strength of the kina and the government’s prudent fiscal policy. Since October 2004 the kina facility rate (KFR, the official interest rate used to indicate its monetary policy stance) has remained unchanged. However, reflecting high excess liquidity in the banking system, commercial banks’ lending and deposit rates have continued to fall.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2003 2004 2005 2006 Real GDP growth World 3.9 5.1 4.2 4.0 OECD 2.0 3.3 2.3 2.3 EU25 1.2 2.3 1.7 2.0 Exchange rates ¥:US$ 115.9 108.1 107.4 103.0 US$:€ 1.132 1.244 1.222 1.260 SDR:US$ 0.714 0.675 0.679 0.666 Financial indicators ¥ 2-month private bill rate 0.03 0.00 0.00 0.17 US$ 3-month commercial paper rate 1.10 1.48 3.31 4.63 Commodity prices Oil (Brent; US$/b) 28.8 38.5 50.5 46.5 Gold (US$/troy oz) 363.3 409.5 425.6 402.5 Food, feedstuffs & beverages (% change in US$ terms) 6.6 9.2 -6.5 -1.5 Industrial raw materials (% change in US$ terms) 13.0 21.0 4.2 -6.2 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. The global economy is experiencing a slowdown, with the US and Japan set to record slower growth in 2005-06 compared with 2004. Growth in Asia and Australasia (excluding Japan) will remain buoyant at around 5.8% a year, but GDP growth in Australia, PNG’s leading export market, will slow to 2.5% in 2005 before picking up to 2.9% in 2006. The Economic Intelligence Unit has revised upwards its forecast for global crude oil prices, one of PNG’s leading export commodities. Oil prices will increase by 31% year on year in 2005 to an average of US50.5/barrel (dated Brent Blend), before dipping to US$46.5/b in

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2006. The price of gold, another of PNG’s leading export commodities, is also expected to rise in 2005, by nearly 4%, before contracting by 5.4% in 2006. Such swings continue to highlight PNG’s vulnerability to changes in international prices for its main export commodities.

Economic growth Despite doubts over the reliability of the government’s estimates for growth in recent years, which we consider to be too high, the economy is picking up. In 2005-06 real GDP growth is forecast to accelerate steadily, notwithstanding the potential for adverse weather conditions to disrupt economic activity severely. (Poor weather conditions have already had a negative impact on the production and export of key agricultural commodities in the first quarter of 2005.) This trend reflects a fairly positive outlook for the mining and petroleum sectors, with the Kainantu and Simberi goldmines expected to commence operations by the end of 2005. Construction of the Hidden Valley gold project and the US$650m Ramu nickel-cobalt project could also begin later this year. In addition, prospects for the long-delayed PNG Gas Project, which centres on a pipeline to transport gas from the PNG Highlands to Queensland, Australia, continue to improve. In other areas of the economy, the outlook is mixed. Although the government’s efforts to promote export-led growth in agriculture will help to support steady expansion in this sector, there remain a number of weaknesses, most notably poor transport infrastructure that prevents easy access to markets. In terms of local demand, outstanding private-sector credit was down by around 5% year on year at end-2004, despite the looser monetary policy environment, but has since picked up rapidly, expanding by around 11% in April compared with the level of credit outstanding at end-2004. However, mitigating against any sustained substantial pick-up in private consumption and investment are the ongoing security concerns and bouts of social instability, which will continue to offset the positive impact of the recent stabilisation of the macroeconomic environment.

Inflation After accelerating slightly in late 2004, consumer price inflation has again eased, falling to only 0.1% year on year in the first quarter of 2005. The slowdown in inflation primarily reflects the improvement in the government’s fiscal regime as well as the strengthening of the kina. Food prices, which account for over 40% of the consumer price index, have also been relatively stable. It is unlikely that inflation will remain at such a low rate throughout 2005-06, as the BPNG’s decision to cut interest rates sharply in 2004 to support economic growth will result in a small rise in inflation. However, upward pressure on prices will not be strong by PNG’s standards, and average annual inflation will remain in single digits.

Exchange rates The kina continues to trade at a stable rate against the US dollar. In June the kina was trading at around Kina3.07:US$1; an appreciation of around 0.8% compared with January. Also, despite some volatility, the kina has generally strengthened against the Australian dollar, appreciating by 0.9% during the first half of the year to around Kina2.35:A$ in June. During the remainder of year, rising imports by the mining and agricultural sectors will put some downward

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pressure on the kina, particularly against the Australian dollar, which is set to appreciate against the US dollar. However, the kina will not weaken significantly, as the forecast deterioration in the current-account balance will be partly offset by stronger foreign investment receipts. In 2006 the kina could strengthen slightly against the Australian dollar as the latter currency depreciates against the US dollar. Moreover, in line with the relatively high level of foreign-exchange reserves (which totalled around US$550m in April 2005), the BPNG will be in a reasonably strong position to intervene in the currency market and provide support for the kina when necessary.

External sector The current-account balance is set to deteriorate steadily in 2005-06, after recording healthy surpluses equivalent to an estimated 3.2% of GDP in 2003 and 1.9% in 2004. Despite weakening export volumes for most commodities, export revenue will increase in 2005 in line with rising global oil prices (up by 31.2% year on year), gold (up by around 4%) and copper (up by 10.4%). This expansion in exports, however, will be offset by even stronger growth in the import bill. This trend was evident in the first quarter of 2005, when export revenue (in kina terms) increased by 5.8% year on year, compared with import growth of 28%. In 2006 export revenue will contract in line with weaker global prices for gold, crude oil and copper, which will offset expected gains in export volumes. The import bill will also continue to expand in 2006, owing in particular to increased mining-related imports as construction work on new projects continues. The combined deficit on the services and income accounts will remain stable in 2005-06, and the current transfers surplus will remain fairly healthy.

Forecast summary (% unless otherwise indicated) 2003a 2004b 2005c 2006c Real GDP growth 1.8b 0.7 1.1 2.8 Gross agricultural production growth 3.0b 0.5 2.0 2.8 Consumer price inflation (av) 14.7 2.1a 2.8 6.0 Consumer price inflation (year-end) 8.4 2.4a 5.0 6.5 Short-term interbank rate 13.4 13.3a 11.0 11.0 Government balance (% of GDP) -0.8b 1.5 -0.1 -1.0 Exports of goods fob (US$ bn) 2.2b 2.5 2.8 2.7 Imports of goods fob (US$ bn) 1.2b 1.5 1.7 1.8 Current-account balance (US$ bn) 0.1b 0.1 0.1 0.0 Current-account balance (% of GDP) 3.2b 1.9 1.2 -0.6 External debt (year-end; US$ bn) 2.5 2.2 2.0 2.0 Exchange rate Kina:US$ (av) 3.56 3.22a 3.15 3.30 Exchange rate Kina:¥100 (av) 3.075 2.980a 2.933 3.204 Exchange rate Kina:€ (year-end) 4.20 4.23a 3.79 4.47 Exchange rate Kina:SDR (year-end) 4.95 4.85a 4.64 5.20 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

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Papua New Guinea: gross domestic Papua New Guinea: consumer price product inflation (% change, year on year) (av; %)

Papua New Guinea Papua New Guinea Asia excl Japan Asia excl Japan 8.0 16 14 6.0 12 4.0 10 2.0 8 6 0.0 4 -2.0 2 -4.0 0 01 02 03 04 05 06 01 02 03 04 05 06 2000 2000

The political scene

Sir Michael appoints a new In early June the prime minister, Sir Michael Somare, appointed Sir Moi Avei as deputy his deputy, a post that had been vacant since Moses Maladina was sacked in April 2004. The appointment was designed to create regional balance among the most senior positions: Sir Moi is from the Southern region; the governor- general, Sir Paulius Matane, hails from the Islands region; the speaker of the national parliament, Jeffrey Nape, comes from the Highlands region; and Sir Michael’s home is in the Momase region. The appointment ended a period of intense speculation, particularly following the appearance of the prime minister’s legal adviser before the court to explain the status of the appointment. The matter was before the court on a reference by the Morobe governor, Luther Wenge, who claimed that leaving the constitutional post vacant for lengthy periods was unconstitutional. The appointment was unexpected—traditionally, the deputy prime minister comes from one of the larger parties, but Sir Moi is the leader of the Melanesian Alliance, one of the smaller parties in the governing coalition, with only three members of parliament (MPs). However, the decision has not created any marked instability in the coalition. Responding to calls for more representation in executive positions for the Highlands region, particularly the Southern Highlands province, Sir Michael defended the regional balance among senior levels of the public service. Combining departmental heads, chief executive officers of state-owned enterprises, provincial administrators, constitutional office holders and other senior government positions together, the Islands region fills 55 posts, ahead of the Southern region (51), the Highlands region (50) and Momase (39).

A number of political parties The political scene continues to be disrupted by splits in a number of political remain mired in disputes parties, some of which have members on both sides of parliament. The governing coalition, however, appears to be benefiting, as the opposition has struggled to regroup and strengthen itself, and, as a result, talk of no-confidence motions against the government has subsided. In June Mr Nape ruled that only

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the Peoples National Congress constitutes the opposition, although two of its members, including its founder, Sir William Skate, support the government. Currently, three members of the Peoples Progress Party (PPP) sit in the opposition benches, and a PPP member, Andrew Baing, has been chosen as deputy opposition leader. Mr Nape told parliament that he would refer these cases to the Ombudsman Commission for breaches of the Organic Law on the Integrity of Political Parties and Candidates. Mr Nape also advised parliament that he recognised United Resources Party as comprising four members led by Sam Akoitai, the mining minister; all other MPs claiming membership of the party have been labelled independents. The opposition rejected Mr Nape’s rulings claiming that they were inconsistent with those of the Registrar, the rightful authority on the integrity law. A number of other parties continue to suffer internal splits. The dispute over the leadership of Pangu Pati between Sir Rabbie Namaliu, the foreign affairs minister, and the Gulf governor, Chris Haiveta, is still before the courts. Also, Sir Julius Chan and a minority of PPP MPs recently held a convention preparing for the 2007 elections, during which they resolved to remove the trade and industry minister, Paul Tiensten, from the party. Mr Tiensten and the government-supporting majority of the party’s MPs boycotted the convention.

Bougainville’s government is The election in May-June for an autonomous government in Bougainville was established completed without serious incident. The newly elected government was inaugurated on June 15th with Joseph Kabui, the leader of the Bougainville People’s Congress (BPC), securing the presidency. Mr Kabui received around 31,000 votes in the presidential election compared with around 20,000 for his nearest rival, John Momis, who resigned his post as governor of Bougainville to contest the election, and Mr Kabui was ahead of Mr Momis in all three regions. An even bigger gap separated Mr Momis from the other three presidential candidates. Following his defeat, Mr Momis relinquished leadership of his New Bougainville Party to Ezekiel Massat, who immediately pledged his support for Mr Kabui under a grand coalition government. However, Mr Momis has indicated that he intends to challenge the result of the election, alleging intimidation and multiple voting. Mr Kabui has named a ten-member cabinet, eight of whom are members of his party. The remaining two are Mr Massat and Moses Koiri, an independent. Mr Kabui said that his cabinet was fairly representative of the three regions on the island, the committees of which will make recommendations to him. The 39-member assembly comprises 33 constituency seats and six seats reserved for three women and three former combatants, each elected from the island’s three regions. A total of 15 members of Mr Kabui’s BPC gained parliamentary seats, and another 19 successful candidates enjoyed his support. Mr Kabui paid tribute to the UN observer mission in Bougainville, which withdrew on June 30th, for its part in the peace process.

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The Bougainville cabinet portfolios

Joseph Kabui (president): inter-government affairs, labour and employment, national and international affairs, reconciliation and unity and peace. Joe Watawi (vice-president): public service, planning and monitoring, trade and industry, port services and microfinance. Gerard Sinato (former deputy governor): health, environment, conservation, water and sanitation. Ms Magdalen Toroans (women’s representative for central Bougainville): women’s issues and religion, traditional authority, local level government and non- governmental organisations. Mathias Salas (member for North Nasioi): finance and treasury, minerals, petroleum and gas exploration. Moses Koiri (member for Ramu in Siwai): works, transport and civil aviation, lands, physical planning, growth centres, housing, energy and telecommunications and information technology. Ezekiel Masatt (member for Tonsu): police services, justice, correctional service, courts, liquor licensing, customs and quarantine. Michael Otoroa (member for Lato in Bana): education, higher education, research, science and technology and “kastom”, or traditional culture. Taehu Pa is (member for Atolls): fisheries, primary industries, forestry, commerce and culture and tourism. Glyn Tovirika (former-combatants representative for central Bougainville): youth, veterans’ affairs, sports and recreation. The first parliamentary session of the autonomous region of Bougainville has adjourned until July 26th. On its resumption, the focus of attention will be on the economy and the budget. Completion of weapons disposal is also likely to be on the parliamentary agenda. Some weapons were not contained during the peace process, and some contained weapons were subsequently stolen, according to Mr Kabui. The future of the Panguna copper mine, which has been inactive since the secessionist leader, Francis Ona, attacked it in 1989 and began the chain of events that led indirectly and painfully to autonomy, is also certain to feature prominently in parliamentary debate. However, Mr Akoitai, a Bougainvillean, has cautioned against developing expectations about an early resumption of mining at Panguna, noting the deeply sensitive nature of the issue—the Panguna mine divided the community, and resolution of the ensuing conflict took 16 years and cost an estimated 10,000 lives. Moreover, such a move would cost Kina2bn (US$650m). His remarks came in the wake of growing speculation that the region was now open to exploration and mining. Meanwhile, the owner of the mine, Bougainville Copper Limited, is fully engaged in challenging a national court order to pay Kina28m (US$9m) in taxes. Despite Mr Ona’s brief public appearance prior to the elections, denouncing them as unnecessary as Bougainville was a kingdom of which he was king, he did not hinder them. Owing to the unexpectedly high turnout in the Me’ekamui “no go” zone, polling at the Panguna mine site workshop was extended for a day. According to the Bougainville administrator overseeing the

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election on behalf of the national government, Peter Tsiamilili, there was no organised resistance to the elections and the disruption that did occur was the work of unrelated opportunists.

The ECP ends prematurely On May 13th the Supreme Court unanimously declared that parts of the law supporting the establishment of the Enhanced Co-operation Programme (ECP) with Australia were unconstitutional. As a result, the five-year ECP, which only came into effect in June 2004, was immediately suspended, and the 115 Australian personnel working in the country were withdrawn. Under the Kina2bn programme, Australia was set to deploy a full complement of 210 Australian police officers. (Despite the withdrawal of Australian police, getting more police on the streets remains the strategy in the national capital, according to PNG’s police chief, Tony Wagambie.) Although all Australian police officers have been withdrawn, other Australian personnel involved in the ECP and affected by the court decision have remained in the country, according to Sir Rabbie. Both governments want the programme to resume as soon as possible, but PNG has repeated its original stance that it will not change the constitution to accommodate Australia’s original immunity requirement for its personnel. The two governments had compromised on a joint-steering committee on oversight to determine culpability and trial under Australian jurisdiction. However, on a reference by Mr Wenge, the Supreme Court found this arrangement to be inconsistent with the independence granted under PNG’s constitution to the offices of the public prosecutor and police commissioner. Sir Rabbie was critical of a related article in an Australian newspaper based on a paper published by an Australian think-tank, Centre of Independent Studies, that he claimed implied without substantiating evidence that PNG’s elite had conspired to bring about the demise of the ECP. Sir Rabbie argued that under a political conspiracy MPs would not have been allowed to pass the law that made the ECP operational.

PNG reinforces the “One PNG continues to adhere to its “One China” policy, under which it recognises China” policy Taiwan as part of mainland China. This position was reaffirmed in late May during the visit of a high-level Chinese delegation to PNG, led by Wang Jiarui, China’s minister of the International Department of the Chinese Communist Party. Sir Michael said that he valued “China’s friendship”, and during his meeting with Mr Wang both sides agreed to strengthen bilateral relations. China’s interest in investing in PNG’s mining industry has been growing, with the China Metallurgical and Construction Company agreeing earlier this year to take up a six-month option for a stake in the long-delayed US$650m Ramu nickel-cobalt project in Madang province. PNG’s policy towards Taiwan, however, has often complicated ties with China, particularly as Taiwan has been permitted to establish a presence in PNG under a trade mission to promote bilateral economic ties. The opposition recently criticised the government for its failure to uphold its “One China” policy, after

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the health minister, Melchior Pep, supported Taiwan’s bid to be a World Health Organisation (WHO) member during his address a recent WHO conference. The issue, however, did not create any problems during Mr Wang’s visit.

Economic policy

The government records a In the first quarter of 2005 the government recorded a budget surplus of budget surplus Kina127.1m (US$41m), up from Kina13.8m in the same period of 2004. The surplus reflected the continued expansion in revenue and a fall in expenditure. Tax revenue rose by 18.3% year on year in the period, and was equivalent to around 22% of the full-year budget projection. Rising global prices for crude oil and some agricultural products contributed to a threefold expansion in company tax in the first quarter compared with the revenue collected in the year-earlier period. Personal income tax also rose during this period, increasing by 11% in line with higher salaries and increased private-sector employment. Government expenditure fell by 0.5% year on year in the first quarter, and was equivalent to only 11.7% of the full-year budget. Recurrent expenditure fell by 6.7% year on year, mainly because of lower interest payments, which fell to only Kina41.4m in the first quarter compared with Kina142.7m in the year- earlier period. However, rising salaries and the higher cost for goods and services pushed up national departmental and provincial government spending. Although development expenditure in the first quarter totalled only Kina58.8m, around 3% of the full-year budget, this was more than double the amount spent in the year-earlier period. The slow pace of development spending is partly the cause of the slow disbursement of foreign grants. In 2004 only around 70% of the full-year budget for development expenditure was spent, and foreign grants were much lower than had been expected. The failure to execute the development budget remains one of the main weaknesses of the government’s fiscal policy, and the Bank of PNG (BPNG, the central bank) is calling on the government to generate sustainable economic growth through its development budget. By running a budget surplus in the first quarter, the government was in a position to reduce foreign debt by repaying Kina101m worth of external obligations. Total public debt dropped slightly in the first quarter to Kina7.5bn, with net repayments and exchange rate movements contributing to a drop of 5% in external debt, which was partly offset by a 6% increase in domestic debt.

Central government finances (Kina m) 2004 2004 2005 1 Qtr 2005 Budget Outturna Budgeta Outturn Total receipts 3,837.1 3,939.5 4,639.7 684.2 Tax revenue 2,791.8 3,220.2 2,985.0 645.2 Personal tax 815.0 826.5 865.6 226.4 Company tax 712.4 1,071.0 882.1 100.0 Value-added tax 313.3 315.7 332.4 77.0 Other sources 951.1 1,007.0 904.9 241.8 Non-tax revenue 195.6 240.1 371.6 39.0 Foreign grants 849.7 479.2 1,283.1 0.0

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Central government finances (Kina m) 2004 2004 2005 1 Qtr 2005 Budget Outturna Budgeta Outturn Expenditure 4,032.6 3,705.5 4,777.4 557.1 Recurrent expenditure 2,756.0 2,801.9 2,889.1 498.3 National departmental 1,272.7 1,556.6 1,586.6 270.9 Provincial governments 607.3 672.2 628.1 139.1 Interest payments 692.4 375.6 480.5 41.4 Foreign 177.4 138.1 133.4 29.4 Domestic 515.0 237.5 347.1 12.0 Other grants & expenditure 187.6 207.9 197.9 46.9 Net lending & investments -4.0 -10.4 -4.0 0.0 Development expenditure 1,276.6 903.6 1,888.3 58.8 Overall balance -195.5 234.0 -137.7 127.1 a Preliminary data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The privatisation programme The government has made no progress in selling off state assets. In June the is at a standstill national planning and rural development minister, Arthur Somare, indicated that the government was no longer planning to sell the state-owned telecommunications firm, Telikom PNG—this followed the rejection in late 2004 by the cabinet of an agreement to sell 51% of the firm with Econet Wireless, a firm representing Botswanan and South African interests. Instead, a task-force has been established to return the enterprise to good technical and financial health. Telikom is, however, experiencing an increase in vandalism as a result of high copper prices in the scrap market, and has blacklisted some 25 precincts in the national capital. It is looking to wireless technology as a possible solution to this ongoing problem. Recent government-initiated changes in the composition of the boards of several state-owned enterprises (SOEs) and the government’s privatisation agency, the Independent Public Business Corporation (IPBC), have also raised questions over the independence of SOEs. (The IPBC was established in 2002 by Sir Mekere Morauta under his privatisation strategy as a holding entity for all SOEs, partly in order to make them immune to political interference.) The entire board of PNG Power, the state electricity utility, was replaced, and the prime minister’s eldest son, Sana Somare, was subsequently appointed to the board. The managing director of the IPBC, Masket Iangalio, who had previously been removed from the boards of Telikom, PNG Power and the Rural Development Bank, was also removed from the PNG Harbours board in June. Mr Iangalio, who has publicly questioned the process by which some of these appointments were made, was subsequently sacked by the prime minister, apparently for leaking information relating to plans for Telikom to the Milne Bay governor, Tim Neville.

Monetary policy remains The BPNG has maintained a neutral monetary policy. In June 2005 the BPNG neutral kept the kina facility rate (KFR, the rate it announces at the beginning of each month to indicate in which direction it wants interest rates to move) at 7%, unchanged since October 2004. It has also retained the 25% liquid assets ratio

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and 3% cash reserve requirements ratio. Short-term Treasury-bill rates increased during the first quarter of 2005, whereas longer-dated ones declined, flattening the yield curve. Reflecting the banking system’s high liquidity, which has kept inter-bank activity subdued, the BPNG has been selling T-bills and central bank bills in an effort to diffuse excess liquidity and maintain stable interest rates. As a result of excess liquidity in the banking system, interest rates on commercial bank deposits fell to 0.88% per year in May from an average of 1.73% in 2004 and 4.38% in 2003. Lending rates have also dropped, falling to 11.63% in May from an average of 13.32% in 2004.

Papua New Guinea: interest rates (%) 18 16 182-day Treasury-bill rate 14 Kina facility rate (a) 12 10 8 6 4 2 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2004 05 (a) Monthly BPNG benchmark rate. Source: Bank of Papua New Guinea, Statistics Update.

Money supply (Kina m; end-period) 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Domestic credit 2,501.4 2,614.5 2,733.8 2,919.6 3,106.0 Non-government 1,482.1 1,468.2 1,466.4 1,451.0 1,559.2 Central government 1,019.3 1,146.3 1,267.4 1,468.6 1,546.8 Net foreign assets 1,654.3 1,874.8 1,984.0 2,155.9 2,025.5 Total money supply (M3) 3,008.1 3,279.0 3,384.7 3,597.9 3,575.8 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The government seeks new The government appears keen to tweak policy and introduce legislative legislation in key sectors changes in the mining, forestry and fisheries sectors, ostensibly to improve efficiency. In the mining sector, the government is currently reviewing the role of the Mineral Resources Development Company, which looks after both state and landowner interests in the mining and petroleum sector. It seems likely that the company’s role will be limited to looking after landowner interests, and that a new entity will be created to deal with state interests. The government has also decided to proceed with the establishment of the Mineral Resources Authority, which will reduce dependency on the national budget of the cost of administering the minerals sector by introducing a production levy on the industry. Mining legislation is being reviewed under a World Bank

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sectoral project. Possible legislative changes include the introduction of regulations relating to mine closure and the extension of the duration for exploration licences, with a mid-term review and automatic renewal provided certain conditions have been met. A bill to amend forestry legislation is proving controversial. The bill is aimed at streamlining the licensing process in line with the country’s export-driven recovery strategy. Opponents of the bill claim that it sides with the loggers at the expense of the landowners, and that it would legalise some currently illegal practices. A former chief justice, Sir Arnold Amet, considers the bill to be unconstitutional. Sir Michael’s advice to those who oppose the changes is to challenge them in court after they become law, not in the parliament in the process of becoming law. Meanwhile, the government is calling for the inclusion of rainforests in the Kyoto protocol, noting the finding of the UN Intergovernmental Panel on Climate Change that 20-25% of carbon emissions during the 1990s were generated primarily from degradation of forest resources. Among other things, the government has proposed carbon trading credits for deforestation abatement. In the fisheries sector, the government is considering a new method for allocating access rights to PNG’s 322-km economic zone. Currently, bilateral agreements allow for an annual catch by vessel. The alternative, known as the vessel day system, would allocate a number of fishing days per year. The peak management authority for Pacific fisheries would then allocate a number of vessel days to PNG, whose national fisheries authority would then allocate them among the fleet operating in its waters.

The domestic economy

Economic trends

Employment and nominal Although regular and timely GDP data are not available, it appears that the sales rise steadily economy remained fairly stable towards end-2004 and in early 2005. According to the employment index published by the Bank of Papua New Guinea (BPNG), employment (excluding the mining sector) increased by just 0.3% year on year in the fourth quarter of 2004 (the latest data available). Increases were recorded in a number of sectors, with employment rising by 12.6% year on year in the wholesale sector, by 7.7% in transportation, by 3.2% in finance and other services, and by 2.7% in manufacturing. Offsetting this growth were decreases in employment in building and construction (down by 11% year on year), retailing (3.3%), and agriculture, forestry and fisheries (down by 2.8%). The mining sector recorded a slight expansion of 0.4% in employment, reflecting recruitment by several major gold and copper producers. Employment increased in all regions except the Highlands and Southern regions. In Morobe it increased by 5.2%, in Momase by 4.2% and in the Islands region by 3.9%. In the National Capital District employment increased by only 0.6% year on year. In the Southern and Highlands regions employment declined by 6.7% and 12.1% respectively.

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Further signs of only steady economic growth in 2004 are provided by the results of the BPNG’s Business Liaison Survey. The survey showed that nominal sales growth reached only 3% in 2004, down from 6.7% in 2003. The nominal value of sales rose in all sectors except transport, and agriculture, forestry and fisheries. In the manufacturing sector total nominal sales value increased by 7.9% year on year, up slightly from 7% in 2003. This expansion reflects higher production of processed food and beverages, in addition to higher sales of metals, plywood and sawn timber. The 5% drop in the nominal value of sales from agriculture, forestry and fisheries, the second year of decline, reflected the lower production of most agricultural products, including key export commodities such as coffee, cocoa and palm oil, offsetting the impact of higher prices.

Inflation continues to fall, as PNG experienced some consumer price deflation in the first quarter of 2005, the kina remains strong partly owing to the general appreciation of the kina against its major trading partners. For example, against the Australian dollar the kina appreciated by 1.3% at the end of the first quarter of 2005 compared with its value at the end of the preceding quarter, and by 2.6% year on year. (However, the kina has depreciated against the Australian dollar from its strong position in mid-2004.) The kina also steadily appreciated against the US dollar and the yen. Partly reflecting these trends and the drop in import prices in kina terms, inflation (based on the consumer price index) fell by 1.2% quarter on quarter in the first quarter of 2005. Year-on-year price changes were marginal, with inflation dropping to only 0.1% year on year in the first quarter. All expenditure groups except food and miscellaneous goods recorded quarter- on-quarter price falls. The steepest fall, of 8.3% in quarter-on-quarter and year- on-year terms, came in the transport and communication services category. Despite high global prices for fuel, the impact on domestic prices has been offset by the general appreciation of the kina. Prices also fell quarter on quarter in the household equipment and operations expenditure group (by 3.8%), clothing and footwear (2%), and drinks, tobacco and betelnut (1.1%). In the first quarter food prices increased by 2.3% quarter on quarter and 1.4% year on year, with rising prices for cereals, meat and fish offsetting a decline in prices for fruit and vegetables. Underlying inflation, which excludes the prices of betelnut, fruits and vegetables, and the effects of government policy decisions on prices of consumer goods, was negative in the first quarter.

Quarterly inflation (1977=100) 2003 2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Consumer price index 766.8 769.8 778.0 780.7 778.3 788.1 778.7 % change, year on year 11.8 8.4 2.5 1.9 1.5 2.4 0.1 Underlying inflationa 496.6 496.6 501.6 505.3 512.4 506.3 500.2 % change, year on year 14.5 10.0 5.3 2.6 3.2 1.9 -0.3 a Exclusion-based. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Papua New Guinea: exchange rates (a) (scale inverted) 2.0 2.2 2.4 2.6

2.8 K:US$ 3.0 K:$A 3.2 3.4 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2004 05 (a) First week of month. Source: Bloomberg.

Oil and gas

Prospects for the PNG Gas The prospects for the eventual go-ahead for the long-delayed PNG Gas Project, Project improve which centres on the construction of a pipeline to pump gas from the PNG Highlands to Queensland, Australia, continue to improve. The project’s operators, led by the US’s ExxonMobil, reached a sales agreement with Canada’s Alcan, the operator of an aluminium smelter at Gove in the Northern Territory of Australia, in June. Under the agreement, Alcan has agreed to take 43.5 petajoules a year over 20 years. In early July Australia Gas Light Company signed a deal to take 75 petajoules a year over 20 years. In late June Sir Moi Avei, the petroleum and energy minister, and newly appointed deputy prime minister who has had ministerial responsibility for the project from the outset, led a bipartisan parliamentary delegation to Queensland to allay potential customers’ concerns about supply reliability. Such concerns have been played up by competing energy supply sources in Queensland. Sir Moi has said that there is strong support for the PNG Gas Project by the Queensland government in addition to the federal government of Australia. In February the official opening of the offices in Brisbane for the Front-End Engineering Design (FEED) phase lifted the project’s profile and stimulated optimism about its prospects. A final decision on whether to proceed with the project is expected to be made in 2006. In addition to Exxon Mobil, PNG-based Oil Search, MRDC (a PNG company representing local landowner interests) and Japan’s Nippon Oil Exploration have a stake in the project.

Crude oil production falls A month-long repair to two of the six sea anchors to the Kumul oil loading temporarily terminal in February-March caused a reduction in crude oil production at most fields in the first quarter of 2005. Oil Search, which has controlling stakes in a number of fields, reported that its overall production fell in the first quarter to around 2.1m barrels, down by 22% quarter on quarter and 20% year on year. However, since returning to full production following the completion of repair work on the loading terminal in early March, the firm has reported that its daily

output exceeded 50,000 barrels for the first time in a number of years. Oil Search has therefore forecast that most of its deferred production will be made up over the course of the remainder of the year. It also forecasts extra production from NW Moran field, despite landowner issues slowing progress, and from the SE Mananda field. Before the temporary closure of Kamul, two new wells on the Kutubu oilfield raised full production there to 19,000 barrels/day, the highest rate since 2003, and production at this rate has reportedly continued from early March. Production at the Moran field has exceeded 7,000 b/d, and the Gobe field produced slightly less than 9,000 b/d. Crude oil export volume in the first quarter of 2005 declined by nearly 36% year on year to 2.1m barrels. In addition to the natural decline in reserve levels, the temporary closure of the Kumul loading terminal contributed to this downturn. However, export revenue from crude oil dropped by around 26% year on year owing to the rising global prices. Prices for Kutubu oil averaged around US$50.7 per barrel in the first quarter compared with around US$34.5/b in the year-earlier period. Prices have continued to rise, reaching US$59.3/b in early May before slipping back to around US$53.5/b in mid-June.

Papua New Guinea: Kutubu oil prices (a) (US$/barrel)

30 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2004 05

(a) Price during first week of the month. Source: Bloomberg.

Mining

Gold production and Production at the country’s two largest goldmines declined in the first quarter exports fall of 2005, and total gold exports fell by 22% both year on year and quarter on quarter. The Porgera mine produced 240,000 oz (around 6.8 tonnes) of gold in the first quarter of 2005, down by 6% year on year. The mine’s operator forecasts output of 800,000 oz for the full year compared with slightly more than 1m oz in 2004. The Lihir mine produced around 101,000 oz of gold in the first quarter, down by 39% quarter on quarter and 10% year on year. A planned maintenance shutdown accounted for most of the quarter-on-quarter reduction at Lihir, but lower ore grades contributed to all of the year-on-year decrease. The company forecasts 130,000 oz of gold production in the second quarter and 700,000 oz for the full year resulting from higher ore grades.

The mine, which is located in the caldera of a still-hot volcano, commissioned a 30-mw geothermal electricity power plant in May to add to the 6-mw prototype already operating. A further 20-mw plant is planned, which would make operational power self-sufficient at current design production level. As a result of this development, the company expects soon to become eligible to sell carbon credits in the international market. The Lihir mine plans to raise annual production by 140,000 oz of gold poured by early 2007 with an investment of US$160m in a flotation plant, construction of which will commence before the end of 2005. The company also plans field trials, commencing later in the year, of biological oxidation of low-grade ore. If successful, this would allow earlier processing of 3m oz of stockpiled ore originally scheduled for processing after mining operations cease in 2020. Construction of the Kainantu goldmine in the Eastern Highlands province is progressing. PNG-based Highland Pacific, the developer of the short-life (four and half years), high-grade goldmine, expects that the mine will be completed by the end of 2005 at a cost of US$57m. Around 60% of construction was reportedly completed by mid-2005. The simple, low environmental impact mine is designed to produce 21,500 tonnes of high-grade gold concentrate per year for export to Japan, where it would be smelted, and 115,000 oz of gold would then be recovered. High metal prices in 2004 allowed Ok Tedi Mining to achieve the highest copper and gold revenue in around 15 years, despite reduced volumes owing to low water levels in the Fly River. Copper production in 2004 was 10% below plan and equivalent to only 60% of total production in 2003. However, copper export volume picked up strongly in the first quarter of 2005, rising by 40% year on year.

Mineral exports by volume 2003 2004 2005 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Crude oil ('000 barrels) 2,857 3,268 3,791 2,331 3,175 2,104 Copper ('000 tonnes) 69.1 46.3 49.1 39.8 38.7 64.8 Gold (tonnes) 18.8 17.7 17.3 14.7 17.6 13.8 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Agriculture, fisheries and forestry

Exports of most agricultural In the first quarter of 2005 there was a sharp downturn in export volumes of commodities decline most agricultural commodities. Exports of palm oil plunged by 36.5% year on year to only 64,200 tonnes owing to unfavourable weather conditions in the palm oil producing regions. The sector thrived in 2004, with the largest producer, New Britain Palm Oil, reporting a 16% year-on-year increase in crude palm oil production to a record 225,000 tonnes, exceeding its forecast by 7%. Refinery production, taking about 40% of crude palm oil output, also increased in 2004, rising by 22% year on year.

Coffee output dropped by 26.8% year on year to 6,000 tonnes, with lower sales volumes partly attributable to the deterioration in road infrastructure. PNG’s coffee exports, however, still have potential for expansion, according to a recent local study of the Japanese coffee market. Japanese importers appreciate the reliability of supply from PNG and the minor time difference compared with Africa. Japan is now the third-largest market for coffee exports from PNG, after the US and Germany, but it sources just 1.3% of its supply from PNG. The study noted that although 80% of PNG’s crop is organically grown, only a small fraction is so recognised. PNG could therefore benefit strongly from the establishment of a certifying authority. Cocoa export volume dropped by 17.3% to 8,600 tonnes, again because of poor weather conditions in cocoa-growing regions. In a recent review of the cocoa industry, the chief executive of the industry association raised concerns over low productivity and high freight costs. Smallholders in PNG produce 300-400 kg per ha compared with 900 kg by their Indonesian counterparts.

Logging exports rise The forestry sector has enjoyed an expansion in logging exports in recent quarters, with export volume in the first quarter of 2005 rising by 22.8% year on year to 608,000 cu metres. This mainly reflected higher production and ship- ments from major logging projects as a result of favourable weather conditions. However, in terms of forestry management, there are serious problems. In May 2005 the World Bank cancelled its Forestry and Conservation Project after it failed to reach an agreement with the government on a number of key issues. The project, which was introduced in 2001 and was supported by a World Bank loan of US$17.4m and two Global Environment Facility grants totalling the equivalent of US$17m, had been suspended since 2003. The cancellation of the World Bank project could lead to an expansion in the industry, raising some concerns over long-term sustainability. One of the main causes of tension between the World Bank and the government was the latter’s decision to issue new timber permits despite concerns over compliance issues of the firms receiving the permits. When coming into office in 2002, the administration of the prime minister, Sir Michael Somare, planned to start ten new forestry projects, but none have yet been established.

Agricultural exports by volume ('000 tonnes unless otherwise indicated) 2003 2004 2005 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Cocoa 13.6 10.1 8.5 10.4 9.1 10.5 11.5 8.6 Coffee 14.5 28.3 18.1 8.2 17.3 23.7 13.8 6.0 Tea 1.8 1.3 1.6 2.3 2.1 1.9 1.8 1.8 Copra 2.1 1.3 2.8 5.3 4.6 5.6 3.7 6.4 Copra oil 14.4 12.8 11.2 7.6 14.4 8.2 14.9 11.6 Palm oil 83.1 75.2 73.8 101.1 92.9 67.7 77.3 64.2 Rubber 1.0 1.0 1.2 0.8 0.7 1.2 1.1 1.1 Logs ('000 cu metres) 478.0 488.0 507.0 495.0 433.0 442.0 642.0 608.0 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Fisheries exports fall, but there In the first quarter of 2005 the value of fisheries exports declined by 57% year are opportunities for growth on year to only Kina9.8m (US$3.2m), with weak export volume offsetting rising prices. There has been some positive news, with PNG penetrating the European fish market. A recent seafood exposition in Brussels, Belgium, yielded supply agreements for PNG’s largest tuna exporter, Sangko Possan, in addition to sales worth US$17m for three smaller operators. Europe represents a geographic diversification for Sangko Possan, which already services the lucrative Tokyo weekend sashimi market, transhipping through Cairns, Australia. Its product is stored at Port Moresby’s international airport in a facility established by the National Fisheries Authority (which is funded in part by a levy on fishing companies) and managed by the national airline, Air Niugini. The airline services the tuna export market in competition with an Australian-based charter operator. Sangko Possan may benefit from a recent incident that brought Air Niugini’s cool-room charges to the attention of the fisheries minister, Ben Semri. Mr Semri, mindful of the government-owned carrier’s obligations to support the government’s export-led recovery strategy, has called for a cost analysis to be conducted.

Financial and other services

Efforts to improve financial Formal financial services in PNG, although relatively sophisticated, are mainly services access are made urban-based and not easily accessible. However, the government appears keen to improve the situation through reforms of the legal framework governing banks and financial institutions. One of the main thrusts of planned reforms is to provide the opportunity for unlicensed microfinance institutions to become legal, according to Sir Peter Barter, the minister for inter-governmental relations, who spoke on the issue during an address to the Pacific Regional Conference on Micro-saving in late June. The government’s microfinance policy initiatives have so far led to the opening of two microfinance banks on a pilot basis. Sir Peter also said that the government was keen to abolish informal quick money- making schemes, known as “pyramid” schemes. In late 2004 the BPNG governor, Wilson Kamit, warned people against investing in such schemes, which he said had created financial problems for many people.

Air Niugini struggles with Air Niugini has become embroiled in a dispute with the Civil Aviation safety issues, but earns a profit Authority (CAA) over safety-compliance issues, which led to the airline grounding its aircraft for one day on July 9th. The issue centres on Air Niguni’s failure to install Enhanced Ground Proximity Warning System (EGPWS) devices on its Fokker aircraft by a set deadline of July 1st. The CAA reportedly had agreed to grant Air Niugini an exemption until October 31st 2005, but decided to revoke this decision effective July 8th. Air Niugini returned to normal operation on July 10th and began legal action against the CAA. The opposition has since called on the government to investigate the matter. The safety-compliance issue notwithstanding, Air Niugini has been enjoying a period of positive growth and financial health. According to the airline, in May it was free of all bank and financial institutions’ debt, and the chairman of the airline’s board of directors, Joseph Tauvasa, has said that the airline is set to

become a “financially strong business” over the next few years. Air Niugini carried more than 202,000 international passengers in 2004 (up by 8.7% year on year) and more than 538,000 domestic passengers (up by 6.7% year on year). In its code-sharing arrangement with Australia’s Qantas for flights between PNG and Australia, the local airline increased its share from 51.6% in 2003 to 53.4% in 2004. Freight lifted in 2004 also increased year on year, rising by 8.3%. Mr Tauvasa has attributed the growth in the airline’s business to PNG’s improved macroeconomic environment.

Foreign trade and payments

Export growth lags behind that Merchandise export earnings in the first quarter of 2005 reached Kina2.1bn of imports (US$680m), an increase of 5.8% year on year. In the first quarter, for the first time since the mid-1990s, copper was the leading source of export revenue, accounting for around 31% of the total. Copper exports expanded by a rapid 72.5% year on year to around Kina650m (US$210m), in line with both rising volume and prices. Partly offsetting this expansion, both gold and crude oil exports recorded lower export revenue in the first quarter. Export prices (in kina terms) fell slightly year on year for gold, but rose by nearly 15% for crude oil. The agricultural sector recorded a sharp deterioration in export revenue owing to falling export volumes and prices for most commodities. Exports of refined petroleum products have expanded rapidly since the Napa Napa oil refinery began operations in the second half of 2004, reaching Kina240.7m in the first quarter of 2005, accounting for about 11.5% of total exports. The value of merchandise imports in the first quarter of 2005 stood at Kina1.3bn, up by 27.7% year on year. Some of this increase reflected the depreciation of the kina against the Australian dollar, the principal source of PNG’s imports. Increased demand also contributed to a 32% increase in general imports to Kina1bn. Imports by the petroleum sector in the first quarter rose to Kina75m, almost three and one-half times the level recorded in the year-earlier period, primarily because of construction activity at the NW Moran oil project. Lower capital expenditure at all mines except Ok Tedi led to a 7.4% year-on-year decline in imports by the mining sector, to Kina225m in the first quarter. Exports (Kina m) 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Agricultural products 381.1 403.0 370.2 330.9 215.4 Forestry products 97.7 104.5 107.4 149.9 120.6 Logs 86.0 75.1 79.4 115.2 105.2 Refined petroleum products - - 37.0 165.8 240.7 Marine products 22.9 11.8 13.3 10.2 9.8 Minerals (incl silver) 1,465.0 1,619.1 1,292.9 1,630.5 1,494.3 Gold 726.2 699.1 612.5 741.7 563.4 Crude oil 352.0 473.1 317.7 509.4 260.7 Copper 376.5 438.4 356.9 372.4 649.6 Total 1,966.7 2,138.4 1,820.8 2,287.3 2,080.8 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Trade with Australia declines During the first quarter of 2005 Australia remained PNG’s main export market sharply and leading source of imports. However, PNG’s exports to Australia fell to Kina734.5m in the first quarter, down from Kina898m in the year-earlier period. As a result, Australia accounted for only around 35% of total exports in the first quarter compared with an average of around 45% in 2004. The decline in importance of Australia as an export market has also been the result of increasing exports to Japan and South Korea. In the first quarter PNG’s exports to Japan jumped by 64% year on year to Kina344m, and exports to South Korea more than doubled to Kina210m. Imports from Australia have also dropped, falling by 7.7% year on year to Kina526m in the first quarter, accounting for 40% of the total compared with an average of around 57% in 2004, according to data from the Bank of Papua New Guinea (BPNG, the central bank). Imports from the US have expanded sharply, rising by 155% year on year to Kina230m in the first quarter, and imports from New Zealand have also increased rapidly, reaching Kina127m in the first quarter of 2005, compared with only Kina41m in the year-earlier period.

The current and financial In the first quarter of 2005 both the current account, and the capital and accounts record deficits financial account recorded deficits, producing an overall deficit of Kina255m on the balance of payments. The current account plunged into a deficit of Kina211m in the first quarter from a surplus of Kina450m in the fourth quarter of 2004 owing to the deterioration in the merchandise trade surplus. The deficit on the services account narrowed slightly in the first quarter of 2005 compared with the year-earlier period, reflecting declines in payments for overseas travel, education and financial services. However, the income-account deficit widened slightly in the first quarter of 2005 compared with the year-earlier period mainly because of increased dividend payments, combined with lower income receipts. The surplus in net transfers declined to only Kina75m from Kina177m in the year-earlier period reflecting a decline in receipts from gifts and grants in addition to higher payments for licensing fees. The net outflow on the capital and financial accounts of Kina79m in the first quarter 2005 was considerably smaller than the deficit recorded in the year-earlier period. The net outflow reflected an increase in portfolio investments held abroad and net foreign loan repayments by government more than offsetting direct equity inflow and draw- down on mineral companies’ foreign currency accounts. In line with the overall balance of payments deficit, international reserves at the end of the first quarter fell by 12% compared with the level at end-2004. However, at Kina1.8bn, international reserves remain relatively high, up by 8% compared with the level at the end of the first quarter in 2004. Reserves currently provide around four months of total import cover, and more than five months of non-mineral import cover. According to the IMF, total reserves (excluding gold) stood at US$548m in April 2005, down from a high of US$600m in November 2004.

Balance of payments (Kina m) 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Merchandise exports 1,972 2,143 1,826 2,292 2,086 Merchandise imports -1,032 -1,245 -1,322 -1,102 -1,320 Trade balance 940 898 504 1,190 766 Services balance -700 -687 -590 -495 -632 Income balance -413 -518 -209 -266 -420 Net transfers 177 270 117 21 75 Current-account balance 2 -37 -178 450 -211 Net direct investment 56 12 15 -1 13 Portfolio investment 355 -329 -328 -36 -145 Financial derivatives -8 -16 -4 -3 -3 Other investment -528 423 634 -172 56 Capital & financial account balance -125 90 317 -212 -79 Net errors & omissions 59 30 -28 -39 35 Overall balance -64 83 111 199 -255 International reservesb 1,668 1,751 1,862 2,061 1,806 a Provisional data. b End-period. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Papua New Guinea: foreign-exchange reserves (US$ m) 700

600

500

400

300

200

100

0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Apr 2001 02 03 04 05

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

Public-sector external debt The government repaid Kina101m of its foreign debt in the first quarter of 2005, continues to fall which, together with unrealised exchange-rate gains as the kina appreciated against a weakening US dollar, reduced public foreign debt outstanding to Kina4.1bn, a reduction of 5% quarter on quarter. Between the first quarter of 2005 and the first quarter of 2004, the government reduced its external debt level by Kina484m, or around 10% of the total, with net loan repayments accounting for the bulk of the reduction. In the first quarter of 2005 the government paid Kina29m in interest on its foreign debt, 16% less than in the year-earlier period.

Public-sector external debt (Kina m; end-period) 2004 2005a 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra International agencies 4,419.2 4,192.9 4,143.5 4,108.0 3,894.5 Commercial loans 128.7 124.6 187.8 183.1 182.3 Other loans 25.0 11.7 12.1 12.8 12.5 Total 4,572.9 4,329.2 4,343.4 4,303.9 4,089.3 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.