Country Report

Papua New Guinea

Papua New Guinea at a glance: 2004-05

OVERVIEW The governing coalition, led by the prime minister, Sir Michael Somare, should have a large enough parliamentary majority to defeat a no-confidence motion, if such a motion eventuates. However, the political scene remains unsettled, and the government’s effectiveness will be limited. The economic outlook is fairly positive for 2004-05. Inflationary pressures are easing, and improvements in agriculture, mining and oil activity should contribute to a pick-up in real GDP growth of more than 2% a year in 2004-05. The current account will remain in surplus in 2004, but will shift into deficit in 2005 as export revenue slips.

Key changes from last month Political outlook • The opposition applied for a motion of no confidence in early July, but its application was rejected on “technical grounds”. If Sir Michael is eventually subjected to a motion of no confidence, he should have sufficient support in parliament to defeat it, barring extraordinary circumstances. Economic policy outlook • In the first quarter the government spent only 2% of its development budget. Therefore, there will be pressure on ministries and government agencies to speed up spending, particularly counterpart spending to facilitate the disbursement of international aid. Economic forecast • The kina continues to appreciate against the US dollar. By early July the kina had strengthened by around 6% compared with its value at end-2003. Stronger import demand will put some downward pressure on the kina during the remainder of the 2004.

July 2004

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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 2004-05 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

16 Economic policy

20 The domestic economy 20 Economic trends 22 Oil and gas 23 Mining 24 Agriculture, fisheries and forestry 25 Infrastructure

26 Foreign trade and payments

List of tables

9 International assumptions summary 11 Forecast summary 17 Central government finances 20 Money supply 21 Quarterly inflation 21 Exchange rates 23 Mineral exports by volume 24 Agricultural exports by volume 27 Exports 28 Balance of payments

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List of figures

12 Papua New Guinea: gross domestic product 12 Papua New Guinea: consumer price inflation 17 Papua New Guinea: public debt outstanding 19 Papua New Guinea: interest rates 28 Papua New Guinea: foreign-exchange reserves

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Papua New Guinea July 2004 Summary

Outlook for 2004-05 The governing coalition, led by the prime minister, Sir Michael Somare, should have a large enough parliamentary majority to defeat a no-confidence motion, if such a motion is proposed. However, the political scene remains unsettled, and the government’s effectiveness will be limited. The economic outlook is fairly positive for 2004-05. Inflationary pressures are easing, and improvements in agriculture, mining and oil activity should contribute to a pick-up in real GDP growth to more than 2% a year in 2004-05. The current account will remain in surplus in 2004, but will shift into deficit in 2005 as export revenue slips and the import bill is kept up by the demand generated by mining activity and infrastructure projects.

The political scene The opposition has tried to launch a motion of no confidence in Sir Michael now that his grace period has ended, but he has so far thwarted their attempts. After having its application for a no-confidence motion initially rejected, the opposition referred its application to the Supreme Court. Sir Michael has reshuffled his coalition government in an effort to bolster his support in parliament. The long-running saga to elect a governor-general has come to an end with Sir Paulius Matane being sworn into office on June 29th. The Economic Co-operation Programme with Australia has finally been signed.

Economic policy The government recorded a small budget surplus in the first quarter of 2004, and public debt has remained stable. The sale of the state-owned telecommunications company, Telikom PNG, has been agreed and awaits the cabinet’s approval. Agricultural sector tax incentives have been welcomed. Monetary policy has been eased further.

The domestic economy The government has been fairly upbeat about economic conditions and still expects GDP to grow by 2.8% in 2004. Employment indicators have generally improved. Year-on-year inflation has slowed markedly. Crude oil production and exports have fallen and goldmines have experienced mixed fortunes. Most agricultural export commodities have recorded improved performances.

Foreign trade and payments Export revenue dipped in the first quarter, but the import bill contracted at a faster pace and was at its lowest level since early 2002. The current account has remained in surplus, thereby contributing to the buoyant international reserves position. Editors: Danny Richards (editor); Graham Richardson (consulting editor) Editorial closing date: July 12th 2004 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

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 Vacan t

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

Central bank governor Wilson Kamit

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Economic structure

Annual indicators 1999a 2000a 2001a 2002b 2003b GDP at market prices (Kina bn) 8.8 9.7b 10.4b 11.5 13.5 GDP (US$ bn) 3.4 3.5b 3.1b 3.0 3.8 Real GDP growth (%) 7.5 -1.2 b -2.3b -0.8 1.8 Consumer price inflation (av; %) 14.9 15.6 9.3 11.8a 14.7a Population (m) 5.2 5.3 5.5 5.6a 5.7 Exports of goods fob (US$ m) 1,927.4 2,094.1 1,812.9 1,639.7 2,200.7 Imports of goods fob (US$ m) 1,071.4 998.8 932.4 1,077.5 1,187.3 Current-account balance (US$ m) 94.7 345.3 282.0 -129.1 139.2 Foreign-exchange reserves excl gold (US$ m) 205.1 286.9 422.6 321.5a 485.3a Total external debt (US$ bn) 2.7 2.6 2.5 2.5 2.6 Debt-service ratio, paid (%) 9.7 12.9 12.7 15.2a 15.1 Exchange rate (av) Kina:US$ 2.57 2.78 3.39 3.90a 3.56a 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 26.9 Private consumption 69.7 Industry 41.6 Government consumption 16.9 Mining 28.0 Investment 16.4 Services 31.5 Exports of goods & services 47.3 Imports of goods & services 50.4

Principal exports fob 2003 US$ m Principal imports cif 1994 US$ m Gold 789 Machinery & transport equipment 552 Crude oil 458 Manufactured goods 313 Copper 397 Food & live animals 216 Palm oil 117 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 2002 2003 2004 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Prices Consumer prices (2000=100) 118.0 125.6 130.0 139.0 140.3 140.4 141.0 143.0 Consumer prices (% change, year on year) 9.5 12.2 14.8 20.7 18.9 11.8 8.5 2.9 Financial indicators Exchange rate Kina:US$ (av) 3.75 3.99 4.14 3.79 3.66 3.44 3.36 3.30 Exchange rate Kina:US$ (end-period) 3.98 4.02 4.02 3.66 3.55 3.38 3.33 3.25 M1 (end-period; Kina m) 1,619 1,571 1,630 1,652 1,678 1,759 1,897 1,774 M1 (% change, year on year) 28.3 22.2 15.0 7.9 3.6 11.9 16.4 7.4 M2 (end-period; Kina m) 3,295 3,220 3,312 3,259 3,147 3,196 3,298 3,111 M2 (% change, year on year) 6.0 4.1 4.0 1.2 -4.5 -0.8 -0.4 -4.5 Sectoral trends, exports Copra ('000 tonnes) 4.7 4.8 0.7 1.9 2.4 1.3 2.8 4.9 Copra oil ('000 tonnes) 4.0 6.5 11.6 9.3 14.4 12.8 11.2 7.6 Cocoa ('000 tonnes) 9.7 8.9 10.5 8.1 13.6 10.1 8.5 10.4 Coffee ('000 tonnes) 12.7 25.9 17.8 7.9 14.5 28.3 18.1 8.2 Logs ('000 cu metres) 423 409 621 543 478 488 507 462 Gold (tonnes) 15.6 11.9 16.1 17.1 14.6 17.9 18.8 16.5 Fish ('000 tonnes) 2.5 1.4 2.7 6.4 6.8 4.1 0.5 2.7 Oil, crude ('000 barrels) 4,215 3,607 3,632 3,748 4,107 4,272 2,857 3,268 Foreign trade & reserves Exports fob (Kina m)a 1,677 1,571 1,780 2,038 1,875 1,922 2,007 1,946 Gold 584 494 737 717 585 726 784 717 Oil, crude 379 371 404 473 441 419 300 352 Imports fob (Kina m)a -1,068 -1,119 -1,103 -1,083 -1,072 -1,001 -1,075 -991 Trade balance (Kina m) 609 452 677 955 803 921 932 955 Foreign reserves (US$ m) Reserves excl gold (end-period) 439.7 362.0 321.5 313.7 340.4 400.9 494.2 487.5 a Balance-of-payments basis. Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; IMF, International Financial Statistics.

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Outlook for 2004-05

Political outlook

Domestic politics Despite the best efforts of the prime minister, Sir Michael Somare, to stabilise the domestic political scene in Papua New Guinea (PNG), unstable coalition government and creative political manoeuvring remain dominant charac- teristics of the country’s politics. Sir Michael is the first prime minister to lead an administration since the enactment of the Organic Law on the Integrity of Political Parties and Candidates (integrity law), which in theory stabilises the government by strengthening the party system and limiting the scope of independent members of parliament (MPs), but he has yet to capitalise on the advantages this should bring. Having failed to push through controversial constitutional changes to double the 18-month grace period for new governments during which no-confidence motions are not permitted, Sir Michael has been functioning under the threat of such a motion since February 2004. However, his adroit political manoeuvring, primarily through a series of timely parliamentary adjourn- ments, has so far thwarted the opposition’s efforts. The latest adjournment was effected on July 9th, two days after the opposition’s application for a no- confidence motion was rejected on “technical grounds”. It was no surprise that the opposition’s application for a motion of no confidence was rejected. In early July the government successfully removed all opposition members from the parliamentary private business council, the body that deliberates on parliamentary motions, including motions of no confidence. The parliamentary private business council can also refuse to accept applications for a no- confidence motion if the motion is deemed to be of a “parochial nature”. If Sir Michael is eventually subjected to a motion of no confidence, he should have sufficient support in parliament to defeat it, barring extraordinary circumstances. In order to defeat such a motion, Sir Michael needs a simple majority, rather than the two-thirds majority that he narrowly failed to achieve to support the controversial constitutional amendment to extend the no- confidence motion grace period. Assuming that MPs abide by the integrity law, they either have to vote according to party resolutions or abstain. Officially, only one major party, the People’s National Congress (PNC), which comprises 13 MPs, occupies the opposition benches. However, owing to major splits in a number of other parties, whereby MPs belonging to the same party are sitting on opposite sides of the house, there is uncertainty as to how much support Sir Michael really commands. Although Sir Michael is expected to remain in office, the political scene is likely to remain fractious, thereby preventing effective government. The recent political focus on constitutional amendments and a number of adjournments have ensured that the government has made little progress in dealing with a range of social and law-and-order issues. These continue to prevent the country from embarking on a path towards sustained development.

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International relations PNG’s relations with Australia were boosted in late June when the Kina2bn (US$625m) Enhanced Co-operation Programme (ECP) was signed, six months after it was agreed in Australia. Under the ECP, which creates a new framework of co-operation and partnership, aside from providing aid (currently around US$200m a year), Australian officials will take up senior public-sector positions, and more than 200 Australian police officers will be deployed to help to improve law and order. The deal had been under threat owing to differences of opinion over legal immunity for Australian officials deployed to PNG. By resolving this issue, the foreign affairs minister, Sir Rabbie Namaliu, and his Australian counterpart, Alexander Downer, have been keen to demonstrate the strong ties that exist between the two countries. However, the recent discord between the two sides is likely to have encouraged PNG to make efforts to move away from its traditional dependence on Australia. In recent months, for example, PNG has made progress in improving diplomatic and economic ties with China.

Economic policy outlook

Policy trends The government is expected to continue to show a degree of fiscal restraint in 2004-05, which will enable the Bank of Papua New Guinea (BPNG, the central bank) to loosen its monetary policy stance. This will complement Sir Michael's efforts to drive the economy under his recurrent policy theme of “stabilisation with growth”. In 2004-05 the government will continue to direct its resources towards export-oriented sectors, namely agriculture, fisheries, forestry, mining and petroleum. Although the sale of the telecommunications company, Telikom PNG, has been agreed, the government's commitment to structural reform, and particularly privatisation, remains unclear, and this may mean that it fails to attract much-needed financial assistance. The government has been growing increasingly frustrated by its failure to obtain funds from multilateral donors, owing to problems in meeting donor conditions attached to the disbursement of funding. Reflecting this frustration, the government has announced its intention to tap the international bond market for the first time in order to raise funds for development. In mid-May Sir Michael announced that the government was planning to raise US$100m-200m by issuing bonds. However, political pressure over the high cost of this method of financing and the likely difficulty in attracting interest from international investors will limit the likelihood of such a venture being successful.

Fiscal policy The government improved its fiscal position sharply in 2003; its budget deficit dropped to Kina124.1m (US$35m), equivalent to 0.9% of GDP, from Kina450.2m in 2002. For 2004, however, the government's budgetary plans are disappointing, and its operating deficit is expected to rise slightly to 1.3% of GDP in 2004, and it will remain around this level in 2005. The government's budget for recurrent expenditure in 2004 has risen to Kina2.8bn (US$820m), from Kina2.5bn in the budget for 2003. The budget for development expenditure, of which around 35% will finance much-needed infrastructure projects, is Kina1.3bn, about 8% higher than the proposed figure for 2003. However, in the first quarter the government spent only 20% of the full-year budget for recurrent

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expenditure and only 2% of the development expenditure budget. Therefore, there will be pressure on ministries and government agencies to speed up disbursements and spending, particularly counterpart spending to facilitate the disbursement of international aid. Total receipts also disappointed in the first quarter, reaching only 20% of the full-year budget estimate. Although the government did not announce any changes to income tax and corporate tax rates in the budget for 2004, in an unpopular move, it put in place a 2% levy on imports (with some exemptions, most notably for the mining and petroleum sectors) for 2004 only.

Monetary policy In line with the consistent moderation of consumer price inflation in recent quarters, the BPNG has adopted a more accommodative monetary policy stance. The central bank has cut the kina facility rate (KFR, the official rate used to indicate its monetary stance) by 100 basis points on four occasions so far this year. The latest cut, which was made in May, brought the KFR down to 10% from a previous high of 16% in mid-2003. (The KFR remained unchanged in June and July.) Announcing the latest cut, the BPNG governor, Wilson Kamit, said that there had been continued improvement in economic activity in the first four months of the year owing to favourable export receipts, and that fiscal management had been “diligent”. Given that the government is keen to stimulate private-sector activity by easing monetary policy, and assuming that inflation and the government's fiscal position remain under control over the next two years, the central bank will loosen its monetary policy stance further.

Economic forecast

International assumptions Papua New Guinea: international assumptions summary (% unless otherwise indicated) 2002 2003 2004 2005 Real GDP growth World 2.9 3.9 4.9 4.3 OECD 1.6 2.1 3.5 2.8 EU25 1.2 1.1 2.2 2.4 Exchange rates ¥:US$ 125.3 115.9 111.8 108.5 US$:€ 0.945 1.132 1.202 1.293 SDR:US$ 0.772 0.714 0.688 0.662 Financial indicators ¥ 2-month private bill rate 0.10 0.03 0.03 0.10 US$ 3-month commercial paper rate 1.70 1.10 1.38 3.00 Commodity prices Oil (Brent; US$/b) 25.0 28.8 33.5 26.0 Gold (US$/troy oz) 310.3 362.8 421.3 375.0 Food, feedstuffs & beverages (% change in US$ terms) 12.7 6.6 10.6 -0.7 Industrial raw materials (% change in US$ terms) 2.2 12.7 18.8 -0.7 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. The outlook for the global economy is bright, with world GDP (on a purchasing power parity basis) forecast to grow by 4.9% this year, the fastest rate of growth in two decades. However, growth will ease slightly in 2005 to 4.3%. Asia and Australasia (excluding Japan) will enjoy the fastest rate of expansion of any

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world region in 2004 and 2005, growing by 7% and 6.1% in the two years respectively. Japan will also record strong economic growth this year at 4.4%, compared with 2.6% in 2003. These trends bode well for PNG, given that around 40% of the country's exports head for Australia, China and Japan. In 2004 PNG will also benefit from rising crude oil and gold prices, its most valuable export commodities, but prices for both commodities will fall back in 2005. A key risk to PNG’s economy remains its vulnerability to such swings in the international prices for its key export commodities.

Economic growth A pick-up in activity in the mining and petroleum sectors ensured that a fourth successive year of contraction was avoided in 2003. Estimates of real GDP growth in 2003 are difficult, however, since no actual quarterly GDP data have yet been published for the year. In its preliminary assessment of GDP growth, released in January this year, the BPNG estimated that the economy expanded by 2% last year, but this is probably a little optimistic. The outlook for the economy in 2004-05 is fairly bright, with GDP forecast to grow by more than 2% annually. On the output side, the more generous fiscal regime contained in the budget for 2003 is starting to pay off for mining and petroleum, and mineral exploration is reviving from negligible levels after a decade of decline. In terms of specific projects, the Napa Napa oil refinery commenced operations in June, more oilfields in the Moran project will come on stream in the second half of this year, and construction of the Kainantu goldmine is expected to be completed in the second half of 2005. On the expenditure side, domestic demand was generally restrained in 2003 by the government’s tight monetary policy stance (domestic credit contracted by around 6% year on year in 2003). However, with the government easing its policy stance in early 2004 in line with signs of slowing inflation, there should be some expansion in private consumption this year and in 2005.

Inflation Consumer price inflation continues to ease from the high year-on-year rate of 20.7% in the first quarter of 2003. Year-on-year inflation eased to 8.4% in the fourth quarter of 2003, and in the first quarter of 2004 inflation dropped to only 2.9% year on year, the lowest year-on-year rate in five years. This moderation in inflation can be attributed to the tightening of monetary policy in the second half of 2003 and the marked improvement in the government’s fiscal regime. However, the recent imposition of a 2% levy on imports and the currency's weakness against a resurgent Australian dollar later in the year will ensure that inflationary pressures remain a concern. Assuming that the government succeeds in maintaining a tight hold on its fiscal operations, average annual inflation will remain in single digits in 2004-05, after averaging 14.7% in 2003.

Exchange rates The kina continues to appreciate against the US dollar. The improvement in 2003 was largely in line with the general weakness of the US dollar, as against other major currencies the kina did not perform so well—against the Australian dollar, for example, the kina depreciated by 8%. However, so far this year, the kina has also been strengthening against most other major currencies. This has partly been in line with weak import demand. The Economist Intelligence Unit expects the kina to weaken slightly against the US dollar during the remainder

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of 2004 owing to a pick-up in import demand, although it should still average Kina3.28:US$1 (compared with Kina3.56:US$1 in 2003). In 2005 the kina will ease back to Kina3.50:US$1, partly as a result of the weaker current-account outlook. Against the Australian dollar the kina will remain fairly stable this year, before falling by around 4% next year. A significant weakening of the kina is unlikely, given that the deterioration in the current account will be partly offset by continued improvement in foreign direct investment receipts.

External sector The merchandise trade surplus (fob-cif) improved markedly in 2003, pushing the current account back into surplus. Although the sharp rebound in exports in 2003 was largely a result of rising prices for key exports, the government has adopted an export-oriented policy for growth, and this has helped to drive up export volumes. Although export volumes should continue to rise in 2004-05, sharp fluctuations in global prices for major export commodities will largely determine the trend in export revenue growth. In 2004 export revenue will continue on an upward trend, with global gold and crude oil prices forecast to rise by around 16% year on year. However, this improvement will be short- lived. In 2005 export revenue will dip in line with the forecast drop in prices for these commodities. Crude oil prices, for example, are expected to plunge by 22% year on year in 2005. In 2004-05 the import bill will expand, with demand for mining-related imports, in particular, rising to support the expansion in this sector. The services and income balances are expected to remain fairly stable in US dollar terms in 2004-05. The current-account balance will therefore reflect trends in the merchandise trade account: in 2004 the current account will remain in surplus, but it will drop back into deficit in 2005.

Papua New Guinea: forecast summary (% unless otherwise indicated) 2002a 2003a 2004b 2005b Real GDP growth -0.8 1.8 2.4 2.2 Gross agricultural production growth 7.3 1.5 2.8 2.3 Consumer price inflation (av) 11.8c 14.7c 5.0 8.0 Consumer price inflation (year-end) 14.8c 8.4c 7.0 10.0 Short-term interbank rate 13.9c 13.4c 12.5 12.0 Government balance (% of GDP) -3.9 -0.9 -1.3 -1.2 Exports of goods fob (US$ bn) 1.6 2.2 2.4 2.3 Imports of goods fob (US$ bn) 1.1 1.2 1.3 1.3 Current-account balance (US$ bn) -0.1 0.1 0.1 -0.1 Current-account balance (% of GDP) -4.4 3.7 3.0 -2.5 External debt (year-end; US$ bn) 2.5 2.6 2.4 2.4 Exchange rate Kina:US$ (av) 3.90c 3.56c 3.28 3.50 Exchange rate Kina:¥100 (av) 3.107c 3.075c 2.930 3.226 Exchange rate Kina:€ (year-end) 4.22c 4.20c 4.28 4.90 Exchange rate Kina:SDR (year-end) 5.46c 4.95c 5.13 5.66 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

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The political scene

Sir Michael drops efforts to After struggling to push through a controversial bill that would have doubled extend grace period the grace period relating to no-confidence votes from 18 months to three years, the prime minister, Sir Michael Somare, decided to shelve such plans in May. Although Sir Michael’s grace period expired in February this year, he had, by early July, managed to avoid facing a no-confidence motion through adroit political manoeuvring, mainly through adjourning parliament. The latest period of adjournment was effected on July 9th for a two-week period. Despite this two-week adjournment, parliament should still meet its constitutional requirement to sit for 63 days in the current parliamentary year, which ends on August 5th.

An application for a no- On July 7th the opposition moved to bring about a vote of no-confidence in Sir confidence motion is rejected Michael. Its application was rejected on “technical grounds” by the parliamentary private business council, which deliberates on all important motions, including no-confidence motions. The decision by the council was not unexpected. On July 1st the government successfully sought the removal of all opposition members from the council. The council rejected the no-confidence motion on technical grounds primarily because the motion, which was proposed by an independent member of parliament (MP), , was defective because it was not seconded. On July 8th the opposition referred its application to the Supreme Court. The application may still be blocked by the council if it is considered to be of a “parochial nature” and not in accordance with national interests.

The strength of the opposition The leader of the opposition and the People’s National Congress (PNC), Peter remains in dispute O’Neill, has been favoured as the alternate prime minister should a vote of no confidence take place. The initial indecision over such a candidate resulted in some delay to the opposition’s petition for a no-confidence motion. The earlier favourite, PNC founder and former parliamentary speaker, Bill Skate, withdrew from the contest. The opposition officially comprises 13 MPs from the PNC, two from the Christian Democratic Party and two independents, Mr Wingti and

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Jamie Maxtone-Graham, the recently returned MP in the Anglip-South Wahgi by-election. However, on the floor of parliament the numbers are much higher owing to the presence on the opposition benches of dissident MPs belonging to parties aligned with government. The opposition is now claiming that the recent disputed ruling of the parliamentary speaker, Jeffrey Nape, that these MPs must sit on the government side of the chamber, has led to further defections to its side. In early July, during a weekend camp in Alotau, the opposition claimed the support of 40 MPs, with more to come. The affected MPs defied the speaker, despite his ruling being based on these parties’ previous resolutions—affirmed in consultations with the registrar of political parties—to support the government. The MPs have challenged the validity of the ruling, as under the Organic Law on the Integrity of Political Parties and Candidates (the integrity law), MPs must abide by the party resolution on voting only in relation to the prime minister, annual national budgets, constitutional amendments and votes of no confidence. However, wherever they sit in the chamber, in the event of a no-confidence motion they may abstain.

Sir Michael rearranges his In mid-May Sir Michael announced a major cabinet reshuffle in which he coalition sought to reward loyalty and punish dissenters who did not support his moves to extend the no-confidence vote grace period. The most notable change was the acceptance into government of the PNG Party—Sir Mekere Morauta, Sir Michael’s predecessor and formerly the opposition leader, leads the party. The changes also included the ousting from the coalition of the PNC. In total, seven cabinet members were sacked during the reshuffle, including the deputy prime minister, Moses Maladina, who leads the People’s Action Party (PAP). However, in early June the PAP and Mr Maladina rejoined the government, reflecting efforts made by the PAP to reassure Sir Michael that it was fully supportive of his administration. Indeed, Sir Michael later affirmed that PAP had reconsolidated and that all of its 13 MPs were now back in government. Mr Maladina returned to the government as national planning minister, taking over from Sinai Brown who moved to the Ministry of Public Services. Sir Michael said that he was leaving the position of deputy prime minister vacant for the time being, to give time to some parties, both in and out of the government, to decide which side they were on. In announcing the changes to his coalition, Sir Michael lamented the difficulty of managing an effective coalition government of ten political parties with shifting boundaries, and he urged MPs to make the integrity law work. In particular, he encouraged parties with members in both government and opposition to sort out their in-house problems. He also called on political lobbyists to exercise their rights responsibly.

Political party instability reigns A number of political parties have suffered splits in recent months, thereby clouding the political scene and the degree of support for and against the government. The split in the People’s Progress Party (PPP) remains unresolved. The trade and industry minister, Paul Tiensten, claims leadership of the party. Mr Tiensten is recognised by the speaker as PPP leader, although he is the subject of a referral to the ombudsman commission under the integrity law. But

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the party’s founder, Sir , who supports Andrew Baing, has said that the party expelled Mr Tiensten. Mr Baing has refused to obey the speaker’s ruling that he move from the opposition benches to the government side of the chamber. Meanwhile, the party’s strongman, , facing criminal charges of misappropriation, is suspended from parliament. The PNG Party now has six MPs in government and three in opposition. John Muingnepe is the shadow minister for mining and petroleum (an appointment Sir Mekere claims is unconstitutional), and he is joined in opposition by two provincial governors, Hami Yawari and Jacob Jumagot. The People’s Labour Party (PLP), following the suspension of its leader, Peter Yama, has elected Ekis Ropenu as party leader and has joined the government. PLP was the only united party in opposition, a situation causing the speaker to recognise Mr Yama as opposition leader, a post he immediately declined in favour of Mr O’Neill, who commanded greater numbers despite the division in the PNC. The leadership of Pangu Pati is being contested in the courts between Sir Rabbie Namaliu, the foreign affairs minister, and , who is in the opposition.

Mr Skate is sacked as house On May 28th the government used its numbers in parliament to remove in speaker controversial circumstances, the speaker, Mr Skate, through a no-confidence vote, and replaced him with his deputy, Mr Nape. The opposition warned that the move would be challenged in court, and Mr O’Neill, as opposition leader, led 33 MPs out of the chamber in protest. Only eight opposition MPs remained in their seats. The opposition has asked the Supreme Court to quash Mr Skate’s sacking and to restrain Mr Nape from presiding over meetings of parliament, a matter, the court has said, it would determine in accordance with provisions contained in parliamentary standing orders. Opposition MPs boycotted parliamentary sessions in early July in protest against the alleged bias of Mr Nape and claim that his actions questioned the integrity of the speaker’s position. Mr Skate, apparently bored with his eight-month ceremonial stint as acting governor-general, and riled by his party's dumping from the governing coalition, had “resigned” his vice-regal post and taken “leave of absence” from his parliamentary speaker's one; moves which the ombudsman warned were unconstitutional.

Mr Yama is suspended over Peter Yama, a former leader of the PLP, was alleged to have breached the 1997 breach of leadership law Organic Law on Duties and Responsibilities of Leadership when he was works minister in 1997. The ombudsman commission referred him to the public prosecutor, but as Mr Yama lost his seat in the 1997 general election, he automatically escaped prosecution under the leadership code. When he was re- elected as member for Usino-Bundi in July 2002, the public prosecutor re- opened his file and in November that year requested the appointment of a leadership tribunal to investigate the allegations. Mr Yama successfully sought orders to restrain the tribunal from hearing the case on grounds of a breach of natural justice by the ombudsman commission. The ombudsman commission appealed, and in June 2004 the Supreme Court unanimously upheld all seven grounds of appeal and ruled that a leadership tribunal investigate the charges.

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Mr Yama has been suspended on full pay as an elected MP, and he will not undertake any parliamentary duties pending the outcome of the hearing.

Limited preferential voting In a move aimed at achieving a more representative parliament (typically six system is working voters back a losing candidate to every one backing the winner in the first-past- the-post voting system) the 1997-2002 parliament amended the constitution to provide for optional limited preferential voting (ie the number of preferences must equal the number of positions to be filled, not the number of candidates) after the 2002 general election. The limited preferential voting system has since been used successfully in four by-elections. The electoral commissioner has expressed satisfaction with the conduct of the elections. Another by-election, for the Moresby North-east seat stemming from the result of a successful petition to the court of disputed returns, could be held in July. The courts have yet to rule on the seats of Wabag, Tewai/Siassi, Wapenamanda and Mendi. The long-running saga of the governor-general election comes to an end

Sir Paulius Matane was sworn in as the eighth governor-general when parliament re- convened on June 29th. The election process began in September 2003, when parliament elected Sir Albert Kipalan as governor-general elect out of eight candidates. However, the Supreme Court in the following month declared his election null and void owing to a defective election process. Parliament voted again to elect a governor-general in December; Sir Pato Kakarya won the four-man contest, but the runner-up, Sir Albert, cried foul and appealed to the courts. In January the national court stayed Sir Pato’s swearing-in pending a Supreme Court ruling on the validity of the December election. In April a one-judge bench of the Supreme Court declared the December election null and void, and called on parliament to re- convene to elect a governor-general. Parliament met in the third attempt in April to elect a governor-general, but the acting speaker declared all nominations defective. Parliament finally elected Sir Paulius on May 27th, in the fourth election, which for the first time included a woman candidate, Nahau Rooney from Manus Island province. Co-operation pact with On June 30th in Port Moresby Sir Rabbie and his Australian counterpart, Australian is finally signed Alexander Downer, signed the Economic Co-operation Programme (ECP), six months after it was agreed in Adelaide, Australia. The Australian government had dropped its demand for immunity for its officers serving under the ECP and agreed to the establishment of a joint steering committee with an ongoing role in the implementation of the ECP including matters relating to any breaches of the law by Australian officials. Although the focus of the ECP is on policing and law and order, the programme also provides for the assistance of skilled and experienced personnel in macroeconomic management, public- sector reforms, courts and legal services, customs, transport and border security areas. The policing assistance will differ from past support in that seconded Australian police personnel will have a hands-on role, and will work side-by- side with their PNG colleagues with strong emphasis on “capacity building”. The ECP provides for the recruitment and training of 400 new policemen and women, the first police intake since 1996, as well as the supply of vehicles and communication equipment.

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The UN extends its mission in The PNG Defence Force (PNGDF) has withdrawn from Bougainville, but the Bougainville for the last time international peace monitoring group is maintaining a reduced presence on the island as disarmament nears completion. (Bougainville has resisted central government control for decades; talks in 1997 established a framework for resolving the situation.) The UN, at PNG’s request, has extended its tour by six months to the end of 2004. According to the UN, this extension, the third, will be the last. Bougainville’s constitution, which is in its final drafting stage, is expected to be approved by the national parliament by the end of 2004. Tentative discussions about the possibility of re-opening the Panguna copper mine has also begun. The province expects to benefit from the recruitment of police and the deployment of Australian police under the ECP. It would also benefit under the second phase of the Yumi Yet bridge programme likely to be included in the budget for 2005 (see The domestic economy: infrastructure). The government on May 7th acknowledged receipt of a report on provincial autonomy from the East New Britain province consultative committee. The report proposes devolution from the central government of administrative, economic and financial powers. The cabinet has set in motion a bipartisan process to assess the proposal and advise how to respond to it. Economic policy

The government records a The central government recorded a small surplus of Kina13.8m (US$4.5m) in the small budget surplus first quarter of 2004, down from Kina25.4m in the year-earlier period. Total receipts dipped slightly year on year to Kina573.6m and were only equivalent to around 15% of the full-year budget. Tax receipts in the first quarter of 2004 were up by only 0.5% year on year and represented only 20% of the full-year budget. Collection was better for indirect taxes compared with direct taxes. Direct tax receipts were down by 2.5% year on year and represented 17% of the full-year budget. Slower company tax payment was the main drag, with collections representing less than 5% of the full-year budget. Indirect tax collections in the first quarter were more impressive, equivalent to 24% of the full-year budget and up by 5% year on year. Excise receipts in the first quarter represented 28% of the full-year budget and were up by about 20% year on year. Value-added tax (VAT), which was 4% more than a year earlier, represented 24% of the full- year budget. The recent increased audit activity is reflected in these improved collection rates. Non-tax receipts in the first quarter were down by nearly 25% year on year and represented only 14% of the budget, mainly reflecting the absence of any foreign grant receipts, as was the case in the year-earlier period. Contributing to the recording of a small surplus in the first quarter was the slow disbursement of budgeted expenditure; only around 14% of the full-year budget was spent. Development expenditure in the first quarter was down by 55% year on year and represented just 2% of the full-year budget, mainly owing to slow project implementation and shortfalls in counterpart funding. Recurrent expenditure, which totalled Kina534.3m in the first quarter, was up by 7% year on year, but equivalent to only 19.4% of the total budgeted for the year. The government repaid net Kina122.5m of foreign debt, reduced its debt to the Bank of Papua New Guinea (BPNG, the central bank) by Kina20.9m, and to domestic trade creditors by Kina81.3m. However, it borrowed Kina184.2m from the public

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and Kina26.7m from commercial banks. There were no asset sales recorded in the first quarter, as was the case in the year-earlier period. Papua New Guinea: central government finances (Kina m) 2002 2003 2004 Qtr 1 2004 Outturn Outturn Budget Outturna Total receipts 3,231.3 3,610.2 3,837.1 573.6 Tax revenue 2,370.3 2,678.0 2,791.8 545.3 Personal tax 689.9 758.3 815.0 203.4 Company tax 570.2 731.0 712.4 33.3 Value-added tax 289.6 311.8 313.3 74.0 Non-tax revenue 169.9 239.2 195.6 28.3 Foreign grants 691.4 693.0 849.7 0.0 Expenditure 3,681.5 3,734.3 4,032.6 559.3 Recurrent expenditure 2,541.7 2,695.3 2,756.0 534.3 National departmental 1,357.1 1,192.4 1,272.7 233.1 Provincial governments 587.9 594.5 607.3 110.4 Interest payments 436.5 739.6 692.4 142.6 Foreign 188.4 160.8 177.4 35.1 Domestic 248.1 578.8 515.0 107.5 Other grants & expenditure 165.0 178.4 187.6 50.5 Net lending & investments -4.8 -9.6 -4.0 -2.3 Development expenditure 1,139.8 1,039.0 1,276.6 25.5 Overall balance -450.2 -124.1 -195.5 13.8 a Preliminary data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Overall public debt remains Public debt outstanding at end-March was Kina7.8bn (US$2.5bn). Although the stable level of overall debt was practically unchanged from a year earlier, the composition of debt had changed. At end-March debt owed to external creditors accounted for 59% of the total compared with 65% at end-March 2003. The decline in external debt was offset by the 17% year-on-year expansion in domestic public debt. Domestic Treasury bills, which accounted for 38% of total public debt, increased by almost 25% year on year at end-March. In May the government retired Kina190m (US$60m) of T-bills and sold Kina50m of inscribed stock of one- and two-year maturities at an average tender price of 11.6%. Further tenders are scheduled for August and October.

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The government may turn to The government announced in May that it would to seek to raise US$100m- international bond markets 200m in international bonds of five-, seven- or ten-year maturities at a 10% interest rate through a US financier, Bear Stearns. This determination to raise funds through international bonds, although it is a relatively expensive means, partly reflects the government’s frustration with international donors. However, administrative and financial constraints seem to have resulted in the failure to draw down aid commitments, with the EU blaming PNG’s finance and planning departments for Kina500m (US$160m) not being drawn for two years. The outgoing planning minister, Sinai Brown, however, countered this accusation by claiming that part of the problem had stemmed from the EU, pointing to two projects in which delays of 18 months and 12 months were the result of slow responses or failure by the EU.

Sale of Telikom moves The Independent Public Business Corporation, the government’s privatisation fo rward agency, has announced the sale, subject to cabinet approval, of 51% of the state- owned telecommunications company, Telikom PNG, to a Zimbabwean company, Econet Wireless Group (EWG), for Kina100m (US$32m). In addition, EWG has agreed to a Kina45m distribution prior to the sale and to inject Kina50m immediately into Telikom for capital expenditure. The deal, which was announced in early July, envisages investment of Kina400m in the network over the next five years. Part of this investment would involve the rollout of telephony services (which would otherwise not be commercially viable) to about 1,400 rural villages funded through a tax credit scheme. EWG has operations in New Zealand in addition to some African countries. News of the deal has been received sceptically by the business community fearing tariff increases will be the first manifestation of the sale. Also, doubts about the EWG’s competence in New Zealand have emerged. The prime minister, Sir Michael Somare, has reportedly asked the relevant minister why an earlier Korean proposal, generally accepted as technically superior, had lapsed.

The regulatory body reviews The Independent Consumer and Competition Commission (ICCC), which was several sectors established as the independent regulator of competition under the ICCC Act 2002, has completed its review of telecoms regulations, a process that was initiated in September 2003. A draft report on postal regulations for 2005-09 is due to be released in July, following the release in March of an issues paper and responses to it from interested parties. Further submissions are expected pursuant to the draft’s release before the commission finalises its recommen- dations. Regulatory reviews relating to harbours and electricity operations are also scheduled this year. The regulatory contracts specify: minimum service standard requirements; price paths that will apply to the regulated entities over an agreed period; pricing principles that are to be applied in reviewing the price path in future; minimum capital expenditure requirements; and penalties that will be applied to these entities if they fail to meet the requirements that are built into the price path.

Agriculture tax incentives are Despite the agriculture sector’s disappointment at the 2004 budget’s watered- welcomed down version of tax incentives outlined by Sir Michael in mid-2003, it has welcomed the creation of the Extension Services Expenses Approval

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Committee and the release of its guidelines. The committee is now inviting applications for the 150% tax deduction for primary production extension services expenditure, which must relate to the teaching or training of either individuals or groups with respect to: new planting materials, including new crop hybrids and new high-yielding crops for use in a particular area; improved plant maintenance, pest control, land care techniques, harvesting techniques and improving yields; and marketing techniques, including storage and packaging, and market information. The expenditure must also be incurred under an approved plan and not exceed the maximum amount specified in the plan. Moreover, it must not relate to land owned or leased by the taxpayer.

Monetary policy is eased The BPNG continues to ease its monetary policy stance. The kina facility rate further (KFR, the official rate used to indicate the central bank’s monetary stance) has been cut on a number of occasions over the past few months, and by July it had dropped to 10%, from 14% in December 2003. BPNG has also widened the dealing margins in the repurchase agreement facility, first to 200 basis points in January and further to 300 basis points in March. The cash reserve requirement was kept at 3% throughout the first quarter and the minimum liquid asset ratio at 25%. The BPNG used T-bills and the repurchase facility to diffuse excess liquidity resulting from strong growth in net foreign assets in the first quarter.

Broad money supply (M3) expanded by 1.6% year on year to Kina4.2bn (US$1.4bn) at the end of the first quarter. Net foreign assets accounted for 39% of the total, with credit to the central government and private-sector credit accounting for 25% and 33% respectively. Growth of 38% year on year in net foreign assets was offset by contractions in government credit, by 20%, and in private-sector credit, by 8%. Narrow money supply (M1), which made up 40% of the total of M3 at end-March, fell by 9% year on year.

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Papua New Guinea: money supply (Kina m; end-period) 2002 2003 1 Qtr 2004 % changea Domestic credit 2,850.3 2,620.7 2,537.5 -13.4 Non-government 1,593.8 1,497.1 1,482.1 -8.0 Central government 1,256.5 1,123.6 1,055.4 -20.1 Net foreign assets 1,419.4 1,607.3 1,654.3 38.4 Total money supply (M3) 4,269.2 4,228.0 4,191.8 1.6 a First quarter of 2003 compared with year-earlier period. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The domestic economy

Economic trends

The government remains The treasurer, Bart Philemon, sounded a fairly upbeat note over economic upbeat about the economy conditions when he delivered his state of the economy address on July 7th. Although no quarterly GDP data are produced, Mr Philemon said that the government expected real GDP to expand by 2.8% this year, surpassing expected population growth of 2.7%, with all sectors forecast to expand. The Bank of Papua New Guinea (BPNG, the central bank), through its business liaison survey, produces data on the total nominal value of sales, as an indicator of the health of the economy. In 2003 the total nominal value of sales increased by 9% year on year. However, with average annual headline inflation running close to 15% in 2003, this performance is not impressive. Indeed, in 2002 the total nominal value of sales increased by 21% year on year, with annual inflation close to 12%. Agriculture, including forestry and fisheries, recorded an 18% annual increase in sales in 2003, reflecting broadly based production increases and higher world prices, partly mitigated by the kina’s appreciation against the US dollar. Annual sales growth in 2003 in manufacturing was 10%, down from growth of more than 20% in 2002. Sales growth in transport, at 14%, was down by a bit more than one-half. Annual sales in the building and construction sector in 2003 grew by 16% following 54% growth in 2002.

Employment indicators Based on recent employment figures, the economy is in a fairly healthy generally improve position, average employment in 2003 increased by 7.6% year on year. It grew strongest in the Momase region, by 18%, followed by the Islands region, which registered 13% average annual employment growth. Employment in the Highlands region grew at the national average rate and in Morobe region it grew by 10%. However, employment in Port Moresby and the Southern region declined year on year in 2003, by 0.8% and 0.2%, respectively. Employment in 2003 grew faster than the national average in agriculture, including forestry and fisheries (up by 13.5% year on year), in building and construction (12.3%), and in wholesale trade (11%). Employment in manufacturing was up by 6.2% year on year in 2003, and in financial and business services it was 4.2% higher.

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Year-on-year inflation Consumer price inflation dropped to only 2.9% year on year in the first quarter continues to slow of 2004. This indicates a considerable slowdown in inflation from an average annual rate of 14.7% in 2003. Quarter-on-quarter inflation, however, has picked up, rising to 1.4% in the first quarter compared with 0.4% in the fourth quarter of 2003. There was only a marginal increase in prices for food, and clothing and footwear during the first quarter. Household equipment, and transport and communication services prices fell by 2% and 0.3% respectively. However, prices in the drinks, tobacco and betelnut category rose by 3%; prices in the rents, council charges, and fuel and power group rose by 3.5% quarter on quarter. Underlying consumer price inflation, which excludes the prices of betelnut, fruits and vegetables, and the effects of government policy decisions on prices of consumer goods, rose by 1% quarter on quarter and 5.4% year on year. Quarter-on-quarter inflation in the first quarter was twice the national average in Port Moresby and Goroka, and also above it in Madang; but in Lae and Rabaul prices fell, by 1.1% and 1.7%, respectively.

Papua New Guinea: quarterly inflation (1977=100) 2002 2003 2004 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Consumer price index 686.1 709.9 758.9 766.2 766.8 769.8 780.7 % change, year on year 12.3 14.8 20.7 19.0 11.8 8.4 2.9 Underlying inflationa 433.5 451.3 475.8 491.8 496.5 496.5 501.5 % change, year on year 15.4 17.3 21.1 21.4 14.5 10.0 5.4 a Revised series. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The kina strengthens against According to data from the BPNG, at the end of the first quarter the kina had most major currencies appreciated by 12.6% year on year against the US dollar, but was weaker relative to all other major currencies—most significantly, the kina had depreciated against the Australian dollar by 10.5% year on year. However, on a quarter-on- quarter basis, in the first quarter the kina appreciated against all major currencies except pound sterling, against which it fell by 0.2%. The kina appreciated by 5.5% against the euro, 2.7% against the US dollar, 1.4% against the Australian dollar and less than 0.1% against the yen. The overall appreciating trend in the kina continued in the second quarter, and by early July the kina had appreciated against the US dollar by more than 5% compared with its value at end-2003.

Papua New Guinea: exchange rates (Kina per unit of foreign currency; annual averages unless otherwise indicated) Jul 5th 1999 2000 2001 2002 2003 2004 A$ 1.659 1.613 1.753 2.110 2.311 2.214 US$ 2.57 2.78 3.39 3.90 3.56 3.11 ¥ 0.022 0.026 0.028 0.031 0.031 0.029

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

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Oil and gas

Crude oil production and Production from the Kutubu crude oilfield averaged around 18,850 barrels per exports fall day in the first quarter, down by 3% quarter on quarter. The Gobe fields produced 1.1m barrels in the first quarter, down by 9% quarter on quarter, and production at the Moran field dropped by 1% to 1.2m barrels. Moran production failed to meet expectations primarily because of a shutdown of the gas injection compressors for 13 days during the quarter. However, Papua New Guinea (PNG)-based Oil Search, which operates and owns 70% of the field, has reported that, subject to the necessary approvals being granted, the North-west Moran and South-east Mananda fields could proceed to development in the third quarter of 2004. Crude oil exports of 3.3bn barrels in the first quarter were 13% lower than in the year-earlier period. The natural decline in the older fields was only partly offset by production from a new one.

Napa Napa refinery receives In a development that has been regarded by some as PNG’s biggest industrial first oil shipment achievement, in June the Kina700m (US$225m) Napa Napa oil refinery, built by Canada’s InterOil, received its first shipment of crude oil from the Kutubu sea terminal in neighbouring Gulf province. When in full production the refinery will have the capacity to process 32,500 barrels per day of crude oil, converting the oil into diesel, petrol, kerosene, jet fuel and other products. Some of the refined petroleum will be exports to neighbouring countries. Despite this development, the Independent Consumer and Competition Commission (ICCC) has advised that fuel prices will be higher than for currently imported fuel, but by how much depends on refining costs. The ICCC commissioner, Thomas Abe, has explained that although the crude oil would be coming from Kutubu, the freight cost charged would be the same as the freight cost from Singapore and that the landed posted price would be at a premium to the spot price. Also, he said that prices would be higher outside Port Moresby owing to additional freight charges.

Highlands gas project hinges The launch of the long-delayed PNG-Australia gas pipeline (known as the on key purchase agreement Highlands Gas Project) hinges on the approval of conditional long-term gas purchase agreements with the project. Agreements are pending with Australian aluminium producers, Alcan and Comalco, whose refinery at Gladstone, Queensland, is the world’s largest. The US’s ExxonMobil, the managing entity and 39% owner of the gas project, was not persuaded by (54% owner) Oil Search’s view that moving to the front-end engineering and design (FEED) phase was the best way to induce foundation customer agreements. However, the project partners have agreed a budget and are reportedly “FEED ready”. The 2,655-km pipeline from the PNG Highlands to Queensland and Moomba in South Australia is scheduled for completion in 2008. There are also other strategies under active examination for utilising the country’s substantial gas reserves. One of them, involving a consortium of US, Korean and Indonesian interests, is the development of a northern pipeline to a

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processing plant in Wewak aimed at supplying markets in Asia. Another, emanating from Oil Search, is looking to the New Zealand market. Oil Search and Japanese companies, Mitsubishi and Itochu, are also undertaking final feasibility work for the development of a methanol/dimethyl ether plant in PNG, leading to a decision on FEED activities by the end of the year.

Mining

Goldmines experience mixed The Lihir goldmine produced only around 112,000 oz (2.8 tonnes) of gold in the fo rtunes first quarter of 2004, down by nearly 30% quarter on quarter and about 14% year on year. Scheduled maintenance and a breakdown in the oxygen plant explains most of the variances. Production at the Porgera goldmine during the same period, however, expanded by 33% year on year owing to higher grade and increased throughput from mining softer material. Underground production at Porgera, previously expected to cease in 2007, is now expected to continue until 2008. Canada’s Placer Dome, which operates and owns 75% of the mine, has forecast that 2004 production will reach 950,000 oz. The Misima goldmine produced 27,800 oz from processing low-grade ore stockpiles in the first quarter, with high gold prices permitting processing to continue through to May, when operations ceased. The Tolukuma goldmine in Central province continues to produce at the rate of 7,000 oz per month, and exploration there has added 50,000 oz of gold to the mine’s reserves. As a result of these performances, in addition to the shipping timing differences, gold exports in the first quarter dipped by 3.5% year on year. Construction of the Kainantu gold project is under way and is scheduled for completion by September 2005. Gold production at the rate of 115,000 oz per year is expected over the mine’s ten-year life span. In other developments, a pre-feasibility study has begun on two gold deposits on Fergusson Island, Milne Bay province, which could support open-cut mining of 40,000 oz of gold a year.

Copper exports decline The copper mining sector suffered a decline in output and exports in the first quarter of the year. Export volume plunged by 28.2% year on year to only 46,300 tonnes. This was largely owing to declining production levels in addition to reduced shipments because of the low water levels in the Fly river. The extent of the downturn also reflected the unusually high export volume in the year-earlier period. Despite these problems, copper exports received much higher prices, at around Kina8,130 (US$2,600) per tonne, equivalent to a year- on-year increase of more than 34%.

Papua New Guinea: mineral exports by volume 2002 2003 2004 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Crude oil ('000 barrels) 3,632 3,748 4,107 4,272 2,857 3,268 Copper ('000 tonnes) 23.7 64.5 53.2 43.8 69.1 46.3 Gold (tonnes) 16.1 17.1 14.6 17.9 18.8 16.5 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

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Agriculture, fisheries and forestry

Most commodity exports Agricultural commodity export volumes were generally higher in the first record improved performance quarter of 2004 than in the year-earlier period, except for copra oil and rubber. Palm oil exports reached 101,100 tonnes (up by 6.7% year on year), cocoa exports were 10,400 tonnes (up by 28%) and coffee exports totalled 8,200 tonnes (up by 3.8%). Copra exports increased by 20% to 4,900 tonnes, reflecting the issuance of more export licences by the industry regulator, Kokonas Indastri Koporasen (KIK). The decline in rubber exports, by around 20%, was attributed to deteriorating road conditions. The deterioration in copra oil exports, of 18% year on year, reflects the expansion in copra exports. This has significance in terms of the controversial proposal to establish a cocoa-processing factory on the condition that a 30% levy is imposed on exported cocoa beans.

Cocoa-processing plan remains Cocoa growers and exporters are infuriated at the proposal to establish a butter controversial and liquor processing factory in Lae supported by a 30% levy on exports of cocoa beans, the effect of which would be to grant the processor a monopsony and deprive growers of market choice. The relevant ministries are at loggerheads as well, with the Ministry of Trade and Industry supporting the proposal, and the Ministry of Agriculture rejecting it. The promoters claim that the factory would increase the price to growers, which begs the question as to why a levy is needed to discourage exports. Growing of cocoa beans, mainly by smallholders, is widely dispersed. Getting raw material to a central processor would add a substantial cost that would be only partly mitigated by lower freight costs for export of product rather than raw material.

Palm oil production is Production of palm oil is buoyant, with a major producer, New Britain Palm expanding rapidly Oil, recording a 76% year-on-year increase in output in January-May. Production in 2003 was a record 204,402 tonnes, although smallholder production fell short of expectations. The company has announced that it traded at consistent premiums to the quoted prices. The immediate future for prices remains bullish, reflecting declining stocks of competing oils and lower growth in palm- oil production.

Papua New Guinea: agricultural exports by volume ('000 tonnes unless otherwise indicated) 2002 2003 2004 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Cocoa 9.7 8.9 10.5 8.1 13.6 10.1 8.5 10.4 Coffee 12.7 25.9 17.8 7.9 14.5 28.3 18.1 8.2 Tea 1.4 1.0 1.2 1.9 1.8 1.3 1.6 2.3 Copra 4.7 4.8 0.7 1.5 2.1 1.3 2.8 4.9 Copra oil 4.0 6.5 11.6 9.3 14.4 12.8 11.2 7.6 Palm oil 91.4 76.5 75.5 94.8 83.1 75.2 73.8 101.1 Rubber 0.9 1.1 0.8 1.0 1.0 1.0 1.2 0.8 Logs ('000 cu metres) 423.0 409.0 621.0 543.0 478.0 488.0 507.0 462.0 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

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Management of livestock The newly appointed agriculture minister, Mathew Siune, announcing the agency is sacked recent sacking of the entire board and management of the Livestock Development Corporation (LDC), said that his department would restrict its role to regulation. The government plans to sell the LDC to local farmers or businessmen. The corporation, established in 1983 to produce meat for domestic consumption, is reportedly Kina1.2m in debt and has been selling assets to pay staff. Mr Siune has also suspended the chairman and managing director of the KIK for insubordination and indicated that the cocoa and coffee industry boards, too, were in his sights.

There is scope for tuna The acting managing director of the National Fisheries Authority, Sylvester fisheries expansion Pokajam, recently revealed the extent to which PNG’s fisheries industry could expand if more catch from PNG’s waters was brought ashore rather than shipped abroad directly by foreign holders of fishing rights. According to Mr Pokajam, only 6% of PNG’s 330,000 a year tuna catch is actually brought ashore. Mr Pokajam said that by encouraging onshore investment, more fish could be processed domestically, thereby creating a US$1bn a year industry. PNG currently sells tuna-fishing rights to mainly Asian operators. With some of these licences coming up for renegotiation, the government is likely to try to encourage foreign operators to invest in onshore facilities.

Infrastructure

ADB-funded road works are Upgrading work on a 76-km section of the planned total of 220km of Highlands moving forward roads under an Asian Development Bank (ADB)-funded project has been completed, or contracts let or pending approval. Wabag-Kompiam Stage I, Kundiawa-Gumini Stage I, Oliguti-Lufa Stage I and Ogelbeng-Mt Ambra roads have been completed; the Kisenapoi Ialibu road contract was awarded in June; and the tender for work on the Mount Ambra-Cotna Road is pending board approval. With the recent release of the required 50% government counterpart funding, the remaining nine major subprojects have been approved and the contractors pre-qualified, paving the way for tenders to be called. The Southern Highlands provincial government has raised the Kina1m it needs to release Kina11.3m of ADB road funding. In addition, the province has completed feasibility studies for 12 major provincial roads. Delays to the ADB road programme have occurred through high turnover of expatriate consultants who have been the victims of lawlessness in the Highlands. According to the works department, 1,100km of national and provincial roads in the five Highlands provinces have been rehabilitated in 2000-04 under ADB-funded programmes. Australia’s overseas development agency, AusAID recently awarded two contracts totalling Kina8m for work on the maintenance of the 340-km Lae- Chimbu stretch of the Highlands Highway, about two-thirds of its total length. In other AusAID related work, tenders closed in May for projects concerning essential road maintenance costing Kina110m over five years. AusAID has spent Kina35m over the past three years on this part of the highway.

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First phase of a bridge-building The first phase of the Yumi Yet bridge programme, financed by the UK programme is complete government’s export credit agency, has erected 75 bridges in 16 provinces. A broadly based petition of ministers, governors and members of parliament (MPs) is urging the government to find the Kina17m (US$5.5m) of necessary counterpart funding for the second phase, Yumi Yet to Moa Yet, to proceed. Under this phase, North Solomons province, on the eve of achieving autonomy and in great need of an economic boost, would benefit from its share of the 200 bridges, ten wharves and two ferries incorporated in the plan. The Treasury wants the cost-benefit study, which was not done before the programme commenced, completed before committing to the second phase. In making his case to cabinet the works minister, Gabriel Kapris, said in effect that the benefits were so obvious as to make a cost-benefit study a mere academic exercise. The unbudgeted programme was introduced in the dying stages of the previous government. There is no provision in the current budget to maintain the Kina40m of heavy equipment that the works department would take over from the project in October if the second phase does not proceed. In answer to a question in parliament, Sir Michael said that he wanted the second phase of the programme included in the budget for 2005, subject to satisfactory audit of the first one.

Foreign trade and payments

Export revenue dips in the first Export revenue in the first quarter totalled Kina1.9bn (US$0.6bn), down by 4.5% quarter year on year. Gold export revenue was fairly stable year on year at Kina717m (US$230m), with higher prices offsetting a drop in export volume. Gold is now by far the most important export commodity and accounted for 37% of total export revenue in the first quarter. Export revenue from copper, crude oil and combined agriculture commodities each accounted for around 20% of the total, with forest and marine products comprising the remainder. Copper exports dropped by 3.6% in the first quarter, with the sharp drop in volumes only partly offset by higher received prices. Crude oil exports were poor, plunging by 25.5% year on year to only Kina352m, although this represents an improvement from only Kina300m in the fourth quarter of 2003. The agriculture sector recorded the most impressive export performance in the first quarter, with combined revenue rising by 29% year on year to Kina374m. Palm oil exports, which accounted for 36% of the total, rose by only 1.4% year on year, while cocoa and coffee export revenue dropped by 2.6% and 1.4% year on year. The impressive overall increase in agricultural exports, therefore, came almost exclusively from the threefold increase in the “others” category, which accounted for 31% of the total in the first quarter. Exports of forestry and marine products were disappointing, dropping by 28% and 24% year on year respectively.

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Papua New Guinea: exports (Kina m) 2003 2004 2001 2002 2003 1 Qtr 1 Qtra Agricultural products 801.1 1,084.9 1,362.2 289.6 374.3 Forestry products 310.9 414.1 415.8 121.9 88.1 Logs 234.3 365.5 369.6 104.2 76.8 Marine products 77.2 94.1 125.3 30.3 22.9 Minerals (incl silver) 4,895.6 4,774.0 5,890.0 1,591.5 1,455.6 Gold 2,115.1 2,294.8 2,811.2 716.6 716.8 Copper 859.1 1,018.7 1,415.0 390.6 376.5 Crude oil 1,889.4 1,431.2 1,631.9 472.6 352.0 Total 6,084.8 6,367.1 7,793.3 2,033.3 1,940.9 a Provisional data. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Around half of all trade is Australia remains by far PNG’s largest export destination. According to data with Australia compiled by the Bank of Papua New Guinea (BPNG, the central bank), in the first quarter Australia accounted for 45.7% of PNG’s exports, with Japan, the second-largest market, accounting for 10.7% of the total. Germany, China, South Korea, the UK and the Philippines each accounted for around 4-6%, and Singapore, the US and Indonesia, about 2% each. (The BPNG’s export destination data differs from the data published by the IMF, which are incorporated in the Annual indicators table.) Australia also accounts for most of PNG’s imports. In the first quarter nearly 55% of all imports came from Australia, the same proportion as in 2003, but down from 59% in 2002. Other leading sources of imports are the US (9.1% of the total), Singapore (8.8%) and China (6.8%). Imports from China are expanding rapidly. In 2002 only 1.8% of PNG’s imports came from China.

Imports drop to lowest level Imports (fob) in the first quarter contracted by 8.5% to Kina991m (US$320m), the since early 2002 lowest level since the first quarter of 2002. Mining imports, which accounted for 24% of the total, expanded by 28% year on year, reflecting increased capital expenditure at all the goldmines. However, year-on-year declines in general and petroleum imports, by 16% and 23%, respectively, more than offset the increase in mining imports. With the import bill contracting at a faster pace year on year in the first quarter than export revenue, the merchandise trade surplus reached Kina995m, a record high and unchanged from that recorded in the year-earlier period.

The current account remains The large merchandise trade surplus in the first quarter contributed to an in surplus overall surplus on the current account of Kina120m (US$38m). However, this represents a deterioration compared with surpluses of Kina407m in the year- earlier period and Kina256m in the previous quarter. The deficit on the services account expanded markedly in the first quarter, rising by 20% year on year to Kina773m in line with a 9% drop in services credits and a 13% increase in debits. A 90% year-on-year increase in income debits in the first quarter resulted in a Kina383m deficit on the income account, with employee compensation and dividend payments more than offsetting a reduction in interest payments.

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Transfer credits remain impressive, rising by 2% year on year to Kina338m, and more than the total received in the whole of 2002. The capital and financial accounts recorded a deficit of Kina262m in the first quarter of 2004, down from Kina537m in the year-earlier period. Net foreign direct investment inflows in the first quarter totalled Kina52m, down from Kina510m in the previous quarter, but marking the second consecutive quarter of inflows. Portfolio investment contributed Kina355m in the first quarter, reflecting activity by mining companies in the short-term money markets, compared with an outflow of Kina118m in the year-earlier period. These net inflows were more than offset by net loan repayments by both the government and the private sector.

Papua New Guinea: balance of payments (Kina m) 2003 2004 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtra Merchandise exports 2,038 1,875 1,922 2,007 1,946 Merchandise imports -1,083 -1,072 -1,001 -1,075 -991 Trade balance 955 803 921 932 955 Services balance -611 -600 -476 -576 -733 Income balance -205 -887 -306 -301 -383 Net transfers 268 296 82 201 281 Current-account balance 407 -388 221 256 120 Net direct investment -16 -104 -20 510 52 Portfolio investment -118 263 -99 -212 355 Financial derivatives 13 -4 39 34 -9 Other investment -347 316 -23 -347 -660 Capital & financial account balance -537 471 -103 -15 -262 Net errors & omissions -26 -24 36 53 78 Overall balance -156 60 154 295 64 International reservesb 1,223 1,283 1.437 1,731 1,668 a Provisional data. b End-period. Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

International reserves remain According to the BPNG, international reserves at the end of March 2004 totalled fai rly bu oyant Kina1.7bn, down slightly from the level at end-2003, but up from Kina1.2bn at end-March 2003. These reserves provide sufficient cover for 5.1 months of total imports and 6.9 months of general imports (excluding imports by mineral and oil producers). At end-March 2003 reserves covered only around 3.5 months of total imports. According to the IMF, foreign-exchange reserves totalled US$484m in April 2004, down slightly from US$490m at end-2003.

Country Report July 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004 Papua New Guinea 29

Country Report July 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004