COUNTRY REPORT

Papua New Guinea At a glance: 2001-02

OVERVIEW The government has been making progress in implementing its economic reform programme. However, economic activity in all sectors has been fairly subdued in 2000. The EIU estimates real GDP growth of 2.9% in 2000 and forecasts 3.8% in 2001 and 7.0% in 2002. Economic activity will pick up in the next few years with the development of major minerals and gas projects. Growth will also be driven by stronger domestic demand as interest rates fall. Inflation remained high in 2000 but should fall in 2001 and 2002 as price stability becomes the primary focus of the Bank of Papua New Guinea (the central bank). The current account will remain in surplus in 2001 but will fall into deficit as imports of capital equipment for these projects rise significantly in 2002. The kina is steadily depreciating but should remain in an acceptably narrow trading range in 2001 and 2002 as capital inflows counterbalance the increasing demand for imports. Key changes from last month Political outlook • Sir Mekere Morauta has reshuffled his cabinet again in an attempt to rid the government of disloyal members. The former prime minister, Sir Michael Somare, was the latest casualty. He was dismissed for not voting with the government on the integrity bill. The bill was eventually passed by a vote of 84-0. Economic policy outlook • Changes to the tax regime for gas, oil and mining, announced in the 2001 budget should encourage new exploration and development in these areas. Economic forecast • We have revised downwards our estimate for GDP growth in 2000 from 4.1% to 2.9% following a decline in economic activity in all sectors. We still expect an improvement in 2001 and 2002, however this will be less impressive than our previous forecast, at 3.8% and 7.0% respectively.

January 2001

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ISSN 1366-4085

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

Printed and distributed by Redhouse Press Ltd, Unit 151, Dartford Trade Park, Dartford, Kent DA1 1QB, UK Papua New Guinea 1

Contents

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2001-02 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

15 Economic policy

21 The domestic economy 21 Economic trends 23 Oil and gas 24 Mining 25 Agriculture

26 Foreign trade and payments

List of tables

9 International assumptions summary 10 Forecast summary 12 World commodity price forecasts 18 Central government budget 22 Quarterly inflation 23 Money supply 25 Mineral exports, by volume 26 Agricultural exports, by volume 26 Agricultural export prices 27 Balance of payments 28 Exports 28 Exchange rates 29 Public debt outstanding

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001 2 Papua New Guinea

List of figures

12 Gross domestic product 12 Kina real exchange rates 20 Interest rates 23 Kutubu oil price 24 Mineral exports 28 Exchange rates 29 External debt

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Summary

January 2001

Outlook for 2001-02 The government has been making progress in implementing its economic reform programme. However, economic activity in all sectors has been fairly subdued in 2000. The EIU estimates real GDP growth at 2.9% in 2000 and forecasts 3.8% in 2001 and 7% in 2002. Economic activity will pick up in the next few years with the development of major minerals and gas projects. Growth will also be driven by stronger domestic demand as interest rates fall. Inflation remained in 2000, but should fall in 2001 and 2002 as price stability becomes the primary focus of the Bank of Papua New Guinea (the central bank). The current account will remain in surplus in 2001 but will fall into deficit as imports of capital equipment for these projects rise significantly in 2002. The kina is steadily depreciating but should remain in an acceptably narrow trading range in 2001 and 2002 as capital inflows counterbalance the increasing demand for imports.

The political scene The prime minister, Sir Mekere Morauta, will remain in office until the next election in June 2002. The integrity bill has finally been approved with the main body of the law coming into force early in 2002. There have been a number of cabinet reshuffles as Sir Mekere demands loyalty from all members of the government. There is renewed hope for the Bougainville peace talks. Tension has risen between national and provincial governments.

Economic policy The 2001 “recovery to reconstruction” budget was passed in November. It is a balanced budget, if arrears are excluded, with a tax reform favouring the poor and providing incentives for mining, gas and oil exploration. Higher government revenue and a lower budget deficit are expected for 2000. The IMF released the second tranche of the stand-by arrangement in November. The central bank continues to focus on price stability with tight monetary policy. Privatisation plans are in motion.

The domestic economy The government has lowered its GDP growth estimate for 2000 from 4.7% to 0.8%. Inflation is down over the quarter and the year. Interest rates continue to fall. The government is seeking financial assistance for the gas pipeline. Oil exports continue on a downward path. A binding agreement has been signed for the Ramu cobalt-nickel project but there is no third investor yet. Falling agricultural export prices have continued to hurt producers.

Foreign trade and The third quarter was disappointing for foreign trade. There has been little payments respite for the falling kina. External public debt is up slightly over the third quarter.

Editors: Danny Richards (editor); Graham Richardson (consulting editor) Editorial closing date: January 12th 2001 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

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

National legislature Unicameral national parliament; its 109 members (currently 104 are sitting, with five vacancies) are elected for a period of five years, 89 representing “open” constituencies and the rest representing 19 provincial constituencies and the capital district

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

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

National elections June 1997; next election due June 2002

National government Sir Mekere Morauta, the leader of the People’s Democratic Movement (PDM), was elected prime minister by parliament on a vote of 99:5 on July 14th 1999. He leads a coalition government consisting principally of the PDM, the People’s National Alliance and Pangu Pati

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

Main members of the National Prime minister & minister for finance Sir Mekere Morauta (PDM) Executive Council Deputy prime minister & minister for forestry Michael Ogio (PDM)

Key ministers Agriculture Muki Taranupi (PPP) Defence Kilroy Genia (APP) Education John Waiko (PDM) Environment Herowa Agiwa (PDM) Fisheries Ron Ganarafo (PDM) Foreign affairs & Bougainville affairs Bart Philemon (NAM) Health Ludger Mond (PP) Home affairs William Ebenosi (PDM) Lands John Pundari (APP) Labour & employment Charlie Benjamin (APP) Justice Puri Ruing (PDM) Mining Michael Laimo (NAM) Petroleum & energy Chris Haiveta (PP) Privatisation Vincent Auali (PDM) Public service Philemon Embel (PDM) Trade & industry John Tekwie (APP) Transport & civil aviation Alfred Pogo (PDM) Works John Kamb (PDM)

Central bank governor Wilson Kamit

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Economic structure

Annual indicators

1996 1997 1998 1999 2000a GDP at market prices (Kina bn) 6.9 7.1 7.9 9.4 11.4 GDP (US$ bn) 5.2 4.9 3.8 3.7 4.2 Real GDP growth (%) 7.8 –3.9 –3.8 3.6 2.9 Consumer price inflation (av; %) 11.6 3.9 13.6 14.9 17.1 Population (m) 4.4 4.2 4.6 4.7 4.8 Exports of goods fob (US$ m) 2,529.8 2,160.1 1,773.3 1,927.4 2,106.0 Imports of goods fob (US$ m) 1,513.3 1,483.3 1,078.3 1,071.4 1,032.3 Current-account balance (US$ m) 189.0 –192.3 –28.8 97.2 236.5 Foreign-exchange reserves excl gold (US$ m) 583.9 362.7 192.9 205.1 282.8 Total external debt (US$ bn) 2.5 2.6 2.7 2.8 2.9 Debt-service ratio, paid (%) 16.4 20.5 8.6 15.8 14.9 Exchange rate (av) Kina:US$ 1.32 1.44 2.07 2.57 2.74

January 12th 2001 Kina3.31:US$1

Origins of gross domestic product 1999a % of total Components of gross domestic product 1999a % of total Agriculture 29.5 Private consumption 52.1 Mining & quarrying 22.8 Government consumption 19.1 Manufacturing 9.0 Investment 11.7 Construction 3.6 Exports of goods & services 50.2 Electricity, gas & water 1.4 Imports of goods & services –33.4 Services 33.7 GDP at market prices incl change in stocks 100.0 GDP at factor cost 100.0

Principal exports fob 1999 US$ m Principal imports cif 1994 US$ m Gold 601.6 Machinery & transport equipment 442.9 Crude oil 537.9 Manufactured goods 334.0 Copper 223.5 Food & live animals 204.2 Coffee 162.3 Chemicals 85.9 Palm oil 131.5 Mineral fuels & lubricants 40.8 Logs 99.5 Total incl others 1,526.5 Total incl others 2,127.5

Main destinations of exports 1999 % of total Main origins of imports 1999 % of total Australia 30.0 Australia 52.9 Japan 11.9 Singapore 12.7 Germany 6.8 Japan 5.5 South Korea 4.1 New Zealand 4.1 Philippines 2.7 US 3.6 UK 2.6 Malaysia 3.6 a EIU estimates.

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Quarterly indicators

1998 1999 2000 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Prices Consumer prices (1995=100) 144.3 140.2 143.6 158.8 163.4 167.6 175.9 178.1 % change, year on year 21.8 14.2 14.1 18.3 13.2 19.5 22.5 12.2 Financial indicators Exchange rate Kina:US$ (av) 2.16 2.22 2.53 2.78 2.75 2.96 2.50 2.65 Kina:US$ (end-period) 2.10 2.38 2.56 2.96 2.70 2.62 2.43 2.76 M1 (end-period; Kina m) 1,111 1,114 1,298 1,367 1,344 1,294 1,252 n/a % change, year on year 10.3 20.3 35.2 32.8 21.0 16.1 –3.5 n/a M2 (end-period; Kina m) 2,732 2,812 2,916 2,982 2,982 2,929 2,990 n/a % change, year on year 2.5 7.7 7.9 6.5 9.2 4.2 2.5 n/a Sectoral trends Exports Copra ('000 tonnes) 14.9 12.4 14.6 16.6 19.9 29.6 16.9 10.5 Copra oil ('000 tonnes) 12.2 18.1 14.0 11.3 6.9 15.1 9.8 14.5 Cocoa ('000 tonnes) 4.8 7.3 11.2 6.0 4.5 14.2 9.9 9.0 Coffee ('000 tonnes) 19.0 10.8 20.2 33.9 14.3 10.2 20.5 16.7 Logs ('000 cu metres) 395 324 470 230 288 312 322 279 Gold (tonnes) 16.1 12.7 14.8 18.5 17.0 19.4 17.2 16.9 Fish ('000 tonnes) 0.4 0.3 1.3 0.6 0.5 0.4 0.5 0.3 Oil, crude ('000 barrels) 7,322 7,520 7,642 7,735 7,749 5,889 5,930 5,239 Foreign trade & reserves Exports fob (Kina m) 1,004 868 1,208 1,454 1,401 n/a n/a n/a Imports fob (Kina m) –574 –597 –713 –685 –705 n/a n/a n/a Trade balance (Kina m) 430 271 495 769 695 n/a n/a n/a Reserves excl gold (end-period; US$ m) 192.9 138.3 89.1 106.1 205.1 175.7 n/a n/a Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; IMF, International Financial Statistics.

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Outlook for 2001-02

Political outlook

Domestic politics Papua New Guineans face a different political future from normal—an unexpectedly stable one. In the short term, parliament has adjourned until July 23rd 2001 ensuring the continuation in office of the prime minister, Sir Mekere Morauta, until the general elections to be held in June 2002. In the longer term, the unexpected passing of the Organic Law on the Integrity of Political Parties and Candidates on the final day before adjournment, will usher in a period of intense learning about the vastly different way that that election, and subsequent ones, will be conducted and how the resulting parliaments will conduct themselves. New laws will be enacted that, among other things: require the registration of political parties; limit the use of outside funding for political activities; and prevent independent MPs from voting on budgets, participating in votes of no confidence in the government, or voting on constitutional amendments. There have already been calls for amendments to the new laws to make registration conditional on well-formed philosophies and policies. Independents in the past have frequently brought down governments, and no prime minister has ever completed a full term. By forcing nominal independents to join a party, the government hopes to limit their ability to disrupt the political scene. MPs who change party between elections would face the possibility of dismissal, or be forced to stand in a by-election. These restrictions, probably untenable in many other parliamentary systems of government, appear to favour the financial viability of larger, established political parties.

Sir Mekere has brought a sense of stability to domestic politics that was certainly lacking in the previous administrations since independence in 1975, and has received international recognition for doing so. As a result foreign investor confidence should improve, but only time will tell whether the bill can guarantee a stable investment environment in the long term.

Election watch The next general election is expected to be held in June 2002, and Sir Mekere and his People’s Democratic Movement (PDM) must be considered the overwhelming favourites to form the next government. If the economy continues to improve, as the EIU expects, the prime minister’s popularity should increase. However, the economy is particularly susceptible to external shocks, such as sharp declines in commodity prices, and export volumes are susceptible to climatic and seasonal influences. Major privatisations are expected during the next two years, which will be controversial, and the critically important PNG-Queensland gas pipeline project, which is expected to anchor the economy for the next decade, may yet fall through. Any or all of these developments could erode support for the government and revive prospects for the opposition. Moreover, a general election in Papua New Guinea is a two-stage process; first, the people elect 109 members of parliament, who then elect, on the floor of parliament, one of their number to be prime minister. The first stage is very much a tribal matter; prime ministers

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do not necessarily hold their parliamentary seats, despite their national or international standing, a fact that former prime ministers, Sir Julius Chan and Paias Wingti, can both attest to.

International relations Given PNG’s ethnic secessionist history, the country has attracted much international attention following coups in Fiji and the nearby Solomon Islands in May and June. Despite this, the situation on Bougainville has been improving of late, and as a result there has been relatively little spillover into PNG from the troubles elsewhere in the South Pacific. PNG’s relations with Australia, meanwhile, have been improving after a rough patch in early 2000. Economic co-operation with the Chinese and Japanese governments has in- creased, based mainly on new financial aid from both countries. Irian Jaya, or West Papua as it is also called, looms as PNG’s biggest foreign policy challenge.

Economic policy outlook

Policy trends The government has successfully guided the economy through a period of recovery and, with the 2001 budget, is starting on a period of “reconstruction”. The IMF and World Bank have both strongly praised the progress of the government’s economic reform programme and have promised to continue supporting it. The IMF completed the second review of the standby arrangement in November, finding PNG on track to achieve the objectives of the structural reform programme. The IMF plan is aimed at: restoring discipline in the budget, securing independence for the Bank of Papua New Guinea (the central bank), stabilising the kina, reducing high levels of domestic debt, privatising state-owned enterprises (SOEs) and strengthening political institutions. The government has undertaken initiatives in all of these areas. Privatisation may be the most difficult issue facing the government as PNG’s poor reputation among international investors could limit interest, and political opposition towards privatisation is also growing. However, the prime minister is determined to complete the privatisation of the Papua New Guinea Banking Corporation, with the first stage of the sale to be completed by April 2001. The government also hopes to go ahead with the sale of the Air Niugini in the first half of 2001.

Fiscal policy The government is in a strong position to exceed its IMF-agreed budget target, which calls for a deficit of Kina215.1m (US$86m) in 2000. For the nine months to September, the government recorded a budget surplus of Kina33.5m. In order to meet its expected full year deficit of Kina 179m, the government needs to spend as much on development projects in the fourth quarter as it did in the first three quarters, as in 1999. The EIU expects the deficit to be close to Kina170m, equivalent to around 1.5% of estimated nominal GDP. The government announced its 2001 budget on November 28th and forecast a budget deficit of 1.3% of GDP. Debt service payments will account for over Kina1bn (US$335m) out of a total expenditure of Kina3.96bn. A record 35% of total expenditure has been allocated to development, focusing on priority areas of health, education and infrastructure. The 2001 budget does not include any new tax burdens but incorporates taxation reforms, the most significant

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changes being to the tax regime for gas, oil and mining which should encourage new exploration and development in these areas. In 2002 construction work on major minerals projects should provide added buoyancy to the economy and to government revenue.

Monetary policy The central bank has maintained a restrictive monetary policy through the use of open-market operations and retention of its cash reserve requirement (CRR). Even so, all indicative interest rates and the maximum interbank rate have been declining, reflecting the increase in the average level of liquidity in the banking system. The 182-day Treasury-bill rate, for example, has declined from a high of 28.03% in August 1999 to 13.62% in October of this year. It is likely that interest rates will continue to fall, but we would expect a pause until the currency again stabilises—any further decline in interest rates in the short term would place additional pressure on the kina. We would expect the government to move some time in 2001 towards a more accommodative policy stance, possibly by easing or reducing either the CRR or the minimum liquid assets ratio (MLAR). Monetary policy should become slightly more restrictive again in 2002 as growth picks up and new resource development projects accelerate. However, the high import component of major projects, including labour supply and financing, their remote locations, and their weak linkages to the rest of the economy will dampen their domestic impact.

Economic forecast

International assumptions summary (% unless otherwise indicated) 1999 2000 2001 2002 Real GDP growth World 3.5 5.0 4.2 4.1 OECD 3.0 4.1 3.0 2.7 EU 2.4 3.3 3.0 2.6 Exchange rates (av) ¥:US$ 113.9 107.6 108.5 104.5 US$:¤ 1.07 0.92 0.95 1.05 SDR:US$ 0.731 0.766 0.779 0.740 Financial indicators ¥ 2-month private bill rate 0.27 0.21 0.45 0.98 US$ 3-month commercial paper rate 5.18 6.32 6.25 5.25 Commodity prices Oil (Brent; US$/b) 17.9 28.8 23.4 19.1 Gold (US$/troy oz) 278.8 283.2 275.0 270.0 Food, feedstuffs & beverages (% change in US$ terms) –18.6 –6.0 10.6 14.1 Industrial raw materials (% change in US$ terms) –4.2 14.2 4.2 9.6

Note. Regional aggregate GDP growth rates weighted using purchasing power parity (PPP) exchange rates. International assumptions The EIU estimates world GDP growth in 2000 to have reached 5.0%, the fastest rate of expansion in 16 years. GDP is estimated to have grown by 4.4% in Australia, by far PNG’s largest trading partner. After several years of

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above-trend performance, economic growth in Australia will slow to 3.4% in 2001 and to 3.0% in 2002. Gold and oil are PNG’s largest exports by value, and average prices for both will fall throughout the forecast period, although the price of oil in absolute terms will not drop much below US$20/barrel.

Economic growth Economic activity in all sectors has been fairly subdued in 2000 and our estimate for GDP growth is now a more modest 2.9%. Private consumption and investment have been particularly constrained by the tight monetary stance adopted by the Bank of Papua New Guinea (the central bank). This has also contributed to a lack of any major construction projects. Export growth has not been as robust as expected following the poor coffee and copra crops and declining volumes in the minerals sector. Associated services such as transportation and wholesale trade have also suffered. GDP is forecast to grow by 3.8% in 2001 as we expect conditions to improve, with lower inflation and falling interest rates creating stronger domestic demand. We expect the agricultural sector to grow by 3.9% supported by a recovery in coffee production. Government approval of the US$850m Ramu nickel-cobalt project in June means construction work on the mine could start during the second half of the year, providing a boost to growth; although the third project partner has yet to be announced. Major work on the US$3.5bn PNG- Queensland gas pipeline project is not expected to begin before late 2001.

Forecast summary (% unless otherwise indicated) 1999a 2000b 2001c 2002c Real GDP growth 3.6 2.9 3.8 7.0 Gross agricultural growth 15.0 3.2 3.9 3.0 Consumer price inflation Average 14.9 17.1 8.0 8.0 Year-end 13.2 15.0 7.0 6.0 Short-term interbank rate 18.9 18.0 13.5 11.5 Government balance (% of GDP) –2.5 –1.5 –0.6 0.2 Exports of goods fob (US$ bn) 1.9 2.1 2.1 2.2 Imports of goods fob (US$ bn) 1.1 1.0 1.2 1.5 Current-account balance (US$ bn) 0.1 0.2 0.1 –0.3 % of GDP 2.7 5.7 1.6 –4.9 External debt (year-end; US$ bn) 2.8 2.9 3.6 4.4 Exchange rates Kina:US$ (av) 2.57 2.74a 2.90 2.90 Kina:US$ (year-end) 2.70 3.04a 3.10 3.00 Kina:A$ (av) 1.66 1.60a 1.62 1.80

a Actual. b EIU estimates. c EIU forecasts.

By 2002 PNG will benefit from the stimulus of these two very large minerals projects. Historically projects of this size have led to sharp increases in investment, imports and overall growth. We are, therefore, forecasting GDP growth of 7.0% in 2002. All stakeholders in the proposed PNG-Queensland gas pipeline are looking to a favourable response from the Australian government to the Papua New Guinean government’s request for assistance in financing its

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30% entitlement in the project. Investors in both the gas and the nickel projects will be looking closely at the tax changes introduced in the 2001 budget to make Papua New Guinea more attractive to international resource investment.

Inflation The continued depreciation of the kina will push up the landed cost of imports and will have lifted the overall inflation average for 2000 to 17.1%. Oil-related price rises will also have been a factor. The central bank has become more committed to fighting inflation since passage in June of the new Central Banking Act, which establishes price stability as its primary focus. Falling prices for oil, plus fewer tax rises by the government, should help to restrain inflation during the remainder of the forecast period. We expect inflation to fall to 8% in 2001 and 2002, with cost-push inflation (relating to the depreciating exchange rate) tending to dominate the demand-pull variety in the economy, which generally suffers from low levels of capacity utilisation. High levels of unemployment amongst graduates and school leavers will off-set labour demand surges related to the new resource projects in 2002.

Exchange rates The kina has come under sustained pressure against the US dollar in recent months after reaching a yearly high in early June. The approval of the second tranche of IMF funding and central bank intervention provided temporary relief in November but the currency has continued to slide, ending the year at Kina3.04:US$1, at an average of Kina2.74:US$1 for 2000. The kina has not picked up in the early part of the year as many exporters were expecting and looks set to fall to levels not seen since the middle of July 1997. However, we expect an appreciation from this low with the kina stabilising to average around Kina2.90:US$1 in 2001. The current account will move sharply into deficit in 2002 putting pressure on the kina but strong capital inflows, to finance the new resource developments, should offset these pressures. We expect the annual average exchange rate to remain at Kina2.90:US$1, but the day-to-day rate will be subject to fluctuations around this mean.

External sector We estimate a smaller than expected trade surplus in 2000 following a weak third quarter export performance in terms of both volumes and prices. The current-account surplus is estimated to have been a robust US$237m (equivalent to 5.7% of GDP). A decline in the value of copper and gold exports more than offset the increase in crude oil exports, for which the surge in world prices was sufficient to offset the export volume decline. Most agricultural exports also suffered from falling prices and a drop off in volume, with coffee suffering the worst fate. We expect exports to bounce back in 2001, however, the current-account surplus will shrink to US$69m (1.6% of GDP) as import values rise (in preparation for the new mining and gas projects), export prices fall and oil exports decline. World oil prices will fall by nearly 19% in 2001 and new supplies from the Gobe and Moran wells will not offset the declining production from the ageing Kutubu fields. The current account will then plunge into a deficit of US$250m in 2002 as developers of both the Ramu and Queensland pipeline projects import significant quantities of capital goods and construction materials to sustain both ventures. This will be sustainable only because the two minerals projects will be accompanied by significant capital

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inflows, in the form of commercial borrowings by PNG companies participating in the projects, and through foreign direct investment.

World commodity price forecasts (US$/tonne unless otherwise indicated) 1999 % change 2000 % change 2001 % change 2002 % change Cocoa (US cents/lb) 51.7 –32.0 40.4 –21.8 42.5 5.1 54.3 27.6 Coffee (US cents/lb; Arabica) 103.9 –23.2 88.2 –16.1 73.0 –17.2 60.5 –17.1 Tea (£/kg) 1.8 –12.8 1.8 5.0 1.7 –5.2 1.7 0.1 Copra 461.5 12.2 301.0 –34.8 194.3 –35.5 198.0 –1.9 Coconut oil 737.1 12.3 452.0 –38.7 319.8 –29.3 325.5 1.8 Sugar (US cents/lb) 6.3 –29.8 8.3 31.9 9.8 18.0 9.2 –5.8 Crude palm oil 436.0 –35.0 311.5 –28.6 269.3 –13.6 275.8 2.4 Palm kernel oil 694.0 1.1 445.8 –35.8 319.5 –28.3 354.0 10.8 Rubber (natural; London; £/tonne) 447.3 –5.8 512.5 14.6 690.0 34.6 915.0 32.6 Crude oil (US$/barrel; Brent) 17.86 39.9 28.77 61.1 23.36 –18.8 19.13 –18.1 Gold (US$/ troy oz) 278.8 –5.2 283.2 1.6 275.0 –2.9 270.0 –1.8 Copper (US cents/lb) 71.1 –5.5 81.3 14.2 83.0 2.2 85.3 2.7 Source: EIU, World Commodity Forecasts.

The political scene

Sir Mekere to remain in Parliament was adjourned on December 7th until July 23rd, effectively closing office until June 2002 the window of opportunity for the opposition to call for a vote of no- confidence and ensuring continuation in office of the prime minister, Sir Mekere Morauta, until the general elections in June 2002. On the face of it, this ‘survival’ tactic seems rather scheming and evasive, however, votes of no- confidence have routinely brought down governments in the past and have prevented the development of a stable political environment, which is precisely what is needed in PNG to ensure the successful outcome of its critical reform programme. In an attempt to promote transparency, Sir Mekere actually submitted his adjournment motion to the legislature for a vote. In a surprising

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move, the opposition leader and former prime minister, Bill Skate, gave his full support for the motion and stated his belief that for progress to take place in the country there was no need for a change of leadership. However, Sir Mekere had to deal with an attempt to bring his government down when, on October 31st, the then trade and industry minister, Michael Nali, proposed that parliament be adjourned until January 23rd creating the opportunity for a vote of no-confidence. This motion was defeated by 62 votes to 32.

Integrity bill is finally Before parliament was adjourned, it finally passed the Organic Law on the approved Integrity of Political Parties and Candidates, which will change the way that the next election, and subsequent ones, will be conducted and how the resulting parliaments will conduct themselves. The integrity bill is one of the most important legislative proposals to come before parliament (see October 2000) and should come into force around February 2001. By then the administrative systems to handle the all-important registration of political parties would need to be in place. Over the ensuing six months political parties wishing to contest the general elections in June 2002 would need to have themselves registered. Beyond the registration period unregistered political parties cannot be lawfully recognised. The body of the organic law should come into force early in 2002, some months before the elections. As important as the legislation itself, which was championed by Sir Mekere, was the margin of victory: 84-0 following the 79-0 first vote in August. The bill amended PNG’s constitution, and therefore required a two-thirds majority of the 109 MPs, or 73 votes, in two sittings of the parliament. Although some members opposed the legislation, they chose not to vote—apparently because of widespread support for the bill.

Existing MPs intending to contest the election and aspiring candidates, as well as political parties, will need to study the quite restrictive changes to the way elections are held and parliament operates following the implementation of the organic law. These restrictions, probably untenable in many other parliamentary systems of government, appear to favour the financial viability of larger, established political parties. The new law places significant restraints on the conduct of independent MPs, who have tended to follow the destabilising path of political adventurism more than philosophical indepen- dence. It seeks to force independents to align with a registered party. If they do not, and vote for the successful prime ministerial candidate, after the general election they become de facto members of the prime minister’s party and MPs affiliated with a registered political party cannot vote against the party on matters such as no-confidence, budgets or constitutional changes. Members who cross the floor, or resign from a party, will face serious penalties, and may be forced to stand in a by-election.

Cabinet reshuffles as Sir Sir Mekere has proved that he was not simply scaremongering when he said, Mekere demands loyalty after the first reading of the integrity bill, that he would take “appropriate disciplinary measures” in the near future with those members of the government coalition who chose not to vote or encouraged others to abstain. With an unrelenting desire to rid the government of any source of instability, Sir Mekere has sacked a number of senior ministers and reshuffled his cabinet on a number of occasions. Following the attempt by Michael Nali

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(immediately prior to the scheduled final vote on the integrity bill) to move a motion to adjourn parliament until January 23rd, the day after the prime minister’s 18-month grace period lapsed, six ministers were sacked, including Mr Nali and the deputy prime minister, Mao Zeming. Another major reshuffle came as a result of the quite unexpected passage of the integrity bill at the end of the budget session, courtesy of a nod from the opposition leader, Bill Skate. Sir Mekere sacked the foreign affairs and Bougainville minister, Sir Michael Somare, and the justice minister, Andrew Baing, for not voting with the government in the 84-0 vote. This strategy reinforces what has by now become a familiar pattern for the prime minister: an insistence on loyalty from members of his ruling coalition, and the meting out of punishment to those who vote against him, even at the risk, it would appear from editorial opinion and letters columns, of alienating those who regard Sir Michael, the “Chief”, as a national treasure. Not all of the frequent and wide-ranging cabinet reshuffles have had to do with the integrity bill. In December the United Party (including the police minister and party leader, Gabia Gagarimabu, and petroleum and energy minister, Tommy Tomscoll) was expelled from the coalition for plotting to remove the police commissioner, John Wakon.

Renewed hope for Technical officers are scheduled to meet on January 22nd and leaders on Bougainville peace talks January 26th in the continuing peace talks to resolve the decade-long secessionist revolt on the island of Bougainville, where the three-year-old ceasefire remains in place. This followed informal consultations in Buka on January 5th between Bougainville leaders, including the governor, John Momis, the president of Bougainville People’s Congress, Joseph Kabui, and the leader of the bipartisan National Committee on Bougainville, Moi Avei. The consultations replaced the postponed formal resumption of peace talks, scheduled for December 27th-28th, following the stalemate and walkout by Bougainville negotiators on December 9th. Formal resumption was postponed following the sacking of Bougainville affairs minister, Sir Michael Somare, for reasons associated with the vote on the political integrity bill. Notwithstanding “occasional strong words in the past” and based on a “real commitment to peace” evident in the Buka meeting, the leaders expressed confidence in reaching an agreement on referendum and autonomy for Bougainville.

The position of the national government, outlined in a nationally televised speech by the prime minister on September 1st, and later clarified, is that a referendum on independence was still possible, and that the constitutional changes necessary to grant autonomy to Bougainville, and allow at some point a referendum, would be pursued, although the word "independence" would not be used. The prime minister has suggested that several review periods of five years each of Bougainville’s performance as an autonomous province would be necessary before an independence vote could be held. During this time improved political and economic conditions on Bougainville, he hopes, might temper the drive for independence. The rebels have acknowledged that none of the constitutional changes allowing autonomy will take effect until a disarmament plan is agreed and implemented.

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National and provincial The three-tier system of government—national, provincial and local— government tension continues to engender political tension between the national and provincial governments. In October the National Executive Council (NEC) suspended the governments of the Western (Fly River) province, home of the Ok Tedi copper mine, and the Southern Highlands province, the region covering the Kutubu oilfields and the PNG-Queensland gas pipeline project, on the basis of corruption and mis-management of public funds. Enga province, which has the Porgera gold mine, was given 21 days to respond to allegations of mis- management or face suspension. The response elicited a 14-day notice from the national government, which the provincial governor said he will deal with when his officers return from the Christmas-New Year break. Lobbying for the post of administrator is said to be intense. Rumours of two more suspension notices surfaced in Wabag, the provincial capital of Enga, at the Highlands Governors’ Council conference which concluded on December 22nd. The five governors of 2.5m people noted that suspension of any one government affected all of them. Meanwhile, Southern Highlands administrator, Pila Niningi, began the new year by suspending seven public servants including two deputy administrators, three district administrators and the executive officer of a local level government.

PNG will not meddle in Irian Jaya, or West Papua as it is also called, where nearly half the population Irian Jaya’s troubles has been settled there from other parts of Indonesia in transmigration programmes over several decades, seems likely to be PNG’s biggest foreign policy challenge. The ill-defined, jungle-hidden, shared border will be much traversed by both political refugees and independence fighters seeking refuge. Following the meeting in Port Moresby in late December between Sir Mekere and Australia’s foreign minister, Alexander Downer, both governments reaffirmed their stand on the issue, saying it was Indonesia’s internal problem. The prime minister has previously emphasised his country’s obligation to honour the relevant UN resolutions of 1969 and commitments contained in the Treaty of Mutual Respect, Friendship and Co-operation entered into by the two countries in 1986. He had, as recently as September 2000, reaffirmed this position with the Indonesian vice president, Megawati Sukarnoputri.

Economic policy

2001 “recovery to The prime minister, Sir Mekere Morauta, who is also the minister for finance reconstruction” budget and treasury, presented the 2001 budget to parliament on November 28th. Styled “From recovery to reconstruction” in the logical footsteps of the “Road to recovery” 2000 budget, it anticipates a consolidation phase and real gains in social and economic development in 2002. The budget’s underlying fiscal strategy envisages balanced budgets freeing monetary policy to pursue a stable exchange rate and lower inflation and interest rates. It envisages private sector investment and growth flowing from successful monetary policy and government expenditure geared towards providing the private sector with: law and order; stable and transparent government; economic infrastructure; and a healthy, educated workforce. The fiscal strategy is supported by an on-going

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structural reform programme which, the prime minister emphasises, is home- grown and not imposed by the IMF or World Bank; though both bodies have endorsed both the programme and the fiscal strategy. These multi-lateral institutions, together with bi-lateral government donors, have committed half of the US$140m of foreign financing needed in the budget. The remainder will be sought from the same sources in a meeting scheduled for March 2001.

A balanced budget, if The budget, like its predecessor, contains no new revenue measures, these arrears are excluded having been introduced in a supplementary budget immediately on the government’s coming to power in mid-1999. Nevertheless, it is a balanced budget (budget deficits in both 2000 and 2001 need to be read in the light of abnormal expenditures on erasing arrears and one-off structural adjustments), which directs 35% of total expenditure, a record share, to the development budget to be spent on such infrastructure as roads, bridges, aid posts and schools. Priority sectors received 57% of the total budget appropriation, excluding debt service, comprising: education, 20.1%; infrastructure, 13.6%; health, 9.4%; law and order, 8.9%; and the economic sector, 5.2%. As proportions of GDP, the health budget has increased from 2.0% in 1999 to 2.6% in 2001; law and order from 2.2% to 2.4%; and infrastructure from 3.2% to 3.7% per cent of GDP. The education budget in 2001 represents 5.5% of forecast GDP, marginally down on the 5.6% in 1999, although it is higher by 18% in absolute terms. Two-thirds of the infrastructure budget is for maintenance, including major programmes for the Okuk Highway and all Highlands provinces, with a view to increasing agricultural production and improving delivery of government services, especially to outlying districts.

In pursuit of macro-economic stability, overcoming arrears is a major objective. Arrears were 1.7% of GDP in 1999, 1.3% in 2000 and are budgeted in 2001 at 0.6% of GDP. Non-recurring expenditures associated with the reform program amounted to 1% of GDP in 2000 and are budgeted at 0.6% of GDP in 2001. Excluding arrears and one-off reform expenditures, the budget outcome in 1999 was an underlying deficit equivalent to 0.9% of GDP; in 2000 it was a surplus of that proportion; and the 2001 budget is practically balanced.

The 2001 budget balance may put a strain on monetary policy in its efforts to stabilise the exchange rate, inflation and interest rates. In 2000 29% of expenditure—comprising the recurrent budget (less interest payments) and the part of the development budget not financed from external sources—was financed by foreign budget-support grants and taxes and levies on mining and petroleum. In 2001 this proportion drops to 25%. Any shortfalls in securing the budgeted Kina231m (US$69.8m) of external financing or the Kina178m of net proceeds from asset sales would add to the strain on monetary policy.

Tax reform to favour the The 2001 budget implements in large measure the recommendations of the poor comprehensive Taxation Review conducted during 1999 and 2000. Personal taxation changes are revenue neutral but favour the poor.

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Changes to personal and corporate income taxation

• Increases in the taxation of housing and vehicle benefits.

• Higher tax-free threshold, increasing from Kina4,000 to Kina5,500.

• Widening of the first tax band, extending from Kina5,500 to Kina16,000.

• Simplified methods of tax-accounting for depreciable assets—asset values less than Kina1,000 may be immediately expensed.

• Stamp duty set at a fixed rate of Kina10,000 in respect of corporate restructuring.

Tax incentives for mining, The big tax shake out also affects mining, gas and oil as PNG aims to regain its gas and oil exploration former competitiveness in attracting international capital and expertise.

Changes to tax regime for gas, oil and mining

• The mining levy, an emergency measure introduced in mid-1999, will be uniformly phased out over four years from January 1st 2002 subject to existing operators agreeing to dispense, on completion, with the long-standing “basket rate” of import duty.

• From January 1st 2001 the company tax rate will fall from 35% to 30% and the dividend withholding tax rate from 17% to 10%.

• The additional profits tax rates have been reduced but an extra tier has been introduced. Rates of return between 15% and 20% will attract an additional tax at 20%; and on still higher returns, 25%.

• Exploration incentives have been extended to include a deduction of 25% of expenditure anywhere in PNG (previously restricted to the mining lease) and 20 year loss carry forward limit, previously seven years.

• Depreciation, loss carry forward, exploration and additional profits tax provisions apply to oil and gas as well as to mining. Gas projects will pay 30% tax, unchanged, and new oil projects 45%, previously 50%.

• The new arrangements allow the grouping, within one tax “ring fence”, of dedicated gas fields, processing facilities and pipelines (a matter of specific relevance for the US$3.5bn PNG-QLD gas pipeline).

• Investors in major mining and petroleum projects will be protected under proposed ten-year fiscal stability legislation.

• Projects committed to construction before the end of 2003 would be offered fiscal stability for the term of the initial project debt to a maximum of 20 years.

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Higher revenue and lower The Bank of Papua New Guinea (the central bank) reported a Kina34m central deficit expected in 2000 government budget surplus for the three quarters to September 2000. However, in its 2001 budget, the government estimates a deficit of Kina179m for the full year, 17% less than budget. By the end of September the government had spent only 66% of the budget but had collected 72% of revenue. By September 53% of the development budget had been spent and 72% of the recurrent one. The government expects to spend as much on development projects in the fourth quarter as it spent in the first three, as happened in 1999. Tax receipts in the three quarters to September amounted to 79% of the full year budget, off- setting shortfalls in non-tax receipts, where only 45% of budget was achieved, and in foreign grants, only 58%, the latter being a direct result of aforementioned underspending on the development budget. The government’s full year revenue estimate, 6% over budget, and the lower deficit seem well justified by the effects of higher oil prices, robust dividend payments and improvement in arrears evident in performance to September.

Central government budget (Kina m) Budget 3 Qtrs Estimate Budget 1998 1999 2000 2000 2000 2001 Total receipts 1,991.2 2,569.0 2,866.7 2,073.3 3,040.8 3,223.3 Tax revenue 1,598.2 1,920.7 2,079.3 1,646.2 2,311.0 2,475.9 of which: personal tax 448.8 524.4 560.0 397.9 565.0 650.0 company tax 426.1 505.1 525.0 442.7 683.9 636.7 other direct tax 132.9 168.5 183.9 167.3 227.5 233.4 indirect tax (incl VAT) 590.4 722.7 810.4 638.3 834.6 955.8 Non–tax revenue 279.5 171.2 245.1 110.3 175.1 197.0 Foreign grants 113.5 477.1 542.3 316.7 554.7 550.5 Expenditure 2,128.6 2,801.3 3,081.8 2,039.8 3,220.1 3,364.2 Recurrent expenditure 1,950.7 2,065.7 2,182.4 1,564.2 2,264.5 2,313.1 National Departmental 861.5 959.5 1,069.7 771.1 1,143.6 1,184.5 Provincial governments 621.7 594.4 517.1 384.7 540.2 584.7 Interest payments: 337.2 391.6 380.9 320.2 466.9 410.1 foreign 107.4 132.0 147.6 94.2 169.3 167.0 domestic 229.7 259.5 233.3 226.0 297.6 243.1 Other grants & expenditure 135.3 121.2 219.9 88.0 122.1 142.0 Net lending & investments –4.9 –1.0 –5.2 0.2 –8.3 –8.2 Development expenditure 177.9 735.7 899.4 475.7 955.6 1,051.1 Overall balance –137.4 –232.3 –215.1 33.5 –179.3 –140.9 Financing External financing –116.3 178.2 342.6 –47.0 96.3 230.8 Domestic financing 253.7 54.1 –127.5 13.5 83.0 –89.9 Total financing transactions 137.4 232.3 215.1 –33.5 179.3 140.9 Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Sir Mekere pointed to successful budget outcomes in 2000: reconstructed and stabilised monetary and financial systems; responsible and prudent budgetary management; and total disbursements contained within original appro- priations. He pointed also to the welcome reduction in inflation and interest rates. These achievements, he noted, were all the more remarkable in the light

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of the depressed economic environment, mainly as a result of low agricultural export prices and high petroleum product import prices.

Extension to structural The 2001 budget extends its predecessor’s structural reform program (SRP) reform programme introducing new initiatives in pursuit of four key objectives: improve governance; sustain macroeconomic stability; improve public sector perfor- mance; and remove barriers to investment and economic growth. The prime minister explained how vetting by the Central Agencies Co-ordinating Committee (CACC) of all cabinet submissions had replaced haphazard decision-making with an orderly process which has boosted the morale and the quality of the work of public servants. The CACC and the chief secretary are charged with the responsibility for enforcing departmental work plans and financial discipline. The auditor-general, the ombudsman commission and the attorney general all will receive additional funding in the on-going fight against corruption. The strengthening of the Central Supply and Tenders Board, which began in 2000, will also continue into 2001.

Measures to remove barriers to investment and economic growth, another part of the 22-point SRP agenda, include continued involvement with Asia-Pacific Economic Co-operation (APEC) and the World Trade Organisation (WTO) and the tariff reduction program, reviewing the reserved activity list and stream- lining procedures for visas and work permits, all aimed at the still-small, formal sector. Missing from the agenda are initiatives to overcome rigidities in informal land and labour markets, which affect 85% of the population, and have severely restricted commercialisation of the agricultural sector, particularly in exports, resulting in long-term economic growth in this sector lagging population growth and making futile supply-side attempts to stimulate a formal sector constrained by lack of domestic demand.

IMF releases second tranche The IMF has released the second tranche of the stand-by arrangement to support the balance of payments. This followed the completion by its team on November 6th of a two week in-country review of the fiscal out-turn to the end of September and, as estimated for the full year 2000, the fiscal framework for the 2001 budget and the monetary accounts of the central bank. In keeping with the IMF's recently-adopted determination to throw off the cloak of secrecy it has been tagged with, the team spent time outside official circles listening to the private sector. Apparently they were surprised to hear a much gloomier view of the economy than despatches from the local office had engendered in Washington. The World Bank has been slower than the IMF to release the second tranche of its assistance—the governance promotion adjustment loan. Its team's visit overlapped the IMF's but it has yet to release the second tranche. On December 19th the Bank advised the government that it wanted to see, in respect of the privatisation of the Papua New Guinea Banking Corporation, the Rural Development Bank and the Motor Vehicle Insurance Limited, the issuance of bidding documents, sale advertisements and specification of community service obligations, as agreed, before releasing the second, "floating", tranche.

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Continued focus on price The SRP requires the continuing independence of the central bank and for it to stability focus solely on achieving price stability and maintaining a market exchange rate and market interest rates. The central bank has maintained its tight monetary policy stance although official interest rates have declined as market expectations of inflation have been revised downwards. The central bank governor, Wilson Kamit, insists that monetary policy will only be eased when he is satisfied that inflation is firmly on a downward trend. This policy stance has placed a heavy burden on the private sector and many banks and private sector representatives have called on the central bank to ease its policy stance.

In the aftermath of malpractice in the National Provident Fund and the Motor Vehicle Insurance Limited, all financial institutions are now subject to the central bank’s powers to license, regulate and supervise.

Privatisation plans in The prime minister took the opportunity, in the face of serious opposition, motion particularly from labour organisations, to reiterate the benefits of his government’s cornerstone privatisation programme also on the SRP agenda. Not least, he said, it would reduce the scope for fraudulent and criminal activity in the public sector; although it is primarily designed to make the economy more efficient. All net proceeds, Kina178m in 2001 and Kina364m over the ensuing three years would go to debt reduction. Community Service Obligations for each industry affected are the focus of regulatory reviews currently underway, as are quasi-monopoly situations. The Privatisation Commission, charged with ensuring transparency and accountability throughout the privatisation process, is well advanced in bringing the Papua New Guinea Banking Corporation to the point of sale, scheduled for April 2001. As well, it has commenced the preparation of Air Niugini for sale, also expected in the first half of 2001, and will soon appoint project managers to prepare other major state-owned enterprises (SOEs) for sale. Unlike the bank and the airline which are fully commercial undertakings, utilities such as telecommunications and electricity, both with heavy developmental dimen- sions to them, will not be as amenable to effective privatisation, as progress with the regulatory reviews will make evident.

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Recommendation to In a determination which has left employers wondering, the Minimum Wages increase minimum wage Board has recommended that the statutory minimum wage be increased from Kina24.68 per week to Kina60 per week. This is the first tribunal convened since 1992. Prior to this there were two minimum wages; one for urban unskilled workers and the other for rural unskilled workers, as well as a number of minima for different skill levels. In keeping with the first structural adjustment program, agreed with the World Bank and IMF, the 1992 Minimum Wages Board determination deregulated the skills market and eliminated the dual urban-rural wage structure, setting just one minimum wage at the then rural rate. This meant a substantial reduction in the urban minimum wage, which the current recommendation, in effect, reverses, at the same time increasing the rural minimum wage to two and a half times its 1992 level. Since 1992 formal employment has increased by 10%, according to the Bank of Papua New Guinea’s employment index, about half as much as the population. The board gave most consideration to the change in the kina exchange rate with the US dollar since 1992 and sought in its determination to restore real incomes lost under the floating exchange-rate regime. The cabinet has yet to consider the Board’s recommendations, as it is expected to do; although it is not required to do so.

The domestic economy

Economic trends

Government lowers GDP In its 2001 budget the government estimated the economy would grow 0.8% growth estimate for 2000 in 2000, a disappointing shortfall on the 4.7% projected in the budget a year earlier. The mining and petroleum sector was the main drag, contracting an estimated 7.9%, non-mining GDP growth being estimated at 3.3%. Crude oil production was down on 1999, in the third (September) quarter by one-third and for the three quarters to September by one-quarter. The government’s estimates for the full year, down 23.5% on 1999, might prove slightly optimistic. Copper production in 2000 was also down on the previous year, by one-third in the September quarter and about one-sixth for the three quarters to September. Full year copper production will be disappointing, with just 60% of government’s estimate being fulfilled by September. Moving both against and with sectoral trends, gold production for the three quarters to September 2000 was up 16% on the previous year but down 8% for the September quarter. With 86% of government’s full-year estimate booked by the end of September, gold could compensate, but only in part, for the shortfalls in oil and copper. Growth in the other export sector, comprising agriculture, forestry and fishing, estimated at 0.9%, is also lack-lustre.

Actual performance, when it becomes known in 2001, is likely to be worse than these estimates. Whereas the budget estimates 5% growth in manu- facturing, wholesale and retail trade, and transport, the Bank of Papua New Guinea (the central bank), in its September quarterly bulletin, reports a decline in the level of economic activity in the private sector in the first half of 2000

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compared with the second half of 1999. The central bank’s bi-annual business survey showed a 3% decline between these periods in the value of sales by the private sector, excluding mining and petroleum and Bougainville. The decline was evident in all regions except Lae. It occurred mainly in wholesale trade and transportation, more than off-setting increases in retail, manufacturing, construction and agriculture. Formal private sector employment, excluding mining and petroleum and Bougainville, according to the central bank’s quarterly employment survey, fell 0.2% between the second half of 1999 and the first half of 2000. Employment increases in retail and wholesale trade, manufacturing and agriculture were not enough to outweigh decreases in all other sectors. Employment also increased in most regions but not sufficiently to counter losses in the Highlands and the National Capital District.

Inflation down over the Headline inflation abated in the third quarter of 2000. The consumer price quarter and the year index (CPI) was 1.8% higher than in the second quarter which had recorded a 4.3% quarterly increase. All urban areas recorded increases in the third quarter. Between the third quarters in 1999 and 2000 the CPI rose 12.2%, a big improvement on the 21.8% increase between the second quarters. The lower headline inflation rate reflects the passing out of the effects of the introduction in mid-1999 of the value-added tax (VAT) and increases in excise rates. Excluding such policy effects and the seasonal betelnut and fruit and vegetables, the underlying rate of inflation, a new measure (see October 2000), was 0.6% quarter on quarter and 9.2% at an annual rate. Comparable figures for the second quarter were 2.5% and 15.0% respectively.

The 1.8% increase in the CPI in the third quarter comprised mainly: 1.1 percentage points in the food expenditure group; 0.4 in the drinks, tobacco and betelnut group; and 0.21 percentage points in the clothing and footwear expenditure group. The higher food index masked price reductions, attributed by the central bank to the kina’s appreciation in the second quarter, in such food staples as flour, rice, tinned fish, butter and tea. Prices of fuel, power and household appliances also fell for the same reason.

Quarterly inflation

1999 2000 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Index: 1977=100 Consumer price index 447.8 495.1 509.5 522.9 548.6 555.6 % change, year on year 14.1 18.2 13.2 19.6 22.5 12.2 Underlying inflationa 414.9 439.6 453.3 465.3 477.0 480.1 % change, year on year n/a n/a n/a 17.0 15.0 9.2 a Revised series Source: Bank of Papua New Guinea, Quarterly Economic Bulletin

Money supply contracts in Total money supply grew 2.2% between end-September 1999 and 2000, a real real terms contraction in the light of 9.2% annual inflation. An increase by half in net foreign assets was more than off-set by a 9.4% reduction in domestic credit. Net credit to the central government contracted by about a quarter as a result of the government’s December 1999 swap arrangement with the Reserve Bank

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of Australia. Credit to the private sector increased by 5.4%, a contraction in real terms. The average level of private sector credit over the three quarters to September was 10.4% higher in 2000 than in the previous year, real growth of 1%, but from the second to the third quarters 2000 it fell 3.1%, about 5% in real terms.

Money supply (Kina m; end-period) Year 3 Qtr 3 Qtr 1997 1998 1999 1999 2000 % change Domestic credit 2,320.4 2,716.3 2,824.8 2,995.2 2,713.6 –9.4 Non–government 1,480.2 1,747.0 1,747.4 1,748.8 1,763.9 0.9 Private sector 1,063.9 1,372.2 1,516.8 1,462.7 1,541.8 5.4 Official entities 299.0 208.0 158.5 148.4 146.6 9.2 Non-monetary financial institutions 117.2 166.8 72.1 137.7 75.5 –45.2 Central government 840.1 969.3 1,077.4 1,246.4 949.8 –23.8 MRSF –696.4 –677.3 0 –566.8 0 – Other 1,536.5 1,646.6 1,077.4 1,813.2 949.8 –47.6 Net foreign assets 780.8 496.0 675.5 475.8 719.3 51.2 Total money supply (M3) 3,101.1 3,212.3 3,500.3 3,471.0 3,547.3 2.2

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Oil and gas

Government seeks financial Tax changes introduced in the 2001 budget should give some incentive to assistance for pipeline exploration which has been for some time at worryingly low levels. They should also facilitate progress on the PNG-Queensland, US$3.5bn gas pipeline, the largest investment PNG has contemplated (see October 2000). The government of Papua New Guinea has sought assistance from Australia in financing the 30% of the project it is entitled to under law. Prime minister, Sir Mekere Morauta, took the opportunity provided by the conference held in Sydney on December 4th—conducted annually by the Papua New Guinea Chamber of Mines and Petroleum—to publicise the request, emphasising the project’s benefits to Australia; cleaner, cheaper fuel and a more stable neighbour. Informed Australian media analysis urged the Commonwealth government to assist, suggesting A$250m (US$138.3m) would secure the project. The Papua New Guinea government acknowledges that it may have to proceed with less than its full entitlement. It has already received pledged assistance from the European Investment Bank in the amount of A$190m and the International Finance Corporation, the commercial arm of the World Bank, is another possibility. Once the equity funding is finally in place, closing out negotiations with customers, the Queensland State Government’s Energex Corporation and Ergon Energy Corporation, should quickly follow and the project can move to the US$40m up-front design phase. Earliest completion, initially 2001, then 2004, is now marked at mid-2005.

Oil exports continue on Crude oil exports, on a declining trend since the first full year of production in downward path 1993, amounted to 5.24m barrels in the third quarter 2000, down approximately one-third on the previous year. Prices, however, were much

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improved. For the three quarters to September, volumes were down one- quarter on 1999 to 17m barrels, but prices doubled. The government’s estimates for the full year, 23.4m barrels worth Kina1.8bn (US$545m), might prove slightly optimistic. Taxation considerations may have impacted on production in a period of abnormally high world prices.

Mining

Ramu agreement signed As for oil and gas, the tax changes introduced in the 2001 budget should give but no third investor yet incentive to mining exploration which has also been at worryingly low levels for some time. The changes should also facilitate financing of the US$850m Ramu nickel-cobalt project (see October 2000) for which the developers, Highlands Pacific and Orogen Minerals (the majority government-owned company listed on the Australian Stock Exchange) have yet to name the third partner following the granting in June 2000 of the mining licence for the project. On November 16th in Port Moresby: the state, the Madang provincial government, the landowners and the developers signed the project memoran- dum of agreement. This was the culmination of a process known as the development forum embracing educational workshops and awareness patrols, which is a binding agreement, subject to review at five-yearly intervals.

Mixed results for gold and On an uptrend since Lihir came on stream in mid-1997, gold exports for the copper exports three quarters to September 2000 were up 16% to 53.5 tonnes compared with the same period in 1999. However, in the third quarter exports of 16.9 tonnes were 8% down on the previous year. With 86% of the government’s full-year estimate for both volume and value booked by the end of September, gold seems set to surprise on the upside. The government projects gold production to fall slightly in 2001 and then trend upwards to be at some 20% more than the 1999 level of production by 2004. Misima will exhaust its in-ground reserves in 2001 and move to processing low-grade, stockpiled ore. Lihir continues to grapple with technical problems. Porgera had a very good year, consolidating its status as a low-cost, world class gold producer. Two gold prospects in Morobe and Eastern Highlands provinces are progressing encouragingly.

Copper exports in 2000 were down on 1999, by 35% to 24,000 tonnes in the third quarter and by 16% to 87,000 tonnes for the three quarters to September. Prices for the three quarters, however, were 27% higher. Full year copper production will be disappointing, just 60% of the government’s estimate being fulfilled by September. Looking ahead, the government sees copper production stabilising at around 160,000 tonnes.

A “number” of companies There has been no resolution of the differences between the Australian natural interested in Ok Tedi resources conglomerate, Broken Hill Proprietary (BHP), and the government over closure of Ok Tedi (see October 2000). BHP wants to close the mine early but the government is intent on keeping the mine open until the end of its economic life, some ten years from now. Following BHP’s announcement of its intention to end its direct involvement in the mine, the mining minister, Michael Laimo, has said that a “number” of companies have registered an

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001 Papua New Guinea 25

interest in the mine, all of which will need to be thoroughly screened by the government.

BHP also now faces the possibility of a huge pay-out to 30,000 PNG landowners following the ruling by a Supreme Court of Victoria judge on November 22nd to allow the class action against BHP to proceed (see July 2000). Landowners are seeking monetary compensation for the damage caused by the dumping of 100,000 tonnes of waste from the Ok Tedi mine into the river system each day.

Mineral exports, by volume

1999 2000 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3Qtr Crude oil (‘000 barrels) 7,642 7,735 7,749 5,889 5,930 5,239 Copper (‘000 tonnes) 35.8 37.0 40.4 30.5 32.6 24.0 Gold (tonnes) 14.8 18.5 17.0 19.4 17.2 16.9

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Agriculture

Falling export prices hurt Coffee exports suffered big declines for the three quarters to September in both commodities producers volume and price, 27% and 15% respectively, relative to last year. Export value was down a massive 38% to Kina217m (US$65.6m) on volume of 47,000 tonnes. The third quarter was particularly awful; it accounted for practically all of the volume collapse and prices were off by 28%. With the coffee year ending in October, the government budget fully reflected the sorry story. It projects a return in 2001 to 66,000 tonnes and thence 5% annual growth.

Palm oil in 2000 overtook coffee as the premier agricultural export crop. Third quarter exports were a record 100,000 tonnes, up one-third on the previous year. For the three quarters to September 236,000 tonnes were exported, 14% more than a year ago. But average prices received were down around 30%. The prospects for the government’s expected 300,000 tonnes for the full year look good. The government is then looking for 5% annual growth from palm oil.

Like palm oil, volumes for copra and copra oil for the three quarters to September were up on last year but average prices received were down, by 11% and 17% respectively. Prices for the third quarter were particularly poor, nearly 40% lower than a year ago. Volumes, too, were down, by 10% to 25,000 tonnes yielding Kina24m. Fourth quarter exports of copra and copra oil will be a bonus for government. The government budget projects stagnant copra exports but exports of copra oil growing at 10% annually by volume.

Cocoa showed a similar pattern, better volumes than last year but worse prices. For the three quarters to September, cocoa exports were 33,000 tonnes, a one- third increase. September quarter prices were 36% lower than a year ago. However, 9,000 tonnes were exported compared with 6,000 tonnes the previous year. With 64% of full year value estimate booked by September, cocoa exports look set to be disappointing. The government is expecting cocoa

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001 26 Papua New Guinea

export volumes in 2001 to be two-thirds more than they were in 1999, then to remain steady.

Hardwood logs make up more than 90% of exports of forest products. At Kina202m for the three quarters to September, exports of forest products were little changed from last year, better prices compensating for an 11% fall in log volume to 914,000 cubic metres. For the third quarter, 279,000 cubic metres of logs were exported, 21% more than a year ago. Prices, however, were off and value increased by just 7% to Kina58m. Log exports for the full year look set to fall well below the government’s estimated 1.5m cubic metres, a level the government projects to be maintained in the years ahead.

Agricultural exports, by volume (‘000 tonnes unless otherwise indicated) 1999 2000 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3Qtr Cocoa 7.3 11.2 6.0 4.5 14.2 9.9 9.0 Coffee 10.8 20.2 33.9 14.3 10.2 20.5 16.7 Tea 1.8 1.8 2.0 2.6 2.0 2.2 2.3 Copra 12.4 14.6 16.6 19.9 29.6 16.9 10.5 Copra oil 18.1 14.0 11.3 6.9 15.1 9.8 14.5 Palm oil 68.9 64.1 74.4 46.4 49.8 95.6 100.4 Rubber 1.3 0.6 0.7 1.1 0.6 0.9 1.4 Logs (‘000 cu metres) 323.7 470.1 230.3 288.2 312.2 322.4 279.4

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Agricultural export prices (Kina per tonne unless otherwise indicated; fob) Mar Jun Sep 1997 1998 1999 2000 2000 2000 Cocoa 1,899 3,130 2,917 2,548 1,888 2,120 Coffee (all grades) 5,505 5,705 5,266 5,719 4456 4,000 Tea 1,600 2,864 2,317 2,065 2,845 2,102 Copra 523 668 1,047 1,000 916 583 Copra oil 1,051 1,310 1,905 1,711 1,781 933 Palm oil 753 1,277 1,331 1,068 876 803 Rubber 1,477 1,490 1,351 2,144 1,615 1,714 Logs (kina/cu metre) 172 145 195 215 180 202

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Foreign trade and payments

A disappointing quarter External payments for the third quarter recorded an overall surplus of Kina26m for foreign trade (US$7.9m) in 2000, down on the surplus of Kina86m in the previous year. The deficit on the capital account, Kina275m, was much larger than the Kina176m

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001 Papua New Guinea 27

recorded for that quarter in 1999. The current-account surplus of Kina261m was well down on the Kina369m recorded last year. Both the merchandise trade surplus for the quarter, Kina631m, and the invisibles deficit, Kina372m, were lower in 2000 compared with 1999 when Kina787m and Kina476m were recorded, respectively. Merchandise exports were down 16% to Kina1.26bn. Merchandise imports fell 12% to Kina631m. Reduced official transfers, mainly Australian grant aid, down from Kina58m in the third quarter of 1999 to zero in 2000, accounted for most of the smaller current-account surplus.

For the three quarters to September 2000, merchandise exports were Kina4.16bn, up 16% on the same period the previous year. Merchandise imports were up just 1.6% to Kina2bn. On end-month average over the nine months the kina bought US$0.372, a 12-month depreciation of 6.3%. Against the Australian dollar the kina appreciated by 2.2% to A$0.632. Accordingly, exports have grown in US dollar terms by about 9% and imports have grown in Australian dollar terms by 4%. The trade surplus for the three quarters, Kina2.13bn, was one-third more in 2000 than in 1999. The Kina1.4bn invisibles deficit was practically unchanged. The current account recorded a healthy Kina724m surplus, almost three times that in the previous year. Conversely, the capital-account deficit of Kina613m was over twice that of the previous year. Overall, the balance of payments for the three quarters to September 2000 recorded a surplus of Kina101m compared with a Kina74m deficit a year ago.

Balance of payments (Kina m) 3 Qtr 3 Qtr 1996 1997 1998 1999 1999 2000 Merchandise exports 3,334 3,079 3,707 5,006 1,504 1,262 Merchandise imports –1,996 –2,129 –2,231 –2,760 –717 –631 Trade balance 1,338 950 1,476 2,246 787 631 Invisible credits 611 619 699 691 186 209 Invisible debits –1,633 –1,823 –2,238 –2,620 –662 –581 Net transfers 95 87 187 50 58 2 Current–account balance 411 –167 124 367 369 261 Official capital flows 14 –89 –92 119 –37 –48 Private capital flows –147 134 –189 –305 –186 –194 Non–official monetary sector transactions –46 –61 31 –6 34 –53 Change in offshore account balances 237 –46 –114 22 13 20 Capital–account balance 58 30 –364 –170 –176 –275 Net errors & omissions –37 14 –23 –29 –48 40 Overall balance 432 –123 –276 160 86 26 International reserve level 789.1 666.9 390.9 550.8 314.0 651.6 Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The pattern of merchandise imports for the three quarters to September 2000 was similar to that in the third quarter, where falls in general merchandise imports and imports by the petroleum sector off-set rises in the minerals sector. Oil and minerals accounted for 77% of merchandise exports for the third

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001 28 Papua New Guinea

quarter 2000 and agricultural produce for 18%, forest and marine products contributing 4.6% and 0.6% respectively. Crude oil accounted for 45% of sector exports and gold for 42%, copper contributing the remainder. Palm oil contributed 38% of agricultural exports for the third quarter; coffee, 29%; copra and copra oil, 11%; and cocoa, 8%. For the three quarters to September 2000, sectoral shares were the same as for the quarter; commodity shares were slightly changed. Oil and gold changed places. In the agricultural sector, export shares for the three quarters were: palm oil, 36%; coffee, 34%; copra and copra oil, 18%; and cocoa, 11%.

Exports (Kina m) 3 Qtr 3 Qtr 1996 1997 1998 1999 1999 2000 Agricultural 578.6 777.2 1,020.2 1,165.0 366.2 220.2 Forest products 480.3 433.6 173.2 265.9 54.5 58.4 of which: logs 464.8 409.3 154.2 255.6 49.7 52.1 Marine products 10.4 9.6 42.2 30.4 10.7 7.5 Minerals 2,244.6 1,838.9 2,452.1 3,524.0 1,087.6 971.0 Gold 773.6 718.7 1,227.8 1,546.1 486.4 411.3 Copper 387.0 259.8 395.7 574.3 160.4 113.8 Crude oil 827.7 852.2 813.1 1,382.4 415.0 440.9 Total 3,313.9 3,059.3 3,687.7 4,985.3 1,499.0 1,257.1

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Little respite for the falling The approval of the second tranche of IMF funding and intervention by the kina Bank of Papua New Guinea (the central bank) provided temporary relief in November to the decline in the value of the kina since the yearly high in June of Kina2.38:US$1. However, the currency has continued to slide since, ending the year at Kina3.04:US$1, at an average of Kina2.74:US$1 for 2000. The Christmas and New Year period is traditionally a time when the kina suffers from a lack of export receipts, but the kina has not picked up in the early part of the year as many exporters were expecting and has fallen to levels not seen since the middle of July 1997. By year-end 2000, the kina showed a 12-month depreciation against the US dollar of 16.2% and a depreciation of 3.4% against the Australian dollar. The prime minister has said that the central bank, an independent institution, would only intervene to ensure that the kina remained stable. The government is projecting a stable kina in the years ahead, worth 33 US cents and 61 Australian cents.

Exchange rates (foreign currency unit per kina; end-period) 1996 1997 1998 1999 2000 % changea Jan 12th A$ 0.9653 0.9365 0.7708 0.6086 0.5879 –3.4 0.5410 US$ 0.7553 0.6971 0.4856 0.3922 0.3285 –16.2 0.3025 – 82.17 84.23 63.43 44.74 28.71 –35.8 25.65 0.4845 0.4264 0.2933 0.2426 0.2205 –9.1 0.2025 a 2000/1999 Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; Bloomberg.

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001 Papua New Guinea 29

External public debt up by During the third quarter of 2000 the government of Papua New Guinea drew slightly down Kina4.6m from foreign lenders and repaid them Kina52.7m. But Kina76.1m of unrealised exchange-rate losses pushed the level of overseas public debt outstanding higher at period end to Kina3.4bn. Since the end of September 1999, when foreign public debt reached a maximum, driven by the depreciating kina and despite net loan repayments, debt has eased by Kina458m, or 12%. Unrealised exchange-rate gains of Kina657m more than off-set Kina199m of net draw-downs associated with the structural reform programme agreed with the IMF, World Bank and donor countries. The government paid Kina94.2m interest on foreign debt in the three quarters to September and Kina27.9m in the third quarter.

Public debt outstanding (Kina m) Sep 1995 1996 1997 1998 1999 2000 Domestic 1,605.7 1,969.5 2,251.7 2,473.0 2,021.3 1,705.6 Treasury bills 1,217.5 1,615.3 1,931.6 2,186.9 1,775.2 1,493.5 Inscribed stock 388.2 354.2 320.1 286.1 246.1 212.1 External 1,718.4 1,811.3 2166.3 2,704.6 3,812.8 3,395.2 International agencies 1,475.8 1,579.2 1,997.4 2,567.5 3,650.4 3,247.5 Commercial loans 227.9 219.6 157.1 124.1 144.6 132.5 Other loans 14.7 12.5 11.8 13.1 17.9 15.2 Total public debt 3,324.1 3,780.8 4,418.0 5,177.6 5,834.2 5,100.8

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

EIU Country Report January 2001 © The Economist Intelligence Unit Limited 2001