The rapidly weakening kina, deficit spending and the financing of government debt is piling pressure on the Papua New Guinea government to boost economic confidence. Economist Dr Mark Evans considers some of the issues facing both government and business.

The Pacific Policy Institute’s Mark Evans

The depreciating kina, with its potential impact on inflation, official foreign exchange reserves and investor confidence, is the biggest challenge to face the Bank of Papua New Guinea in recent years.

The depreciation was predicted to coincide with the winding up of the construction phase of the LNG project. However, when it came it came quicker than expected, causing a lot of uncertainty.

The important point to note is that the recent intervention by the Bank of PNG does not change the fundamental driver of the depreciation—a shortage of foreign exchange.

‘The government should be looking to build the foundations for well-managed resource revenues and ultimately economic development that reaches beyond the natural resource industries. Unfortunately, the signs are pointing in a different direction.’

In the near-term, inflows from the PNG LNG project are unlikely to provide relief as a source of foreign exchange and the continued fiscal stimulus is driving the demand side: this means the foreign exchange shortfall will remain.

Attracting further foreign direct investment is therefore vital.

For the exchange rate, the important thing to keep an eye on is the official foreign exchange reserves, particularly the direction and rate at which they are travelling. Looking ahead, if little else changes, this will be the most significant factor that will drive the centres bank’s decision-making.

Maintaining business confidence

This is a sensitive period for Papua New Guinea. With the first shipment of LNG, the government should be looking to build the foundations for well-managed resource revenues and ultimately economic development that reaches beyond the natural resource industries.

Unfortunately, the signs are pointing in a different direction.

There are understandable concerns, which government officials also share, about the rapidly weakening kina and that the government has reached the practical limits of a prolonged period of deficit spending.

The cost of debt

A little discussed issue, outside of government, is that government debt financing is becoming problematic and costly. This has meant that the government has increasingly been relying on lending from the central bank.

There are signs this year that the government is relying on revenue growth that will fall short of expectations. If this is true, the need to manage spending may become more pressing before the year is out.

The government must find a credible road out and engage with these concerned voices in the run up to the 2015 budget. This is crucial. Not least to instill confidence in the government’s macroeconomic policies.

Global factors affecting PNG and the Pacific

The monetary policy stances of key central banks, such as the US Federal Reserve, are fundamental external drivers of exchange rate developments.

It is expected that Pacific economies will have to manage the external pressures of a weakening Australian dollar and strengthening US dollar. How this will play out for exporters and inflationary pressures will vary across the Pacific.

‘Papua New Guinea should be watching closely the longer-term developments that are re-shaping world energy markets, particularly new gas exporters coming forward and the United States ‘shale gas revolution’ spilling over to other countries.’

Recent signals from the US Federal Reserve that it will maintain its policy stance are holding back speculative flows into the US dollar to strengthen the currency. This has supported the Australian, which has seen a bit of a recovery. So, understanding the timing of a shift back to the longer-term trend is key.

Higher commodity prices

In the Pacific, we have also seen some upward movement in commodity prices over the past year.

This may help out some of our exporters, but it is important to keep an eye on cost of imports, particularly food prices.

These have picked up slightly and potentially the El Nino weather patterns may create further pressures.

Papua New Guinea should be watching closely the longer-term developments that are re-shaping world energy markets, particularly new gas exporters coming forward and the United States ‘shale gas revolution’ spilling over to other countries.

Changing demand conditions in Asia with the return of Japanese nuclear power will also impact on prices.

Dr Mark Evans is a Senior Policy Analyst and Economist at Pacific Institute of Public Policy in Vanuatu.