The lack of availability of foreign exchange is creating imbalances within Papua New Guinea’s financial system, according to a report by Kina Securities. It says there is a build up of liquidity in kina, which may have implications for the financial strategies of domestic companies.

Net foreign exchange inflows/ouflows and the Bank of PNG’s intervention Source: Bank of PNG

The Kina Investment Outlook for May says ‘a large amount of funds are held “captive” within PNG, resulting in a very liquid financial system.’

‘Extra liquidity in the market ‘is sufficient to drive domestic investments, and agriculture seems to be a strong contender for this.’

‘Long term interest rates are likely to gradually increase and short term rates will stabilise over the next six to 12 months as a consequence of continued foreign exchange supply issues,’ the report says.

Domestic investments

One consequence of the high levels of liquidity may be a greater availability of capital for local companies. The Business Council of PNG’s recent quarterly report says that the extra liquidity in the market ‘is sufficient to drive domestic investments, and agriculture seems to be a strong contender for this.’

‘Import substitution and local content have increased in the market due to import challenges posed by the shortage of foreign currency,’ the Business Council report notes.

‘The decline of the kina will occur at a stable pace as the government draws on offshore credit facilities to refinance domestic debt.’

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‘The SME sector will continue its growth due to its flexibility in adapting its business models and limited requirements on foreign currency.

The Business Council’s Douveri Henao

‘Top corporates will continue major adjustments in their business models and will see further impacts on consumer behaviour, unemployment and investments. This does not negate the fact that liquidity in the market is sufficient to drive domestic investments.’

Executive Director of the Business Council, Douveri Henao, reportedly said that chief financial officers for companies ‘are now utilising these huge sums of money to enhance their business’.

He added, however, that other CFOs may hold the funds back ‘because if the value of the kina drops they will have to pay more.’

Currency

Companies that do have foreign exchange exposure certainly have reason to be wary. The Kina Securities report anticipates ‘ongoing depreciation’ of the kina against the US dollar.

It says, however, that the decline of the kina will occur ‘at a stable pace’ as the government draws on offshore credit facilities to refinance domestic debt.

‘The Kina will remain on a downward trajectory as the market continues to clear the backlog of import orders.’

‘The financial sector remains healthy with positive results and strong growth.’

Company earnings are also expected to be depressed because of the subdued economic activity.

‘Earnings results from companies in discretionary consumption industries have been particularly impacted by the foreign exchange shortage issues,’ the Kina Securities report says. ‘The financial sector, however, remains healthy with positive results and strong growth.’

Monetary flexibility

Meanwhile, the excess liquidity in kina is affecting the Bank of Papua New Guinea’s (BPNG’s) policy options, according to a Banking Industry Country Risk Assessment by ratings agency Standard & Poor’s.

‘The residential property market is likely to remain under pressure due to an increase in supply.’

‘We believe the BPNG’s monetary policy flexibility is severely hampered by the very limited transmission of monetary policy settings to the interest rates faced by borrowers—largely because of the high level of liquidity in the banking system,’ the S&P report says.

‘Close to half the commercial banks’ assets consist of government-related debt and securities, including deposits held with the central bank.’

Equity and property markets

High levels of kina liquidity are unlikely to affect the level of the stock market, according to analysts. The Standard & Poor’s report says PNG’s equity markets ‘remain underdeveloped and lack the degree of participation by both households and corporates typically observed in developed markets.’

The Kina Securities report says PNG’s two stock market indexes, the KSi index and Home index, are likely to ‘remain at current levels based on the main constituents of the equity indices’.

Kina Securities says the residential property market is likely to remain under pressure due to an increase in supply of housing. ‘Commercial office space leasing has stabilised,’ the report also observes.