Halfway through the building of its major liquefied natural gas project, Papua New Guinea finds itself in a strong fiscal position, but with some key challenges.

After ten straight years of economic growth, culminating in an impressive 8.9% increase in GDP in 2011 (compared to a world average of 4%), Papua New Guinea’s economy is in robust shape.

Corporate profits are strong, with corporate tax revenue budgeted to rise by a heady 19.9% in 2012, the country’s foreign reserves are at record levels and Government finances are in order, with the December 2011 budget not only balanced, but promising greater development expenditure than any budget in the country’s history.

The reasons behind PNG’s current performance were identified by the International Monetary Fund’s February 2012 mission to the Pacific democracy:

Elevated commodity prices, the construction of a liquefied natural gas (LNG) project and its spin-off effect to other sectors such as manufacturing, building and construction and transportation, and election-year government spending are boosting the economy.

Mid-way through a construction boom

At the start of 2012, PNG finds itself half-way through the construction phase of the US$15 billion Exxon-Mobil-led PNG LNG project.

‘Obviously a lot of the small businesses in PNG are benefiting from the spin-off from the LNG project, there’s no doubt about that, and many of the existing businesses that we bank are experiencing immense growth,’ notes Greg Pawson, Chief Executive Officer—Pacific for Westpac.

While profits are high and formal employment is growing by 7.1% per annum, there are downsides to having such a large project in a small country. As well as creating a shortage of skilled workers and general capacity, the importing of materials for the project’s construction has made a dent in PNG’s current account deficit (riding at of 35% of GDP). Capacity constraints have also driven inflation higher (officially expected to run at 7.6% in 2012, but anecdotally expected to be much higher), although it has been tempered somewhat by a stronger kina.

Even as the economy pushes ahead at full steam, companies are already preparing for the inevitable slow-down once the construction phase of the LNG project is completed in 2014.

‘Yes, there will be some reduction in GDP,’ notes Ian Clyne, Chief Executive Officer of Bank of South Pacific, PNG’s largest retail bank. ‘But then ultimately I think Papua New Guinea, given its wealth, will continue to do well.’

Towards a diversified economy

Internationally, PNG is often seen as a resources-based economy, but what is noteworthy about its economic performance in 2011 is that the country’s non-mining sectors actually outperformed its resources sector, growing by 10.8% compared to 7.4%. Indeed, as central bank Governor Loi M Bakani observed to an audience of Australia and Papua New Guinean accountants in November 2011, the non-mining sector has driven most of the country’s 5.4% GDP per annum growth over the past decade.

With its conducive climate, fertile soils and expansive exclusive economic zone, PNG has natural advantages in agriculture, fisheries and forestry, while it also possesses substantial manufacturing and services sectors. With major resources projects such as Hidden Valley (gold/silver), Ramu (nickel), Wafi-Golpu (gold/copper), Frieda River (gold/copper) and a second LNG project in the pipeline, the opportunity exists to develop a truly diversified economy in the future—a stated goal of the PNG Government’s Development Strategic Plan, 2010–2030.

Political instability

Since April 2011, when then-Prime Minister Sir Michael Somare, was taken gravely ill, the political stability that has been a feature of Papua New Guinea for the past decade has given way to a period of political and constitutional instability. In August 2011, Somare’s National Alliance government was replaced by one led by former Treasurer Peter O’Neill, and constitutional arguments about the legitimacy of the new Government have continued ever since.

While the political disputes have been heated, it is worth noting that, up to the time of writing, they had not engendered significant social unrest. Many of the business leaders Business Advantage spoke to for this publication expressed admiration for the calmness with which nearly all Papua New Guineans have reacted to the political situation. There is a consensus that national elections due in June 2012 have probably acted as a circuit breaker. So too is the fact that, as one commentator put to us, ‘people have felt more comfortable with the new Government’.

Indeed, up to the time of writing, the political unrest seems to have caused more consternation outside of Papua New Guinea than inside. At the end of January 2012, news came into Papua New Guinea’s capital, Port Moresby, that international credit rating agency Standard & Poor’s had downgraded the country’s long-term sovereign credit rating from ‘stable’ to ‘negative’, following a widely reported but comically short-lived coup attempt.

The International Finance Corporation’s Resident Representative Carolyn Blacklock was in meetings when the news came through: ‘Everybody around the world was getting these reports before we did … and so the phone was running hot … and the meetings just continued,’ she tells Business Advantage. ‘This place is very busy at the moment … I think everybody’s just firmly focused on getting the business done.’

Standard & Poor’s had blinked, but those on the ground had their eyes on the main game. Indeed, other rating agencies failed to follow S&P’s suit and by mid-March rival agency Moody’s was concluding that the political situation, while yet to be resolved, was ‘little threat to near-term drivers of economic growth’.

Addressing the challenges to business

This view is supported by PNG’s senior business leaders, whom Business Advantage surveyed extensively between December 2011 and March 2012 for our PNG 100 CEO Survey.

While they are keeping an eye on the political situation, they told us they were more concerned about skills shortages, law and order more generally, the unreliability of state-owned utilities, lack of government capacity, and the challenge of moving produce, goods and equipment into, around and out of an underdeveloped country. While PNG businesses are innovative in managing these challenges, the business community is also looking to government to improve service delivery, address corruption and reduce red tape.

‘The challenge for the country is to take the windfalls and really enhance the infrastructure, get real benefits to the population and obviously improve law and order and judicial systems to reflect the needs of what is going to be a very vibrant place to do business,’ asserts BSP’s Ian Clyne.

Future-proofing the economy

There is some encouraging news in this respect. A Sovereign Wealth Fund is to be created to house state revenues from the PNG LNG Project and help prevent PNG succumbing to the ‘Dutch disease’ that has affected some other developing countries with major resources projects. This move, according to Moody’s, ‘augurs well for continued fiscal discipline’. A portion of this fund will be used to invest in badly-needed infrastructure, including re-capitalising of state-owned enterprises.

Ultimately, if PNG’s state-owned enterprises are to start performing as the country needs, far-reaching reforms will be needed similar to those that have taken place in its deregulated information and telecommunications sector.

Another welcome development in early 2012 was the abolition by the O’Neill Government of tuition fees for primary and secondary children up to Year 10 and the reduction of fees for older students.

‘This place is very busy at the moment … I think everybody’s just firmly focused on getting the business done.’

First published in Business Advantage PNG 2012/2013