The Bank of Papua New Guinea and the International Monetary Fund believe continued depreciation of the kina is the way to alleviate the country’s ongoing foreign exchange shortages. ANZ economists Kishti Sen and Tom Kenny argue there are better alternatives.

There are many opinions on how to ensure the stability of the kina. Credit: Maksym Kapliuk, Adobe Stock

A number of views exist on how Papua New Guinea’s foreign currency shortage came about and how best to alleviate the undersupply.

Some believe a downward adjustment to the exchange rate is the answer. The Bank of Papua New Guinea (BPNG), on advice from the International Monetary Fund (IMF), is taking this approach.

The domestic exporting sector can’t, at this point, capitalise on the benefits of a lower currency.

Depreciation’s downside

Close to 18 months into the depreciation cycle, we believe that the fall in the kina’s (PGK) value has created more challenges than solutions.

Firstly, it is adding to inflationary pressures. With prices for staple food, which is mostly imported, currently up 8 per cent year-on-year, this is well above the total weighted average CPI increase of 2 per cent.

Secondly, currency depreciation has not attracted sufficient foreign currency or suppressed import demand enough to materially reduce the foreign currency deficit.

In fact, the market backlog remains stubbornly above its pre-depreciation level of K1 billion. The PGK/USD exchange rate is now 27 per cent lower than its June 2014 value, when the initial market backlog emerged. Despite this, a large foreign currency order book remains.

We don’t believe another few percentage points of depreciation will significantly reduce the backlog.

The trouble with model-based solutions for PNG: they don’t work

PNG’s economy has several unique features. Growth comes from a few sources, and its exporting and import-competing industries are not mature enough to take the baton from resource investment and drive growth between investment booms.

Manufacturing makes up 1.7 per cent of PNG’s total industry value-add. The number of visitors to the country pre-pandemic was about 120,000. Rural and non-rural exports are more or less at capacity. So, the domestic exporting sector can’t, at this point, capitalise on the benefits of a lower currency.

Until PNG develops exports and domestic industries, that can viably compete with the expensive imports that result from currency depreciation, we believe the debate about the appropriate value of the kina to underwrite a structural shift to trade-exposed industries is premature.

Kina needs to be stabilised

We believe the PGK/USD exchange rate should be stabilised to take pressure off inflation.

We see two alternative options for approaching the kina’s value:

ANZ’s Kishti Sen. Credit: ANZ

• revalue the currency to US$0.28, where it was in 2022 and until May 2023, prior to the recent round of depreciation. This will reduce the price of imported goods, either directly via prices of imported goods or indirectly via lower prices of imported inputs into goods manufactured in PNG; or
• maintain stability at the current trading rate of US$0.2560.

We also believe the BPNG has the capacity to increase its liquidity intervention to US$150m a month (from USD100m currently). In our view, this will materially reduce the backlog of foreign currency demand, while PNG waits for a permanent solution.

Resources projects

A more permanent solution to restoring balance is through foreign direct investment, which would materially increase supply, restart the foreign currency interbank market and lay the groundwork for a return to a fully flexible exchange rate regime.

The ramp up of foreign reserves over 2008–2012 coincided with the construction of the PNG LNG project. We expect a similar trend to emerge once major resources projects start in 2026. Additionally, PNG LNG debt will be retired by 2026, meaning more dividend inflows from that project.

The kina will also be on an upward march from 2026. The spending on the PNG LNG project in 2011–12 brought US dollars into the country, leading to a 27.4 per cent appreciation in the PGK/USD exchange rate to a high of US$0.4893 in the third quarter of 2012. We expect a similar path for the kina from mid-2026.

With demand for kina rising to pay for local contractors, suppliers and labour associated with the project, kina should start strengthening against the US dollar from mid-2026, picking up pace in 2027 as other construction projects join the upswing.

Looking ahead

We believe PNG’s foreign currency market backlog will pass and the country can return to a free-floating exchange rate regime when its next round of resource projects come to commencement. The earlier these projects begin, the sooner the forex market will balance.

In the meantime, stabilising the kina and providing more liquidity support to the interbank market is a pathway to restoring confidence, taking pressure off inflation and providing macroeconomic stability.

This is an edited version of an ANZ Research Pacific Insight paper, “A fix to PNG’s kina and foreign currency woes,” written by Kishti Sen, International Economist, and Tom Kenny, Senior International Economist. Republished with permission.