The Bank of Papua New Guinea argues that the government should fund its spending plans from the domestic banking system. Meanwhile, the government is ramping up its borrowing from foreign sources. Who is right?

The Papua New Guinea government has ambitious plans in this year’s budget to boost spending on education, health and much-needed infrastructure.

Indeed, the spending will be enough to send the budget sharply into deficit by US$1.13 billion (K2.6 billion), or about 7.2% of gross domestic product (GDP), compared with a deficit of US$147 million (K339 million) last year or one per cent of GDP.

‘We are working already with a range of organisations to raise the necessary financing, and I am confident that we can do so,’ Treasury Minister Don Polye said in delivering the 2013 budget.

The financing strategy includes tapping into domestic savings to raise US$696 million (K1.6 billion), plus an international sovereign bond to raise about US$435 million (K1 billion).

In addition, the O’Neill government has negotiated a US$2.6 billion (K6 billion) loan with the Export-Import Bank of China to help fund its investments in roads, ports and other projects.

Among the projects being funded partly or fully by the Chinese loans are: six major road projects for the National Capital District; a four-lane airport highway in Lae; the Madang Pacific Marine Industrial Zone; and an upgrade of the Telikom PNG network by Chinese technology provider Huawei.

Domestic funding

However, the nation’s central bank, the Bank of Papua New Guinea, has raised concerns that if the government borrows from foreign sources, it could overheat the economy and boost domestic prices, leading to higher inflation.

‘The infrastructure projects… should be financed from domestic sources,’ central bank Governor Loi Bakani said in a recent speech.

He argued that any financing arrangements that required a foreign component, which meant adding to the GDP of the country providing the financing, ‘should not be entertained’.

Bakani said the domestic financial system contained US$1.95 billion (K4.5 billion) of central bank bills that could be used to fund the government’s spending plans.

‘Using local contractors and domestic financing will result in an increase in salaries and wages, purchases of goods from local suppliers, profits of local companies, which all add up to domestic GDP,’ he said.

As the construction phase of the massive LNG project winds down, the government should take advantage of machinery, equipment and trained labour force that were employed on the LNG project to implement infrastructure works across the economy, Bakani said.

Risk of overheating

Economists say the Bank of Papua New Guinea’s main concern would be whether borrowing from offshore results is overheating the local economy, by adding to already high levels of cash.

‘I don’t think they have any concern about foreign ownership per se,’ said Tim Harcourt, economics fellow at the University of New South Wales’ Australian School of Business, told Business Advantage PNG.

‘Their concern is the macroeconomic impact and how much it is heating up the economy,’ he told Business Advantage PNG.

Another risk with borrowing from overseas is that changes in foreign exchange rates can make loans more burdensome to repay. The kina has fallen some eight per cent over the past year, making foreign interest payments more expensive.

But Harcourt said that for a small, open economy such as Papua New Guinea’s, which is heavily dependent on commodities exports, it is quite realistic for financing to be sourced both domestically and internationally.

‘It is not unusual if you look at other oil and gas-led economies, they have relatively strong levels of foreign investment,’ Harcourt said.

He said that it may be difficult to fund the O’Neill government’s wide-ranging spending plans, including education and social programs and law and order, purely from local sources.

‘I would have thought it would be quite natural to have a fair bit of foreign investment in PNG. I don’t see how you could do it without foreign borrowing.’