Papua New Guinea’s Controversial Decisions Could Lead to Crisis

Last year in Papua New Guinea was eventful, marked by a series of controversial government decisions.

Last year in Papua New Guinea was eventful, marked by a series of controversial government decisions.

In March, the government decided to take out a loan of about 3 billion kina (US$1.2 billion, about 8 percent of GDP) to buy shares in Oil Search. The decision divided the government, and the treasurer’s opposition to it resulted in his sacking. Questions over the legality of the decision have led to references of the Prime Minister Peter O’Neill being a leadership tribunal, a mechanism to deal with accusations of corrupt or illegal conduct by the country’s members of parliament. The prime minister is currently challenging that referral in the courts.

In June, the PNG central bank appreciated the kina against the US dollar by 15 percent. Since then the kina only depreciated modestly. Appreciation of the kina at a time of falling commodity prices makes little sense.

Also in June, the prime minister disbanded Taskforce Sweep, the anti-corruption body he himself had created just a couple of years ago, because it levelled charges of corruption against him. Along the way, the prime minister also sacked or suspended a deputy police commissioner and the acting public prosecutor. He continues to fight in the courts the issuance of an arrest warrant consequent to the recommendations of Taskforce Sweep. Whatever the outcome of the case, the prime minister’s anti-corruption credentials are in tatters, and the rule of law in Papua New Guinea has taken a battering.

In October, the PNG central bank indicated that it would act as a buyer of last resort for government bonds, a risky move in the direction of printing money.

And then in November, the government brought down a budget which was more restrained on the expenditure side than those seen in recent years, but which failed to lay out a credible fiscal adjustment path to bring down high deficits and rising debt.

One positive development in 2014 was the resurrection of legislation to establish a sovereign wealth fund, delayed by two years.

Unfortunately, however, the need for a sovereign wealth fund in this resource cycle seems to have disappeared with the collapse of oil prices. The timing of this could not have been worse for PNG, with its liquefied natural gas (LNG) project coming on line in the second half of 2014, ahead of schedule. LNG prices link to oil prices, and with oil prices currently nearly half the level of the budget assumption of US$90, the revenue from the PNG LNG Project will be much less than expected. This will have, as my colleague Paul Flanagan pointed out at the end of last year, major negative impacts on the budget, on GDP growth and on the balance of payments.

At first, the government responded to Flanagan’s analysis with the counter-claim that contracts fix LNG prices. Since then, however, it has acknowledged the severity of the problem, with the most recent statement by Prime Minister O’Neill indicating that the impact of the oil price fall should ‘not be underestimated’ and that ‘hard decisions’ may be needed.

Clearly, the central bank needs to allow the exchange rate to depreciate significantly. And the government needs to cut spending. Both should be possible. In particular, there has been incredibly rapid expenditure growth over the last few years, so finding savings should not be difficult.

Politics could be the constraint. As of this month, protection of the prime minister by constitutional provisions that, as amended by the parliament in 2013, prohibit a vote of no confidence for the first 30 months of the government’s term. Elections in 2017 are no longer that far away. The political scene may also be destabilised if the prime minister is forced to stand down, resulting from one or both of the two cases now pending against him.

If politics gets in the way — and if the exchange rate is not allowed to fall, and expenditure is not cut — then PNG’s economic problems will worsen. Reports of foreign exchange rationing and government cash flow problems will intensify. In the medium term, we could see the emergence of high interest rates and inflation, and the depletion of PNG’s foreign exchange reserves.

In sum, this year will be a year for tough decisions in PNG, or it will be a year of descent towards crisis. A recovery of oil prices is an unlikely way out. Politics will tell which way the country turns.

Is PNG heading for a crisis? is republished with permission from East Asia Forum