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COUNTRY REPORT

Papua New Guinea

2nd quarter 1998

The Economist Intelligence Unit15 Regent Street, London SW1Y 4LRUnited Kingdom

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ISSN 1366-4085

Contents

3 Summary

4 Political structure

5 Economic structure

6 Outlook for 1998-99

11 Review11 The political scene15 Economic policy and the economy21 Agriculture and forestry23 Energy and mining24 Foreign trade and payments

28 Quarterly indicators and trade data

List of tables8 Forecast summary9 Commodity price forecasts

17 Central government budget18 Inflation19 Employment classified by industry20 Money supply20 Commercial banks’ liquid asset holdings21 Commercial bank interest rates22 Export prices22 Agricultural exports23 Mineral exports25 Exports25 Balance of payments26 Exchange rates27 Public debt outstanding28 Quarterly indicators of economic activity28 Direction of trade29 Domestic exports

List of figures8 Gross domestic product8 Kina real exchange rate

18 Consumer prices22 Exports

Papua New Guinea 1

EIU Country Report 2nd quarter 1998 © The Economist Intelligence Unit Limited 1998

May 8th 1998 Summary

2nd quarter 1998

Outlook for 1998-99: The policymaking environment remains unstable,despite attempts to crack down on corruption, and the prime minister, BillSkate, remains vulnerable. The government has sought help from the IMF andWorld Bank. The economy was hit hard by the drought, but a sharp recovery isexpected during 1998. This will be driven by exports from the minerals sector,but weak world commodity prices are expected to keep the current account indeficit. Inflation is expected to increase.

The political scene: Changes in both the cabinet line-up and in the publicservice have continued, the most visible change being the replacement ofKoiari Tarata as governor of the central bank by John Vulupindi. The primeminister has established a new political party. A government bill proposing anindependent commission against corruption has been referred to a specialcommittee, and Mr Skate’s plans to reduce political instability do not seem tohave been successful. A permanent ceasefire has been signed for Bougainville,although one important rebel leader, Francis Ona, appears opposed to the deal.

Economic policy and the economy: The central bank now estimates thatthe economy contracted by 6.2% in 1997, mainly owing to the poor perform-ance of the mining sector. The government has announced a tight budget, inwhich it has had to find resources to finance a 56.7% leap in debt interestpayments. Inflation is on the rise. Loose monetary policy contributed to asharp increase in domestic credit in 1997, although interest rates havenow risen.

Sectoral trends: Agricultural commodity export volumes declined in 1997,but increases in world prices for coffee and palm oil led to an increase in exportvalues. The forestry industry has continued to call for tax breaks, although thegovernment has so far ruled them out. Mining export volumes declined signif-icantly during 1997, but can be expected to rise following the start of prod-uction at the Gobe oil project.

Foreign trade and payments: A sharp decline in the value of mineralexports led to a 7.9% fall in the total value of merchandise exports. Combinedwith a rise in import values, the trade surplus fell by over 25%. Overall, thecurrent-account balance moved into deficit for the first time since 1991, andthe overall balance of payments also moved into the red. The kina has depreci-ated sharply against major trading currencies, and the level of external debtoutstanding began to increase again towards the end of 1997.

Editor:All queries:

Paul CaveyTel: (44.171) 308 1007 Fax: (44.171) 830 1023

Papua New Guinea 3


Political structure

Official name Independent State of Papua New Guinea

Form of state Constitutional monarchy

Head of state Queen Elizabeth II, represented by the governor-general, who is nominated by theNational Parliament

The executive The National Executive Council, presided over by the prime minister, has executivepowers; the prime minister is appointed by the head of state on the proposal ofparliament

National legislature Unicameral National Parliament; its 109 members are elected for a period of five years,89 representing “open” constituencies and the rest representing 19 provincialconstituencies and the capital district

Provincial government Each of the 19 provinces has its own government which may levy taxes to supplementgrants received from the national government

Legal system Series of regional and magistrates’ courts leading to a Supreme Court at the apex

National elections June 1997; next elections due by June 2002

National government Following the June 1997 election, no party held a majority in parliament. Aftercoalition negotiations Bill Skate of the People’s National Congress was selected primeminister on July 22nd. Mr Skate’s cabinet originally included MPs from the five mainparties. There are now three main parties in the government

Main political organisations Papua New Guinea First (PNGF); People’s Progress Party (PPP); Pangu Pati; People’sDemocratic Movement (PDM)

Main members of theNational Executive Council

Prime minister Bill SkateDeputy prime minister, minister of trade & industry & tourism Michael NaliSenior minister for state Sir Rabbie Namaliu

Key ministers Agriculture & livestock Tukape MasaniBougainville affairs Sam AkoitaiDefence Peter WaiengEducation, culture & science Muku TaranupiEnvironment Herowa AgiwaFisheries Sir Mekere MorautaForeign affairs Roy YakiHousing Mao ZemingMining Philemon EmbelPetroleum & energy Masket IangalioProvincial & local government Simon KaumiPublic services Ian Ling-StuckeyTransport Vincent AualiTreasury & corporate affairs Iairo Lasaro

Central bank governor John Vulupindi

4 Papua New Guinea


Economic structure

Latest available figures

Economic indicators 1993 1994 1995 1996 1997a

GDP at market prices (Kina bn) 5.0 5.4 6.1 7.1a 6.9

GDP ($ bn) 5.1 5.4 4.8 5.4a 4.8

Real GDP growthb (%) 16.6 5.2 –2.9 3.9 –6.5

Consumer price inflation (av; %) 4.9 2.9 17.3 11.6 4.0c

Population (m) 3.9 4.0 4.1 4.2 4.2

Merchandise exports fob ($ m) 2,604 2,651 2,670 2,530 2,136c

Merchandise imports fob ($ m) –1,135 –1,325 –1,262 –1,513 –1,465c

Current account ($ m) 646 569 674 313 –112

Reserves excl gold ($ m) 141 96 261 584 363c

Total external debt ($ bn) 3.3 2.8 2.5 2.4 2.1

Debt-service ratio, paid (%) 28.9 30.8 20.8 12.6 15.8

Exchange rate (av; Kina:$) 0.978 1.011 1.280 1.319 1.438

May 8th 1998 Kina2.0347:$1

Origins of gross domestic product 1996 % of total Components of gross domestic product 1993 % of total

Agriculture 26.4 Private consumption 50.5

Mining & quarrying 25.8 Government consumption 20.3

Manufacturing 8.7 Investment 18.8

Construction 5.5 Exports of goods & services 50.2

Electricity, gas & water 1.3 Imports of goods & services –39.7

Services 32.4 GDP at market prices incl change in stocks 100.0

GDP at factor cost 100.0

Principal exports fob 1997 US$ m Principal imports cif 1994 US$ m

Crude oil 592.6 Machinery & transport equipment 442.9

Gold 499.8 Manufactured goods 334.0

Logs 284.6 Food & live animals 204.2

Copper 180.7 Chemicals 85.9

Coffee 225.3 Mineral fuels & lubricants 40.8

Palm oil 144.0 Total incl others 1,526.5

Total incl othersd 2,122.2

Main destinations of exports 1996 % of total Main origins of imports 1996 % of total

Australia 36.3 Australia 51.0

Japan 21.5 Singapore 10.2

Germany 8.1 Japan 10.1

UK 5.9 US 4.5

South Korea 5.4 New Zealand 4.3

China 3.5 Malaysia 2.8

a EIU estimates. b Series 1993-96 from IMF, Papua New Guinea: Recent Economic Developments. c Actual. d Includes immigrant effects, andconsequently differs from total given above.

Papua New Guinea 5


Outlook for 1998-99

The policymakingenvironment has not

improved—

Partly in an attempt to maintain his position as prime minister, Bill Skateundertook a major cabinet reshuffle in December. However, although Mr Skatemade fundamental changes to his government, he still does not appear to havebeen satisfied with his cabinet, and further changes have been made since.Mr Skate has also continued to move personnel within the public service, mostnotably removing the central bank governor, Koiari Tarata, in April. The pres-ident of the PNG Chamber of Mines and Petroleum, Moseley Moramoro, saidthat these changes in the public service were “creating a very unstable anduncertain environment not only for the public service but for the business andcommercial sector in general”. It is also unlikely to lead to any improvement ingovernment policy, which was recently criticised by the Asian DevelopmentBank (ADB) as being “ad hoc and politicised”. The Bank added: “Effectivemedium-term fiscal planning and fiscal responsibility legislation are lacking,policy reversals are common and large gaps between announced policies andactual implementation are common”.

—despite attempts tocrack down on

corruption—

The government has made one notable attempt to improve the political envi-ronment in PNG by tabling a bill to establish an Independent CommissionAgainst Corruption (ICAC). However, the degree of support for this proposedlegislation from within the political elite is unclear. The bill was put beforeparliament in March, but was not put to a vote, apparently because the govern-ment could not rally the support needed to have the bill passed. Although thebill is supposed to be put before parliament once again in June, it is not clearhow or why the popularity of the proposed institution will be increased amongMPs during the intervening period.

—and the prime ministerstill looks vulnerable

At the same time that the corruption bill was put to parliament, the govern-ment proposed more controversial reforms of the constitution. It suggestedthat the prime minister be chosen by a government caucus of six MPs, ratherthan by the whole of parliament. If parliament wanted to change the primeminister directly, or voted out the government caucus, new elections would becalled. This perturbed many MPs; turnover rates at elections in PNG are veryhigh, and incumbent MPs are anxious to keep their seats for the full term.Mr Skate therefore calculated that this reform would lead to fewer changes ofgovernment.

Such a reform might well be of long-term benefit to PNG, as argued by Mr Skate,as political instability would be reduced. However, it would also probably ex-tend Mr Skate’s own tenure at the top. Without these changes, and given thefluid allegiances of politicians in PNG, it is likely that Mr Skate would face a voteof no confidence soon after the 18-month period of grace for new governmentsends. Mr Skate’s failure to win support for his proposed changes, at least at thefirst attempt, therefore signals that political instability is likely to continue inPNG, and a change of government in early 1999 cannot be ruled out.

Francis Ona is a threat tothe peace process—

The one real achievement of the Skate government has been the signing of apermanent ceasefire for the troubled island of Bougainville. There is now a real

6 Papua New Guinea


chance that peace will return to the island. However, the founding father of therebel movement, Francis Ona, who has always been seen as the biggest threatto peace, may yet scupper the process—he apparently recently ordered theimplementation of a “shoot-to-kill” policy against peace monitors in selectedparts of the island. Earlier signs that Mr Ona was becoming isolated within therebel movement appear to have had some basis. Another prominent inde-pendence leader, Joseph Kabui, called for the removal of Mr Ona from his“symbolic position as president” of the Bougainville Interim Government(BIG). However, such an action will not disarm Mr Ona and his supporters, andindeed is likely further to fuel his opposition to the peace deal; is is also notclear how or whether Mr Kabui will see this decision through. The possibilityof bloodshed on the island therefore still exists, and Mr Ona’s opposition pre-sents a real danger to the holding of an election to a government of reconcili-ation on Bougainville at the end of the year.

—and the governmentfaces an uphill struggle in

rebuilding the economy

Even if the election goes ahead, the government in Port Moresby faces a formi-dable challenge in persuading the residents of Bougainville that they are betteroff being part of PNG than independent. One way of doing this would be toengineer a quick economic recovery. However, the funds needed to do this maybe in short supply. Although there have already been pledges of aid forBougainville from Australia, the ADB and the EU, a more significant source offunds would be the reopening of the Panguna mine, which was the originalcatalyst for the rebellion, and has been closed since 1989. However, the reopen-ing of the mine is not imminent. Apart from the political implications in-volved in any move to reopen the mine, large amounts of capital will beneeded: the New Zealand foreign minister, Don McKinnon, recently said that$500m would be needed and it would probably be ten years before the minewas reopened. Other efforts, such as the recently announced plan to replace20m cocoa trees on the island, will also only have significant effects in thelonger term.

The economy has had abad time—

The Ministry of Finance now estimates that the economy contracted by 6.5%in 1997, led by a substantial decline in the mineral sector. The drought seri-ously affected PNG’s export sector, although the worst effects were not experi-enced until the last part of the year: in the fourth quarter the merchandisetrade surplus fell by 70% year on year, compared with a fall of only 23% in thethird quarter. This deteriorating export performance combined with the finan-cial crises in much of Asia as well as some widely publicised bouts of domesticpolitical instability to exert considerable downward pressure on the kina fromOctober last year. The currency fell by 30.9% against the dollar between themiddle of October 1997 and the beginning of May 1998. The inflationarypressures this depreciation caused led to a sharp increase in interest rates inPNG, adding to the pressure on the domestic economy. The current-accountdeficit recorded in the last two quarters of 1997, and probably during the firstquarter of 1998, also began to drain PNG’s foreign-exchange reserves, whichaccording to the treasury and corporate affairs minister, Iairo Lasaro, had fallento just Kina300m ($147m) in March, sufficient for only two months of mer-chandise import cover.

Papua New Guinea 7


—with the governmentseeking outside help

In an apparent attempt not to understate the seriousness of the situation,Mr Lasaro said in March that the economy was being affected by the worstfinancial crisis since independence. The government has been in talks with theIMF, with the aim of boosting confidence in the economy, improving theinternational reserves position and encouraging bilateral donors to providemore assistance. The government is also seeking help from the World Bank.Although detailed deals with the two multilateral institutions have yet to bereached, the government included Kina192m in structural adjustmentprogramme financing in the 1998 budget, according to the central bank.

Forecast summary($ m unless otherwise indicated)

1996a 1997a 1998b 1999b

Real GDP growth (%) 3.9 –6.5 5.1 6.9 of which: agriculture 6.2 –1.5 –3.5 6.1 industry 2.2 –14.1 16.2 7.5 of which: mining & petroleum –9.6 –25.0 26.0 8.0 services 4.1 –2.5 1.7 6.9

Consumer price inflation (year-end; %) 7.0 5.3 8.5 5.3

Merchandise exports fob 2,530 2,136 2,162 2,528

Merchandise imports cif 1,741 1,685 1,639 1,739

Current-account balance 313 –112c –14 209

Exchange rate (year-end; Kina:$) 1.35 1.75 1.96 1.84

a Actual. b EIU forecasts. c EIU estimate.

The worst may now beover—

Despite the crisis identified by the government, the EIU remains optimisticabout PNG’s economy. The worst of the drought now appears to be over; at theend of February the Australian government announced that it was scaling backits drought relief assistance, with the number of people targeted falling from70,000 to 54,000. In the first quarter of the year, production at the two largestmines in PNG began to rise; output at the Porgera gold mine between Januaryand March, although 10% below the output of the first quarter of 1997, wasabove that recorded in the last quarter of 1997, and in March managementat the Ok Tedi copper mine announced that they had recalled the mine’sworkforce.

—and a strong recovery isexpected

During the remainder of 1998 we expect a sharp recovery driven by the miner-als sector, with real economic growth for the year reaching 5.1%, and increas-ing to 6.9% in 1999. Although production at the country’s two largest minescontinued to be affected by low water levels during the first quarter of the year,output seems to be gradually returning to normal. The export recovery will beparticularly sharp as rising water levels on the Fly River will allow productionstockpiled at the Ok Tedi mine during the drought to be transported immed-iately. During 1998 the economy will feel the full benefit of the beginning ofproduction at the Lihir gold mine, and oil output is also expected to risesignificantly once the Gobe oil project reaches full production in mid-year. Afurther boost to growth will come in 1999 with the expected start of prod-uction at the Morobe gold project.

8 Papua New Guinea


Export prices will remainweak—

This recovery will not, however, occur in all areas of the economy. The agricul-tural sector is expected to continue to suffer during 1998, with the output ofmost commodities falling owing to the damaging effects of the drought. Thefinancial contribution of the export sector to the domestic economy will alsobe limited by weak world commodity prices. Prices of many of PNG’s majorexports are expected to decline during 1998. Particularly significant will be theweak world prices for oil and copper: oil prices are expected to decline by 18.3%in 1998 (compared with our previous forecast of a 7.9% fall) and copper priceswill fall by 23.7%. The prices of PNG’s most important agricultural commodi-ties are also expected to remain weak: the coffee price is expected to fall by17.1% (after rising by 54.9% during 1997). Altogether the EIU’s general indexof food, feedstuffs and beverages prices is now expected to fall by 3% in 1998,before increasing by 3.1% in 1999.

Commodity price forecasts($/tonne unless otherwise indicated)

% % % % %1995 change 1996 change 1997 change 1998 change 1999 change

Agricultural commoditiesCocoa (US cents/lb) 65.1 2.7 66.0 1.5 73.4 11.2 78.0 6.3 79.0 1.3Copra oil 669.5 10.2 751.5 12.2 659.5 –12.2 639.3 –3.1 740.8 15.9Arabica coffee (US cents/lb) 151.2 0.7 122.1 –19.2 189.1 54.9 156.8 –17.1 115.0 –26.6Copra 438.5 5.1 488.5 11.4 433.5 –11.3 412.0 –5.0 479.3 16.3Palm oil 628.5 18.8 531.0 –15.5 545.8 2.8 576.5 5.6 581.3 0.8Sugar (US cents/lb) 13.3 10.3 12.0 –9.8 11.4 –5.0 10.6 –7.0 10.8 1.9Tea (pence/kg) 111.3 –17.9 118.0 6.0 143.0 21.2 166.8 16.6 144.5 –13.4

Industrial raw materialsCopper (US cents/lb) 133.1 27.2 104.1 –21.8 103.3 –0.8 78.8 –23.7 75.5 –4.2Crude oil ($/barrel) 17.2 –6.1 20.5 19.2 19.1 –6.8 15.6 –18.3 16.7 7.1Rubber (£/tonne) 1058.0 32.7 954.3 –9.8 655.8 –31.3 477.3 –27.2 527.5 10.5Source: EIU.

—and with rising importprices, will limit the

current-account recovery

These weak prices would usually reduce PNG’s import bill. However, althoughthe dollar value of the import bill is expected to fall slightly, this will be morebecause of the expected sharp increase in the kina price of imports followingthe depreciation of the kina, which will deter the consumption of importedgoods. The trade balance, although rising by 9.8% from the 1997 level, willremain considerably below the $1bn-plus levels experienced between 1993 and1996. This will limit any improvement in the overall current account, which isexpected to record a deficit during 1998 equivalent to around 0.3% of GDP,before returning to a surplus in 1999 equivalent to 4.2% of GDP.

Inflation is expected torise—

Weak world commodity prices will therefore only slightly mitigate the infla-tionary pressure generated by the 30.9% depreciation in the value of the cur-rency since October. We forecast an average inflation rate of 13.4% for 1998,falling to 7.5% in 1999, as the one-off effects of the depreciation fall out of theinflation calculation. Although the government has the power to resist pricerises—at the end of 1997, 30% of the basket of goods used to measure theconsumer price index were subject to some form of price control—its willing-ness to enforce such controls strictly may be limited. The recent temporaryhalting of production at the International Food Corporation factory at Laeindicates that, in the absence of government subsidies to cover the cost

Papua New Guinea 9


increases caused by the sharp rise in prices of imported goods, there will be atrade-off between the government’s attempts to limit price rises and employ-ment. In the present weak state of the non-minerals economy, the governmentmay in the future be more prepared to allow prices to rise than to cause animmediate contraction in the non-export part of the economy.

—and may be boosted bygovernment activities

The government’s fiscal stance may be a further spur to inflation. In the budgetthe government estimated that it would have a negative net domestic borrow-ing requirement during 1998. However, in its latest Quarterly Economic Bulletin,the central bank points out that in formulating this scenario, the governmentincluded Kina20m ($9.8m) in external financing, the source of which was notspecified. The bank is therefore sceptical that this financing will materialise,leaving a positive domestic financing requirement equal to Kina32m. There arealso some doubts about whether the government will be able to achieve itsforecast deficit of 1.2% of GDP. This is based on an assumption that theeconomy will grow by 6.7% in real terms during 1998, and that mining com-panies will be prepared to bear the extra tax burden demanded of them in thebudget. If this rate of economic growth is not achieved, as we believe will be thecase, or if the government becomes concerned that the high taxes miningcompanies are supposed to pay (see below) will deter foreign investment inPNG, revenue growth will be slower than estimated by the government and thedomestic financing requirement will be greater. Such recourse to domesticfinancing will add liquidity in the banking sector, and may act as a furtherstimulus to inflation.

Debt service eats intobudget expenditure

The budget has anyway come in for some criticism. The government had verylittle room for manoeuvre: the fall in the kina has contributed to an increase inthe cost of servicing the public debt to over K702m ($360m), accounting for25.6% of the total budget. However, in the budget the government againdelayed the long-promised implementation of value-added tax (VAT), makingthe government’s revenue forecasts look even more optimistic. Furthermore,the government has hit the minerals sector hard to try to cover any revenueshortfall. Past attempts to ban “fly-in-fly-out” through legislation have at-tracted much criticism, with some operators warning that such prohibitionwould threaten the very viability of some mines. The imposition of the very

70

80

90

100

110

1990 91 92 93 94 95 96 97 98(b)99(b)

Kina real exchange rate (c)1990=100

Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$Kina:$

Kina:¥

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Kina:DMKina:DMKina:DM

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Kina:¥

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Kina:DMKina:DMKina:DM

98(b) 99(b)

Kina:$

Kina:¥

Kina:$

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Kina:$

Kina:¥

Kina:$

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Kina:$

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Kina:$

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Kina:$

Kina:¥

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Kina:¥

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98(b) 99(b)98(b) 99(b)98(b) 99(b)98(b) 99(b)

-8

-6

-4

-2

0

2

4

6

8

1995 96 97(a) 98(b) 99(b)

Papua New Guinea

Asia excl Japan

Gross domestic product % change, year on year

(a) EIU estimates. (b) EIU forecasts. (c) Nominal exchange ratesadjusted for changes in relative consumer prices.Sources: EIU; IMF, International Financial Statistics.

10 Papua New Guinea


heavy tax burden on “fly-in-fly-out” (see Economic policy and the economy)activities is therefore unlikely to increase the international attractiveness ofPNG’s minerals sector, although the economy will be heavily dependent onthis sector for growth during 1998.

Review

The political scene

There are yet morecabinet changes

Apparently not content with the extensive cabinet reshuffle implemented inmid-December (4th quarter 1997, page 11), the prime minister, Bill Skate, hasrecently made further changes to his government. Sir Mekere Morauta, a for-mer governor of the Bank of Papua New Guinea (BPNG, the central bank), wasmoved in April from the planning and implementation ministry to fisheries.His appointment attracted some criticism, as Sir Mekere owns a successfulprawn export business. It was later announced that the Ombudsman Commis-sion would look into any conflict of interest that may arise. Mr Skate defendedthe appointment, saying that he had considered the possibility of a conflict ofinterest arising before making the final decision.

On April 21st yet more changes were made to the cabinet line-up. FollowingMr Skate’s assumption of the defence portfolio in December, responsibility formilitary affairs was shifted again, with Peter Waieng becoming the new min-ister. Mr Waieng was replaced as public services minister by Ian Ling-Stuckey.Simeon Wai was also removed as communications minister, and the post sub-sumed under the prime minister’s department. In addition Mr Skate an-nounced the creation of a new Public Enterprise Department, to be headed bythe current forestry minister, Dr Fabian Pok.

There have also beenchanges in the public

service—

Changes in the public service have also continued. The most significant wasthe apparent sacking in mid-April of the BPNG governor, Koiari Tarata.Mr Skate denied that Mr Tarata was sacked, although no official explanationhas been offered for his removal. Mr Tarata was replaced by John Vulupindi, aformer finance secretary and more recently the secretary for the Ministry ofPlanning and Implementation. Although Mr Tarata may be retained as anadviser, the change is unlikely to bolster confidence in PNG’s battered cur-rency. Mr Tarata had been reappointed central bank governor for another termonly in September last year. At the time Mr Skate had said the move was in theinterests of continuity and stability.

The mining department secretary, Robin Moaina, was also replaced, by a for-mer diplomat, Kiatro Abisinito. Mr Abisinito has been on the political staff ofthe current mining minister, Philemon Embel. A new secretary for lands andphysical planning, Morris Alauku, was also appointed, taking over from JohnPainap. These changes reinforce the impression that Mr Skate is not afraid tomake wholesale changes in the public service: in January the governmentnamed 17 new heads of department and offices (1st quarter 1998, page 11).

Papua New Guinea 11


—and institutionaladjustments

Apart from the creation of a new Public Enterprise Department to oversee aprivatisation programme, the government also announced that the Constit-utional Development Commission would be abolished, and its budget takenup by the Law Reform Commission. In March the government proposed thecreation of a new post of chief secretary to the government, to replace thecurrent position of secretary of the Prime Minister’s Department and NationalExecutive Council. The new official’s remit would be to ensure that the publicservice and public bodies perform effectively and are accountable to parlia-ment. The opposition, calling the new post a “super secretary”, criticised theplan as another part of Mr Skate’s efforts to become a “dictator”.

A new political party isborn—

On April 17th Mr Skate announced the formation of a new political party—Papua New Guinea First (PNGF). The party consists of Mr Skate’s previousparty, the People’s National Congress (PNC), the Christian Country Party andseveral one- or two-member parties. Mr Skate said that PNGF was the largestparty in parliament. This seems credible; earlier reports indicated that the PNChad 35 MPs, while its coalition partners in the government, the People’s Pro-gress Party (PPP) and the People’s Democratic Movement (PDM), had 14 and 19members in parliament respectively. Such numbers would give the govern-ment a total of 68 MPs in parliament, leaving the opposition with 41. However,over time this distribution will almost certainly change as MPs switch alle-giance between parties. This number, as Mr Skate was to find out (see below),would also not be sufficient for the government to pass constitutional bills,which require a majority of between 66% and 75% of members.

—but internal dissentcontinues within one of

the older parties

In mid-March the parliamentary caucus of the PPP sacked three of its members,including a former party leader, Andrew Baing. The three MPs had apparentlycalled for the new party leader—the deputy prime minister, Michael Nali—toresign, and subsequently left the government benches to sit with the oppos-ition. However, at the end of the month a meeting of some of the party’snon-parliamentary national executive members overturned the decision of theparliamentary caucus, saying that only the national executive has the power todiscipline and expel members. The PPP national co-ordinator, John Tangila,responded that only the parliamentary caucus could determine the affairs of theparliamentary wing.

Mr Skate proposes acommission to control

corruption—

The government’s strength was tested in March when, following up on earlierpromises, the prime minister introduced two bills into parliament to establishan Independent Commission Against Corruption (ICAC). It seems that such acommission would have a busy time in PNG—earlier in March the primeminister himself said that he had been offered three bribes during the previoussix months, the largest being for Kina40m ($27.8m; Mr Skate was quick to addthat he had not accepted any of them). However, maybe because of the preva-lence of such practices in PNG, the bills face an uphill battle to be approved. Itseems that lack of support resulted in the bills being referred to a parliamentaryselect committee, rather then being voted on. The bills may return to parlia-ment in June.

12 Papua New Guinea


—and a constitutionalchange to increase

political stability—

Mr Skate also attempted to make more controversial changes to the constit-ution through a Government Caucus Committee Bill. The bill proposed thatthe prime minister should be chosen by a caucus of six government members,rather than by parliament directly. The caucus could vote to change the primeminister, but not the government, ensuring, according to the prime minister, agreater degree of political stability (votes of no confidence have been extremelycommon in PNG in the past, meaning that no prime minister since inde-pendence has survived the full five-year parliamentary term). The caucus couldbe removed by parliament, and a majority of three-quarters of MPs could voteto dismiss the prime minister. However, in either of these cases, parliamentwould be dissolved and a new election called.

—which is also withdrawn It was later reported that Mr Skate had withdrawn the bill, presumably becausehe could not muster sufficient support for it to be passed. The opposition ac-cused the prime minister of trying to create a dictatorship through his proposedreforms. There was also concern that it is easier for the prime minister to exertinfluence over six people than over the whole of parliament, meaning thecaucus would be unlikely to change the prime minister. However, a furtherreason for the dissatisfaction of MPs was that they would not be able to engineera change of prime minister without forcing a general election. Elections in thepast have resulted in a high turnover of MPs, with around 50% of incumbentsusually failing to gain re-election at each turn of the electoral cycle. MPs there-fore try to avoid going to the country, and have preferred to limit participationin changes of government between elections to those already in parliament.

A commission of inquiryinto the tapes affair is

prevented

At the beginning of March the government easily blocked an opposition mo-tion to set up a commission of inquiry into the so-called Sefa tapes affair, by59 votes to 33. The opposition wanted to have an inquiry into video footage,shown in Australia, which showed the prime minister apparently authorisingthe distribution of bribes and describing his involvement in the killing of menwho had threatened his life (4th quarter 1997, page 12; 1st quarter 1998,page 10). Despite the government’s parliamentary victory Mr Skate may still bedamaged by the tapes controversy; the Ombudsman Commission investigationinto this incident is continuing.

A permanent ceasefire issigned on Bougainville—

In Arawa, the provincial capital, a permanent ceasefire for the troubled islandof Bougainville was finally signed on April 30th. The agreement was signed bythe state negotiator, Sir John Kaputin, the Bougainville affairs minister, SamAkoitai, the pro-PNG Bougainville Transitional Government (BTG) premier,Gerard Sinato, the rebel Bougainville Interim Government (BIG) head, JospehKabui, the Bougainville Revolutionary Army (BRA) representative, SamKauona, the resistance leader, Hilary Masiria, and Bougainville MPs JohnMomis, Micheal Laimo and Micheal Ogio. Witnessing the signing were a largegroup of local people and some foreign dignitaries, including the Australianforeign affairs minister, Alexander Downer, his New Zealand counterpart, DonMcKinnon, and Dr Francesc Vendrell, a representative of the UN secretary-general.

Papua New Guinea 13


—which establishes aPeace Process Consultative

Committee

The agreement introduced a “permanent and irrevocable” ceasefire onBougainville. The ceasefire will be monitored by a peace monitoring group(PMG), which will carry on the work of the truce monitoring group (TMG),which has been on Bougainville since November. There will, however, be somechanges, with the bulk of the personnel in the PMG being from Australia,rather than from New Zealand as in the TMG. A Peace Process ConsultativeCommittee (PPCC) will also be established, and it is hoped that the leader of aUN observer mission that is to be invited to Bougainville will also serve aschairman of this body. The responsibilities of the PPCC will include overseeingplans for the decommissioning of weapons, and for the withdrawal of the PNGDefence Force (PNGDF) and the police mobile riot squad from the island.

Bougainville benefitsfrom aid offers—

Just before the signing of the ceasefire, the UN Development Programme(UNDP) pledged Kina4m ($2m) for projects on Bougainville. In addition the EUhas given Kina1m to upgrade roads on the island. Australia, traditionally themost important source of aid for PNG, has promised to spend A$100m(US$63.7m) over the next five years on restoration projects on Bougainville.This money will come from the existing A$300m annual aid programme underthe PNG-Australia Development Co-operation Treaty.

—but the peace processmay be endangered by

Francis Ona—

The one major absentee from the peace process has been Francis Ona, the“ideological leader” of the rebel movement. Since the current efforts to resolvethe conflict on Bougainville began in July last year Mr Ona has appearedequivocal on the issue, with some reports talking of his support for the peaceprocess, and others pointing towards his scepticism. The most recent indic-ations are that Mr Ona actually represents a threat to the process. He did notattend the ceasefire signing ceremony, and soon afterwards appeared to issuean order proclaiming parts of Bougainville to be “no-go zones” for the peacemonitors, and that if members of the PMG attempted to enter these areas, a“shoot-to-kill” policy would be applied. The PNG prime minister tried to playdown the threat, apparently calling Mr Ona a man of integrity, and evenclaiming that the controversial orders were not actually issued by Mr Ona, butinstead by “a lady in Australia”.

—and a split in the rebelranks

However, it seems that there are BIG and BRA members willing to believe thatthese orders were indeed issued by Mr Ona. In response to reports of the “shoot-to-kill” policy, Mr Kabui issued a statement saying: “Francis Ona has left us nochoice but to move a vote of no confidence and remove him from his symbolicoffice of president [of the BIG]”. There were also reports that rebels loyal toMr Kabui and Mr Kauona, the two most important independence leaders in-volved in the ceasefire process, were “up in arms” following Mr Ona’s statement,but that Mr Ona and his supporters remained in a strong position around thePanguna township. Despite these indications it is difficult to confirm that realdivisions have developed in the rebel ranks, although, it is also not clear thatbloodshed has yet left Bougainville for good.

The second Sandlineinquiry is completed

The second inquiry into the attempt of the previous government of Sir JuliusChan to hire mercenaries from Sandline International to settle the Bougainvilleconflict by force ended in March. However, although the commission, chaired

14 Papua New Guinea


by Justice Kubulan Los, was supposed to submit its report to the prime ministerby the middle of April, it had still not done so by the end of the month. Thereason given for the delay was that the commissioners were still seeing to someoutstanding matters, although no further details were forthcoming.

Australia will continue toreform aid conditions

At a meeting in March to discuss the replacement of the PNG-Australia aidtreaty, which expires in June 2000, Mr Downer told the PNG government thatthe move from direct budgetary support to specific programme aid will con-tinue, and is expected to be completed within two years. The foreign ministersaid that specific project aid ensured the level of accountability required byAustralian taxpayers.

Economic policy and the economy

The economy contractedby over 6% in 1997—

The economy is now thought to have experienced a serious contraction during1997: the Ministry of Finance estimates that GDP fell by 6.5%. The centralbank estimates the fall to have been only 6.2% and blames the contraction onCyclone Justin in March, the severe drought and frosts of the second half of1997, weak world prices for copper and gold and a fall in demand for logexports because of the economic upheavals in South-east Asia.

—mainly because of themining and petroleum

sectors

The all-important mining sector, which accounted for 60.3% of merchandiseexports in 1997, was hit hard by the drought. Output from PNG’s two largestmines, Ok Tedi and Porgera, was halted for prolonged periods by inadequatewater levels. The sector was also hit by lower levels of production at Kubutu,PNG’s main oilfield, as available reserves continue to decline. The contractionof this sector more than wiped out the weak growth of the non-mining andpetroleum private sector, which expanded by just 0.6% in real terms. Thebuilding and construction sectors also slowed, as a number of major construc-tion projects were completed, such as the new Jackson’s airport terminal at PortMoresby and the Poreporena/Waigani Drive roads. PNG’s small manufacturingsector was also hit. The central bank attributed this to the knock-on effects ofdeclines in other sectors. The power cuts experienced in Port Moresby fromSeptember last year must also have affected activity in this sector.

A belt-tightening budgetis announced

On March 11th the treasury and corporate affairs minister, Iairo Lasaro,handed down a Kina2.7bn ($1.3bn) budget, which was drawn up in consult-ation with the World Bank and the IMF. Mr Lasaro said that the tight financialcircumstances—created by the prolonged drought during 1997 and early 1998,the sharp fall in the value of the currency since October last year and theimpact of the regional economic slowdown—would require all Papua NewGuineans to tighten their belts. Mr Lasaro said that the government wouldrecord a budget deficit of Kina88.6m in 1998, equivalent to 1.2% of GDP,compared with a small surplus of Kina14.1m in 1997, equal to 0.2% of GDP(the effects of the drought clearly had an adverse affect on the government’sfinances towards the end of last year, as for the nine months to the end ofSeptember, there was a surplus of Kina166m).

Papua New Guinea 15


Debt-service payments areexpected to rocket

According to the budget figures released in the Department of Finance’s MonthlyEconomic Bulletin, total government recurrent expenditure and lending is ex-pected to increase by 18.1% in 1998, from Kina1.8bn ($1.3bn) in 1997 toKina2bn. However, all of this increase is expected to be caused by a rise in debt-service payments. Interest payments on domestic and external debt are expectedto rise by 57% between 1997 and 1998, from Kina297.6m to Kina466.3m.

The government willattempt to restrict

recurrent expenditure—

Other areas of expenditure will therefore be squeezed; the budget for nationaldepartments will fall from Kina820m in 1997 to Kina771m (although the pro-vincial governments’ budget will be increased by 13.1%, from Kina357.2m toKina404m). Central expenditure on goods and services will be cut, but so willsalaries and wages. This will partly occur through a wage freeze, which will becontinued from 1997. There will also be efforts to reduce the overall size of thepublic sector, with attempts being made to improve efficiency and productivity.Mr Lasaro claimed that these reforms would reduce the total wage bill for publicservants by Kina20m. However, this substantial saving is not reflected in thebreakdown of expenditure in the budget, which indicates that central govern-ment expenditure on salaries and wages will fall by only Kina9.6m, while ex-penditure on workers at the provincial level will increase by Kina11m.

—but boost developmentexpenditure

Announcing the budget, Mr Lasaro also said that development expenditurewould rise by 44.1% in 1998, from Kina372m to Kina536m. Of this, Kina179mwould be spent on infrastructure development and Kina148m on the socialsector, which includes education. However, it seems that this increase is largelycosmetic rather than real. Funds available for investment were boosted by thetransfer of road maintenance from the recurrent to the development budget. Afurther concern is that PNG is financing only a small proportion of develop-ment expenditure itself; Sir Mekere Morauta, then planning and implement-ation minister, said on March 17th that the government was financing only20% of the total development budget, with most of the remainder being fi-nanced by Australian aid.

Total revenue is expectedto rise—

Mr Lasaro said that total revenue would increase by 9.5% in 1998, fromKina2.2bn to Kina2.4bn. However, almost all of this increased revenue isbudgeted to come from an increase of Kina156m in project grants. Non-taxrevenue is also expected to increase, because of a projected Kina75m fromprivatisation. This will come from the transfer of the outstanding Kina13.5mgenerated from the initial public offering of Orogen Minerals, representing thegovernment’s shares in major mining and petroleum projects in PNG, andKina61.5m from the sale to Orogen of the government’s remaining 5% interestin the Porgera mine.

—but the mining industryis hit particularly hard

Compared with last year’s budget outturn, tax revenue is expected to decline by0.4%, from Kina1.68bn to Kina1.67bn. This is despite the robust 6.7% rate ofeconomic growth that the government expects in 1998, and increases in taxeson the mining sector. The PNG Chamber of Mines and Petroleum estimatedthat the changes would increase the tax burden on the sector by Kina66.6m, andargued that its international competitiveness would be affected as a result. Theire of the industry was aimed in particular at the proposed 50% tax to be levied

16 Papua New Guinea


on the “fly-in fly-out” practice. This is where workers fly into PNG and workevery day for a certain period (generally two weeks) before returning to theirhome country. Although this practice is unpopular with MP’s (4th quarter 1997,page 21; 1st quarter 1998, page 21) lobbying by the mining sector may wellcause the government to back-track on this measure.

Central government budgeta

(Kina m)

1996 1997 1998 Outturn Budget Outturn Budget % changeb

Total revenue & grants 1,897.7 2,057.2 2,202.9 2,411.3 9.5 Tax revenue 1,526.3 1,556.0 1,678.8 1,672.8 –0.4 Personal income tax 317.3 328.6 370.4 399.0 7.7 Company tax 118.0 134.0 150.2 156.0 3.9 Other direct taxes 476.3 410.3 469.7 391.5 –16.6 Indirect tax 614.7 683.1 688.5 726.3 5.5 Import duties 341.2 357.0 372.2 441.4 18.6 Export duties 157.2 164.0 149.4 95.0 –36.4 Excise 114.9 161.6 148.6 167.0 12.4 Other indirect 1.4 0.5 18.3 22.9 25.1 Non-tax revenue 201.3 200.7 211.5 289.0 36.6 Grants 170.1 300.5 312.6 449.5 43.8

Expenditure 1,860.8 2,176.3b 2,188.5 2,499.9 14.2 Total recurrent expenditure & lending 1,417.9 1,755.1c 1,816.6 1,964.2 8.1 National Departments 720.1 742.9 820.4 770.6d –6.1 Salaries & wages 345.9 356.8 368.8 359.2 –2.6 Goods & other services 374.2 386.1 451.6 386.1 –14.5 Provincial governments 334.9 327.8 357.2 404.3 13.2 Salaries & wages 258.3 250.2 284.8 295.8 3.9 Goods & other services 76.6 77.6 72.4 108.5 49.9 Conditional grants n/a 240.5 223.9 210.5 –6.0 Transfers & loans to statutory institutions 112.2 120.3 120.6 117.5 –2.6 Interest payments & fees 257.1 328.6 297.6 466.3 56.7 Domestic 174.5 246.6 206.3 342.8 66.2 External 82.6 82.0 91.3 123.5 35.3 Net lending –6.4 –5.0 –3.1 –5.0 61.3 Development budget 442.9 421.2 371.9 535.8 44.1 National projects 252.8 421.2 371.9 535.8 44.1 National departments 226.0 345.6 283.8 422.7 48.9 Provinces 0 45.7 54.1 57.1 5.5 Statutory institutions 26.8 29.9 34.0 56.0 64.7 Provincial conditional grants 190.1 n/a n/a n/a –

Overall balance 36.9 –119.1c 14.4 –88.6 –

Financing (– indicates deficit)External financing 10.1 71.0 –73.3 103.4 – Domestic financing –47.0 48.1b 58.9 –14.8 –

a Presented in a slightly different format to our previous reports as the BPNG’s Quarterly Economic Bulletin has yet to release 1998 budgetstatistics. b 1998 budget/1997 outturn. c Figures differ from those in source, but have been reconciled with central bank data. d Does not sumin source.

Source: Department of Finance, Monthly Economic Monitor.

Air Niugini reducesoperations

From May 31st Air Niugini, the national carrier, will temporarily suspend flightsto Sydney and Hong Kong, and cut one of its two weekly flights to Manila. Thisfollows the earlier suspension of flights to Japan, and the decision to sell one ofthe company’s two Airbus A310 aircraft. The acting managing director, Chris

Papua New Guinea 17


Mek, said that these moves, and other cutbacks, including the closure of someof the airline’s international offices, were made as a “commercial decision”. AirNiugini also increased its international fares by 11% to offset the effects of thesharp depreciation of the kina. It seems that the airline has been badly affectedby the Asian financial crises, as well as the contraction of the domestic economyduring 1997. The local press reported in April that Air Nuigini had accumulateddebts of Kina135m ($66.5m), and was only saved from insolvency in March bythe Papua New Guinea Banking Corporation (PNGBC) extending Kina15m tothe company.

Inflation

1996 1997 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

QuarterlyIndex 350.8 354.2 358.8 364.9 369.5 % change, year on year 5.3 2.8 3.7 3.8 5.3

1993 1994 1995 1996 1997

AnnualIndex: 1977=100 258.5 265.9 311.9 348.1 361.9 % change, year on year 5.0 2.9 17.3 11.6 4.0Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Inflation is on the rise— In 1997, for the first time in three years, the average annual rate of inflation asmeasured by the urban-based consumer price index (CPI), was in single figures,at 4%. The lower rate was the result of the relatively stable exchange rate for thefirst three quarters of 1997, greater fiscal restraint by the government and thelack of substantial economic activity. However, towards the end of the year,there were signs that the rate of inflation was increasing. In the fourth quarterinflation was 5.3% year on year, compared with 3.8% in the third quarter. TheCPI in the last quarter of 1997 was also 1.3% higher than the previous quarter.An increase in inflation is to be expected; the kina has fallen by 30.9% sinceOctober, greatly adding to the costs of imported goods, and as the economybegins to recover from the effects of the drought, economic activity can beexpected to pick up.

—and may present thegovernment with a

difficult choice—

This expected rise in inflation confronts the government with a difficultchoice. Although the PNG authorities have some influence on the CPI throughvarious types of price control, a decision to limit price increases in order toprovide financial stability and protect consumers may result in an increase inunemployment. In April the International Food Corporation (IFC) halted prod-uction at its fish cannery at Lae, apparently because the government hadrefused to allow the company to increase its prices. This was despite the rapidincreases in production costs at the factory, driven by the declining value ofthe kina, and the additional tax burden the company had to bear followingchanges unveiled in the November 1997 Supply Bill. The future of the factoryis unclear: the company has kept 50 staff on to maintain the facilities.

0

4

8

12

16

20

1993 94 95 96 97

Consumer prices% change, year on year

Source: Bank of Papua New Guinea, Quarterly EconomicBulletin.

18 Papua New Guinea


Employment classified by industry(Jun 1989=100)

3 Qtr % 1993 1994 1995 1996 1996 1997 changea

Retail 83.9 88.4 92.6 94.8 95.8 102.6 7.1

Wholesale 83.9 90.6 82.3 82.1 83.3 82.1 –1.4

Manufacturing 103.7 120.1 110.2 114.7 116.7 122.2 4.7

Building & construction 73.6 77.8 69.6 90.5 87.7 89.1 1.6

Transport 90.7 95.2 89.6 96.6 94.8 98.6 4.0

Agriculture, forestry & fisheries 95.1 101.1 87.4 91.3 88.2 82.0 –7.0

Financial & business 104.3 102.3 111.0 116.1 116.9 125.6 7.4

Total excl mining 91.4 98.1 93.5 100.5 99.3 98.9 –0.4

Mining 106.4 104.9 112.2 116.2 119.9 115.6 –3.6

a 3rd quarter 1997/3rd quarter 1996.

Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

—as employment is falling According to the central bank’s latest formal survey, employment was 4.3%lower in the third quarter of 1997 relative to the previous quarter. However,despite the sharp contraction in the economy, employment fell by only 0.4%year on year. The central bank attributed the quarter-on-quarter decline to acontraction in the agriculture, forestry and fisheries sector, which was causedby the early ending of the coffee harvest in the highlands, the severe droughtand frosts and slack world demand for logs (the Forest Industries Associationreported back in September that six logging operators had already decided tosuspend logging activities).

Loose monetary policy in1997 increases domestic

credit—

During 1997 the level of domestic credit outstanding increased by 22.7%,compared with an increase of 6.5% in 1996, and just 1.5% the year before. Thiswas driven by the low interest rates for most of the year. Although lending tothe government continued to increase rapidly, by 22.7%, so did lending to theprivate sector, which increased by 36.3%, ending a period of stagnation inprivate-sector credit that had existed at least since 1993.

The source of credit for the government also changed. In the past the govern-ment has sold large quantities of Treasury bills to the commercial banks. How-ever, most of the new lending to the government came from the central bank,which increased net credit to the government by Kina156.1m during 1997.Commercial banks’ holdings of short-term government securities actually fellby 6.8% between December 1996 and December 1997 (although the commer-cial banks did loan Kina74.7m to the government in December 1997 by refi-nancing a non-bank financial institution loan to the government). Commercialbanks’ outstanding kina-denominated lending to the private sector and officialentities increased, however, by an annualised rate of 23.7% in December 1997.This reflects a change from previous trends; the annualised growth rates inJune 1997 were 24.6% for holdings of government securities, and 8.6% forkina-denominated lending to the private sector and official entities.

Papua New Guinea 19


Money supply(end period; Kina m)

% change1993 1994 1995 1996 1997 1997/96

Domestic credit 1,634.8 1,750.7 1,776.5 1,891.3 2,320.4 22.7Non-central government 1,128.5 1,262.6 1,201.9 1,206.5 1,480.2 22.7 Private sector 808.9 855.2 846.8 780.4 1,063.9 36.3 Official entities 300.9 380.6 330.8 316.9 299.0 –5.6 Non-monetary financial institutions 18.7 26.8 24.3 109.1 117.2 7.4

Central government 506.3 488.1 574.6 684.9 840.1 22.7 MRSFa –120.9 –190.4 –302.0 –531.4 –696.4 31.1 Other 627.2 678.5 876.6 1,216.3 1,536.5 26.3

Net foreign assets 177.7 109.4 291.5 845.5 748.4 –11.5

Total money supply (M3) 1,812.5 1,860.1 2,068.0 2,736.8 3,068.8 12.1

a Mineral Resources Stabilisation Fund.


Commercial banks’ liquid asset holdings(Kina m unless otherwise indicated; end-period)

% change1993 1994 1995 1996 1997 1997/96

Notes and coins 28.2 43.2 42.5 45.6 50.9 11.6

Deposits with central bank 8.7 10.2 27.4 79.1 26.2 –66.9

Government securitiesTreasury bills 350.0 355.8 659.5 1,025.6 941.8 –8.2Short-term stocks 34.9 51.9 55.7 74.0 82.8 11.9

Total liquid assets 421.8 461.1 785.1 1,224.3 1,101.7 –10.0

Liquid asset ratio (%) 28.9 31.7 43.9 54.8 43.6 –20.4

Liquid asset requirement (%) 11.0 26.0 32.0 27.0 20.0 –25.9Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

—and the money supplyincreased rapidly—

The loose monetary policy also led to a rapid increase in money supply. Theaverage level of M3 rose by 21.2% in 1997 compared with 20% in 1996.The size of the broad monetary base, defined by the central bank as currencyheld by the public and the liquid assets of commercial banks, including depos-its held with the central bank under the Kina Auction facility, also increased,by 15.7% during 1997, compared with the dramatic 53.5% rise in 1996.

—but monetary policy hasnow tightened

In October 1997, following the sharp depreciation of the currency that threat-ened an increase in inflation, the BPNG began to tighten monetary policy. Thisled to an increase in interest rates, with the Kina Auction rate rising from 9% inSeptember 1997 to 11.8% in February 1998, and the Treasury-bill rate risingfrom 8.8% to 15.3%. As a result commercial banks’ interest rates also rose: theweighted average interest rate on deposits rose from 3.9% in July 1997 to 5.1%at the end of the year. When outlining its monetary policy for 1998, the BPNGstated that the monetary policy would be tightened more if “inflationary pres-sures accentuate further”: as the currency has continued to fall since this state-ment was made, and indeed shows no sign of stabilising, interest rates are likelyto continue to rise.

20 Papua New Guinea


Commercial bank interest rates(%; end-period)

% change1993 1994 1995 1996 1997 1997/96

Weighted average deposit rate 3.7 4.5 9.4 4.0 5.1 27.5

Weighted average loan advance rate 9.2 10.0 15.4 10.2 10.7 4.9 Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Agriculture and forestry

Export volumes decline in1997—

During the whole of 1997 the export volumes of all agricultural commodities,except palm oil and rubber, declined compared with 1996. Several factors wereresponsible for this fall, including Cyclone Justin in March of last year, and thegeneral election in June 1997, which disrupted the harvesting of some majoragricultural commodities. The most damaging event of all, however, was thesevere drought and frosts that afflicted PNG from around the middle of lastyear. The effects of the drought were clearest in the tea industry, where exportvolumes fell by over 30% in 1997, from 9,300 tonnes in 1996 to 6,500 tonnes.Although the worst of the weather has now passed, the drought will continueto affect the output of the agricultural sector in 1998, as the dry conditions willhave damaged agricultural capacity in the countryside. The BPNG is forecastingthat the agriculture, forestry and fisheries sector will suffer a decline in realterms of 7.6% in 1998, compared with a contraction of 3.5% in 1997.

—but export prices rise— Export price movements were, however, kinder to the agricultural sector,helped in large part by the sharp depreciation of the kina. The export prices ofall agricultural commodities except logs increased in 1997 compared with1996; according to the central bank, the weighted average price of non-mineralexports increased by 33% in 1997. The 80.4% increase in the price of coffee wasparticularly dramatic, and was attributed by the central bank to higher worldprices as well as the fall in the currency. Coffee prices therefore remained abovethe minimum level guaranteed by the government, as did cocoa and palm oilprices. This resulted in the Coffee Industry Corporation repaying the govern-ment Kina8.3m and the Copra Marketing Board repaying Kina800,00 ($5.8m).

—and the value ofagricultural exports

increases

The rise in export prices, particularly for PNG’s two most important agricul-tural commodity exports, coffee and palm oil, more than offset the weak vol-ume performance. Overall the value of agricultural exports increased by 33.1%in 1997 compared with 1996, from Kina579m to Kina770m. The value of coffeeexports increased by 70.3%, to reach Kina324m, or 42.1% of total agriculturalcommodity exports. Palm oil export earnings increased by 13.5%, and in 1997accounted for 26.9% of the total value of agricultural exports. The value ofcocoa and rubber exports also increased between 1996 and 1997.

Papua New Guinea 21


Export prices(Kina/tonne unless otherwise indicated; fob)

% change1994 1995 1996 1997 1997/96

Cocoa 1,115 1,559 1,615 1,880 16.4

Coffee (all grades) 3,165 3,893 3,055 5,510 80.4

Tea 1,235 1,286 1,366 1,600 17.1

Copra 292 427 494 523 5.9

Copra oil 579 897 1,036 1,051 1.4

Palm oil 336 762 683 753 10.2

Rubber 853 1,481 1,464 1,477 0.9

Logs (kina/cu metre) 164 174 178 172 –3.4 Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Agricultural exports

% change1993 1994 1995 1996 1997 1997/96

By volume (’000 tonnes unless otherwise indicated)Cocoa 37.8 26.0 30.6 41.0 36.7 –10.5 Coffee 62.8 64.7 55.1 62.3 58.8 –5.6 Tea 6.4 3.4 4.2 9.3 6.5 –30.1 Copra 59.0 50.3 64.2 99.2 90.3 –9.0 Copra oil 45.5 34.7 33.1 49.6 48.6 –2.0 Palm oil 245.7 230.8 186.6 267.0 274.9 3.0 Rubber 3.6 3.4 2.7 2.8 4.4 57.1 Logs (’000 cu metres) 2,374.9 2,943.9 2,512.5 2,607.4 2,375.9 –8.9

By value (Kina m)Cocoa 33.1 29.0 47.7 66.2 69.0 4.2 Coffee 100.5 204.8 214.5 190.3 324.0 70.3 Tea 7.2 4.2 5.4 12.7 10.4 –18.1 Copra 14.2 14.7 27.4 49 47.2 –3.7 Copra oil 19.6 20.1 29.7 51.4 51.1 –0.6 Palm oil 79.2 77.5 142.2 182.4 207.1 13.5 Rubber 2.6 2.9 4.0 4.1 6.5 58.5 Total incl others 270.1 374.6 502.4 578.6 770.3 33.1

Logs 400.2 483.1 436.7 464.8 409.3 –11.9 Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The logging industry hada particularly bad year—

1997 was a particularly bad year for PNG’s logging industry, which has signif-icance for PNG’s overall economy as log exports accounted for 14% of totalexport earnings in 1996. A reduction in demand from Asia caused by the re-gional economic slowdown, coupled with the expiry of some logging licences,led to an 8.9% decline in the volume of log exports, from 2,607cu metres in1996 to just 2,376 cu metres in 1997. This was exacerbated by weak world pricesfor logs, again largely caused by the Asian financial crises. According to thecentral bank, log prices fell by 3.4% in kina terms during 1997. Altogether, thevalue of log exports fell by 11.9%, from Kina465m to Kina409m.

0.0

0.5

1.0

1.5

2.0

2.5

1993 94 95 96 97

Agricultural Logs

Minerals Others

ExportsKina bn

Source: Bank of Papua New Guinea, Quarterly EconomicBulletin.

22 Papua New Guinea


—but the governmentrefuses to offer help

This situation had caused the logging industry to call for tax breaks (1st quarter1998, page 21), and according to the treasury and corporate affairs minister,Iairo Lasaro, the government has been under considerable lobbying pressurefrom the industry. However, Mr Lasaro made it clear during his budget speechthat the government would not be bullied into cutting taxes. The minister saidthat if the government could not receive a reasonable return in the form of taxrevenue from logging, then the trees should stay where they are.

Energy and mining

Mineral export volumesdecline in 1997—

The export volumes of crude oil, copper and gold all declined in 1997 com-pared with 1996. Crude oil exports declined by nearly 30% in volume, from39.3m barrels in 1996 to 28m barrels in 1997, because of a continuing fall inreserves at the Kutubu, the main oilfield in PNG. Copper and gold exports fellvictim to the low water levels caused by the drought, which affected outputfrom PNG’s two largest mines, Porgera and Ok Tedi. The volume of copperexports fell by 39.1%, from 127,700 tonnes to 77,800 tonnes, and gold exportsfell by 5.5%, from 46.9 tonnes to 44.3 tonnes.

Mineral exports

% change1993 1994 1995 1996 1997 1997/96

Crude oil (’000 barrels) 45,842.6 43,456.3 36,990.2 39,307.7 27,972.2 –28.8

Copper (’000 tonnes) 192.2 207.2 215.7 127.7 77.8 –39.1

Gold (tonnes) 59.3 55.8 55.2 46.9 44.3 –5.5 Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

—although production atGobe has begun—

The first oil from the Gobe oil project has finally begun to flow. The project,which consists of two fields, Gobe main and South-east Gobe, is expected toproduce 50,000 barrels/day of oil by the middle of this year. Production fromone of the wells in the Gobe main field began on March 9th. However, somecontroversy still surrounds the project. Export of oil from Gobe, which was dueto begin at the end of March, was initially prevented by disgruntled landowners,who had been demanding the construction of a road in the area for some time.Exports from the Gobe main field were finally allowed to proceed after thepetroleum and energy minister, Masket Iangalio, gave a written commitment tobuild the Samberigi-Kerema road. However, the landowners were holding outfor further concessions before allowing exports from the South-east Gobe oil-field to begin. It seems as though such concessions were finally won when, onApril 18th, the government signed an agreement with the landowners, whichwould provide them with Kina100m ($49m) in cash and Kina150m in infra-structure and other benefits during the 15-year life of the oilfield.

—and the Mount Karegold project may finally

proceed

In April the government registered the Kare-Puga Development Corporation asthe representative company of landowners in the vicinity of the Mount Karegold project, and as the joint-venture partner in the continuing exploration ofthe area. The mining minister, Philemon Embel, called on the rival land-owners’ company, Mount Kare Gold Resources (MKGR), to co-operate with thegovernment’s decision, complaining that divisions among the landowners had

Papua New Guinea 23


delayed the exploration and development of the site. However, the issue hasnot yet been settled; MKGR has taken out an injunction to prevent the min-ister’s decision being implemented. This is despite the considerable potentialthat the site offers. The chairman of Carpenter Pacific Resources, one of thejoint-venture partners developing the mine, was reported in the local news-paper, The National, as saying that Mount Kare might have a potential similarto that of the Porgera project, one of PNG’s largest mines.

Oil Search buys more oiland gas assets in PNG

At the end of April Oil Search spent Kina800m buying all of British Petroleum(BP) Exploration’s upstream oil and gas assets in PNG. This acquisition willmake Oil Search an even more significant player in PNG’s minerals sector; itwill own a 27% interest in the Kutubu oil project, a 52.5% in Hides and Angore,an important interest in Moran Central, and a 24% stake in the new Gobe mainand South-east Gobe oil projects.

Foreign trade and payments

The value of merchandiseexports falls—

The sharp fall in the value of the kina and weak international commodityprices resulted in the value of merchandise exports falling by 7.9% in kinaterms in 1997 compared with 1996. This was despite the 33.1% increase in thevalue of agricultural exports, driven by the impressive performance of thecoffee and palm oil industries. The reason for the overall decline was the slumpin the export values of PNG’s four most important export categories—logs,gold, copper and crude oil. Together these four commodities accounted for73.4% of PNG’s total merchandise exports in 1997. Earnings from mineralexports fell below Kina2bn ($695m) for the first time since 1994. The fall in thevalue of copper and crude oil exports was particularly dramatic. Copper earn-ings fell because of the 39.1% fall in copper export volumes following theintermittent closure of the Ok Tedi mine. The decline in crude oil export valueswas also because of the decline in volumes, rather than prices.

—and together with a risein imports squeezes the

trade surplus

The kina value of imports (fob) increased by 5.6%, from Kina2bn ($1.5bn) in1996 to Kina2.1bn. Although mining sector imports fell by 24.2%, fromKina448.9m to Kina340.4m, mainly owing to the completion of the construc-tion of the Lihir gold mine, imports by the petroleum sector, and generalimports, both increased. The increase in imports associated with the oil ind-ustry, at 220.3%, from Kina34m to Kina108.9m, was related to development ofthe Gobe oil project. The 9.6% increase in the value of general imports, fromKina1.51bn to Kina1.66bn, was driven largely by the sharp weakening of thekina, which drove up the prices of imported goods.

The fall in exports earnings and rise in import costs squeezed the trade balance,which fell by 28%, from Kina1.34bn to Kina965m. This is the first time since1992 that the trade surplus has fallen below Kina1bn.

24 Papua New Guinea


Exports(Kina m)

% change1993 1994 1995 1996 1997 1997/96

Agricultural 270.1 374.6 502.4 578.6 770.3 33.1

Forest products 410.4 494.4 449.7 480.3 432.9 –9.9 of which: logs 400.2 483.1 436.7 464.8 409.3 –11.9

Marine products 7.8 10.3 12.3 10.4 9.5 –8.7

Minerals 1,767.8 1,782.7 2,435.4 2,244.6 1,838.9 –18.1 of which: gold 681.6 702.3 840.1 773.6 718.7 –7.1 copper 256.3 367.4 754.5 387.0 259.8 –32.9 crude oil 817.8 702.7 827.7 1,073.9 852.2 –20.6

Total 2,527.3 2,662.0 3,399.8 3,313.9 3,051.8 –7.9Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Balance of payments(Kina m)

% change1993 1994 1995 1996 1997 1997/96

Merchandise exports 2,547 2,682 3,420 3,334 3,072 –7.9

Merchandise imports –1,110 –1,336 –1,620 –1,996 –2,107 5.6

Trade balance 1,437 1,346 1,800 1,338 965 –27.9

Invisibles: credits 330 262 443 611 615 0.7

Invisibles: debits –1,177 –1,043 –1,477 –1,633 –1,816 11.2

Invisibles balance –847 –781 –1,034 –1,022 –1,201 17.5

Net transfers 42 11 93 95 88 –7.4

Current-account balance 632 576 859 411 –148 –136.0

Official capital flows 65 –107 –25 14 –115 –921.4

Private capital flows –675 –557 –193 –147 131 –189.1

Non-official monetary sector transactions –108 –33 35 –46 –61 32.6

Change in offshore account balances 17 70 –373 237 47 –80.2

Capital-account balance –701 –627 –556 58 2 –96.6

Net errors & omissions –27 25a –59 –37 –8 –78.4

Overall balance –96 –26 244 432 –154 –135.6

International reserves 137.9 112.2 357.4 789.1 634.9 –19.5

a Includes revaluations.


A deficit is recorded onthe current account—

The deficit on the invisibles account increased by 17.5% in 1997 compared with1996, from Kina1.02bn to Kina1.2bn. This deterioration was partly owing to thehigher costs of services associated with the rise in the value of merchandiseimports, such as freight and insurance payments. Invisibles exports also per-formed less impressively towards the end of the year; during the first ninemonths of 1997 invisibles credits were 11.9% higher than in 1996, but for theyear as a whole they were only 0.7% higher. There was also a lower net surpluson the transfers account, reflecting the continuing decline in the value of Aus-tralian grant aid as it switches from direct budgetary support to specific projectsupport, and a rise in transfers abroad for family maintenance and employee

Papua New Guinea 25


compensation payments. The deterioration in all the separate areas led to aworsening in the overall current account, where a deficit of Kina148m wasrecorded in 1997, compared with a surplus of K411m in 1996. This is the firsttime that the current account has been in deficit since 1991.

—pushing the overallbalance into the red

There was also a deterioration in the capital account, with the surplus falling by96.6%, from Kina58m in 1996 to Kina2m in 1997. This was mainly owing to ahigher net official capital outflow as the government increased external debtrepayments. There was also an increase in the net foreign assets of commercialbanks and lower inflows from offshore account balances of mineral companies.These factors more than offset the turnaround in private capital movements,which, because of drawdowns associated with the Lihir and Ok Tedi mines,recorded a net inflow for the first time since 1991. After accounting for errorsand omissions the balance of payments recorded a deficit of Kina154m in 1997,compared with the large Kina432m surplus in 1996. International reserves alsofell significantly, from Kina789m in 1996 to Kina635m by the end of 1997,sufficient for just 3.6 months of import cover. Mr Lasaro was quoted in the localnewspaper, The National, as saying in March that reserves had fallen further, tojust Kina300m, sufficient for just two months of import cover. One reason thegovernment was hoping to secure loans from the World Bank and IMF was toimprove this international reserves position.

Exchange rates(currency units per Kina; end-period)

1993 1994 1995 1996 1997

A$ 1.5077 1.0927 1.0054 0.9324 0.8748

US$ 1.019 0.8485 0.7490 0.7425 0.5710

¥ 113.93 84.71 77.15 86.24 74.18

DM 1.7675 1.3178 1.0773 1.1539 1.0214

Sterling 0.6896 0.5442 0.4840 0.4392 0.3444Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

The kina has depreciatedsharply against major

trading currencies—

The kina has undergone a significant depreciation since October 1997, andthere are no signs that the fall is bottoming out. This weakening has beenagainst both the US dollar, in which most of PNG’s external debt is denomi-nated, and against the Australian dollar; Australia supplies most of PNG’s im-ports. Between October 15th last year and May 1st 1998, the kina had fallen by30.9% against the US dollar, from Kina1.41:$1 to Kina2.04:$1. During the sameperiod PNG’s currency had fallen by 22.6% against the Australian dollar, fromKina1.03:A$1 to Kina1.33:A$1. The depreciation has been brought about by theworsening of PNG’s external trade situation as well as the Asian crises, and ledthe deputy prime minister, Michael Nali, to announce that the governmentwould seek to peg the kina. However, the prime minister later ruled out sucha move.

—pushing up the externaldebt bill

During the first nine months of 1997 it seemed as though the level of PNG’sexternal debt outstanding was stabilising. However, this trend changed in thelast quarter of the year, and at the end of 1997 external public debt outstandingwas 16.7% higher than at the end of 1996. Although the government continuedto pay off commercial creditors, funds owed to international agencies increased

26 Papua New Guinea


by 22.7%. Some of this increased lending would have been owing to the fiscalconsequences of the drought, but the depreciation of the kina would also haveboosted the level of foreign debt.

Public debt outstanding(Kina m)

% change1993 1994 1995 1996 1997 1997/96

Domestic 1,036.6 1,424.3 1,605.7 1,969.5 2,251.7 14.3 Treasury bills 591.8 1,008.1 1,217.5 1,615.3 1,931.6 19.6 Inscribed stock 444.8 416.2 388.2 354.2 320.1 –9.6

External 1,283.3 1,536.9 1,718.4 1,793.9 2,092.7 16.7 International agencies 1,011.0 1,278.6 1,475.8 1,579.2 1,937.8 22.7 Commercial loans 259.8 242.8 227.9 219.6 143.1 –34.8 Other loans 12.5 15.5 14.7 12.5 11.8 –5.6

Total public debt 2,319.9 2,961.2 3,324.1 3,780.8 4,333.4 14.6Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Papua New Guinea 27


Quarterly indicators and trade data

Quarterly indicators of economic activity

1995 1996 1997

3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Exports Qtrly totals

Copra ’000 tonnes 15.8 19.4 15.6 20.2 22.7 40.7 31.7 17.9 18.5 22.2

Copra oil “ 10.9 8.6 12.5 8.3 13.9 14.9 14.7 12.2 14.5 7.2

Cocoa ” 11.1 8.5 10.2 9.9 9.7 11.2 10.1 9.2 7.8 9.6

Coffee “ 27.8 14.2 6.9 19.1 26.0 10.3 5.5 25.8 17.3 10.2

Logs ’000 cu metres 453 555 719 705 623 561 590 703 569 514

Gold tonnes 14.8 13.0 11.4 12.3 11.1 12.1 12.5 10.6 10.3 10.9

Fish ’000 tonnes 1.3 1.1 1.3 0.7 0.6 0.2 0.7 0.8 0.3 0.4

Copper “ 60.0 59.9 20.8 41.2 28.0 37.7 32.8 30.2 14.8 n/a

Petroleum, crude ’000 barrels 8,411 9,146 9,705 9,593 10,424 9,585 8,047 6,545 7,627 5,754

Prices Monthly av

Consumer prices: 1990=100 146.0 151.0 156.0 156.7 159.2 158.9 160.5 162.6 165.3 167.4

change year on year % 23.1 18.7 17.4 15.9 9.0 5.2 2.9 3.8 3.8 5.3

Money End-Qtr

M1, seasonally adj: Kina m 758.8 657.9 699.3 760.3 862.0 1,000.8 1,116.7 1,047.9 1,008.6 n/a

change year on year % 24.8 14.1 16.6 22.5 13.6 52.1 59.7 37.8 17.0 n/a

Foreign tradea Qtrly totals

Exports fob Kina m 927 859 767 880 833 854 822 848 786 616

Imports fob “ 451 482 465 482 496 553 496 558 527 526

Exchange holdings End-Qtr

Foreign exchange US$ m 223.0 260.6 215.1 307.1 439.9 583.8 557.6 547.8 500.2 362.5b

Exchange rate

Official rate Kina:US$ 1.325 1.335 1.316 1.285 1.330 1.347 1.387 1.402 1.437 1.751c

Note. Annual figures of most of the series shown above will be found in the Country Profile.a Balance-of-payments basis. b End-January 1998, 312.5. c End-January 1998, 1.797.

Sources: Bank of Papua New Guinea, Quarterly Economic Bulletin; IMF, International Financial Statistics.

Direction of trade(%)

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-DecImports cif 1993 1994 1995 1996 Exports fob 1993 1994 1995 1996

Australia 46.9 49.8 51.7 51.0 Australia 40.8 34.5 32.5 36.3Singapore 11.9 12.2 13.2 10.2 Japan 27.4 27.7 24.9 21.5Japan 14.5 12.8 9.3 10.1 Germany 6.3 8.1 11.2 8.1US 3.9 4.7 3.9 4.5 UK 3.3 3.3 5.2 5.9New Zealand 4.8 4.2 3.8 4.3 South Korea 0.0 0.0 7.6 5.4Hong Kong 2.7 2.8 2.3 2.2 China 4.3 5.3 2.7 3.5China 1.0 1.1 1.2 1.8 US 4.4 4.5 1.8 3.2Source: IMF, Papua New Guinea Statistical Appendix.

28 Papua New Guinea


Domestic exports(Kina m)

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec1992 1993 1994 1995 1996 1997

Fish 9.3 7.8 10.3 12.3 10.4 9.5Coffee 68.1 100.5 204.8 214.5 190.3 324.0Cocoa 34.1 33.1 29.0 47.7 66.2 69.0Tea 6.6 7.2 4.2 5.4 12.7 10.4Logs 140.0 400.2 483.1 436.7 464.8 409.3Crude petroleum 301.4 817.8 702.7 827.7 1,073.9 852.2Copra & copra oil 36.0 33.8 34.8 57.1 100.4 98.3Palm oil 64.2 79.2 77.5 142.2 182.4 207.1Gold 745.9 681.6 702.3 840.1 773.6 718.7Copper 313.5 256.3 367.4 754.5 387.0 259.8Total incl others 1,862.6 2,527.3 2,662.0 3,399.8 3,313.9 3,051.6Source: Bank of Papua New Guinea, Quarterly Economic Bulletin.

Papua New Guinea 29


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