Currency depreciation

The worsening state of the Papua New Guinea kina, as revealed by the Bank of PNG governor in the bank’s Monetary Policy Statement last Friday in The National, is a big concern for the country.
The kina has continuously been falling against the major foreign currencies like the US dollar and the euro.
This has wider repercussions in the economy.
The depreciating state of the PNG currency means a lot for the country.
Among the major repercussions, one that clearly stands out is that it will raise the cost of loan repayment to foreign lenders.
PNG is among the many developing countries which borrow in foreign currencies.
Its debt level has accumulated over the years and has overtaken the legally-accepted level of 35 per cent of GDP.
The recent increase in Government borrowing to accommodate its spending shortfall has also added to the stock of debt.
This pile-up of debt, especially the foreign debt, has to be reduced somehow.
This implies that foreign lenders demand that loan repayments must be done in terms of their own currencies like the dollars.
They also require borrowing countries to obtain denominated in their own (lenders’) currencies.
For example loans, from US lenders are given in US dollars and loans from the Australian dollars are denominated in Australian dollars, regardless of who is borrowing.
This is because they themselves have large accumulation of their own currencies.
This inability of poor countries in borrowing in terms of their own currencies is putting extended pressure in repaying loans.
Once when the kina is depreciating, it is falling in value against the foreign currencies, which implies that we will need more PNG Kina to service the loan repayments.
Accumulation of foreign reserves is vital for paying for our imports and repaying loans.
Cheap means of receiving this most-needed currency, which is through export receipts, have been devastated by the recent tide of international events which did not turn to our advantage.
As a result, our foreign currency reserves have been continually being drying up in the recent years.
Our ability to sufficiently repay the loan largely corresponds to our exports receipts.
The depressing value of the kina is good as that will promote exports and export receipts ultimately.
However, this advantage has not been realised largely due to recent tide of international events not turning towards our advantage.
The global commodity prices have been falling largely attributed to a decline in the consumption spending in the Chinese economy, together with the oversupply of commodities in the world market.
The resumption of the Ok Tedi mine resulted in an inflow of much needed FX but that has not been sufficient to meet the import demand.
Prior to the commencement of the world-class PNG LNG Project, people had been anticipating a windfall of foreign currency, which was also believed to raise the value of the kina.
Even after the project began, the value of the kina continued to take a downward trend against the major global currencies.
This clearly indicates that kina value cannot be raised by simply raising our exports (making our exports competitive in the world markets).
Thus, the possibility of the kina regaining its value is largely relied on and determined by international events.
Even if we are independent to conduct our own monetary policy and take measures to correct these economic problem, unlike other countries like those in the EU, our greater reliance on the international economy still does not allow us to effectively address the depreciating value of the currency or increase our exports.
We will still succumb to the unfavorable events in the global economy because we, as a developing country, have less ability to influence the terms of trade.
It must be understood that exchange rate stability is very important to maintain confidence in the country and to keep inflation in check throughout the country.
However, the persistence fluctuation in the exchange rate has the possible effects of reducing confidence in the PNG economy.
This also signals the international investment community that our economy’s near future investment climate is not viable.
And as such, any investment plans by both domestic and international investors are likely to be put to hold or deferred at the moment.
The falling value of the kina makes the importing of goods like machines, trucks and other high technology assets used in our production processes very expensive.
This will reduce investments and deteriorate the living standards of the country’s population.
The fear of further depreciating kina also has the likelihood of investors cancelling their proposed investments or pulling their funds out of the country.
Such actions have important ramifications throughout the country such as falling levels of investments and aggregate consumption which are vitally bad for the economy.
If market confidence fails, and if loan default is imminent, reserves will quickly disappear and a possibility of further foreign borrowing will be constrained and the future cost of foreign borrowing will be very high.
The resulting liquidity crunch will make it impossible for PNG to meet its other remaining foreign obligations.
Reserve adequacy will be reduced and securing of foreign credit will be restricted when it is desperately needed.

Mike Napan
Port Moresby