Delicate balancing act needed

THE Government is required to measure up to standards it set for itself when it delivers the 2010 budget today.
It must avoid ongoing and increasing budget deficits. It must not raise the level of debt. And it must produce an affordable and sustainable budget during its term in office.
These are the requirements of the Medium Term Fiscal Strategy, the Medium Term Debt Strategy, and the Fiscal Responsibility Act of 2006.
For a time, these disciplines were exercised on the much welcomed upper extreme in a time of plenty – by keeping a lid on the temptation to spend too much because there was a lot of money for at least six years.
Excellent commodity prices fetched a steady windfall of revenue consistently above projected income over a number of years.
The Government created a device – trust accounts – to catch additional mineral revenue over and above 4% of GDP and this is where much of the excess revenue was parked.
In order to keep inflationary pressures at bay, the MTFS also disciplined Government to spend only up to 4% of GDP on one-off infrastructure projects in any one year, keeping the rest for a rainy day.
The rainy day has finally arrived. Now the situation is reversed. The Government is required to exercise fiscal discipline at the less attractive lower extreme – in a time of scarcity.
With the full impact of the global recession hitting, PNG’s economy which has been resilient so far, is expected to grow by half its forecasted growth next year.
The budget strategy paper forecasts that revenue is expected to drop to 2.4% of GDP next year so there will be no additional mineral revenue. There will be no new funds flowing into the trust funds but expenditure is expected to be maintained at 2009 levels or even increased, so there will be substantial drawdowns on the trust funds of the full 4% of GDP.
This will mainly be the result of a slowing down of production in Ok Tedi and in the oil producing areas.
While the Lihir gold mine is expanding its operations and Ramu nickel will go into production next year, the Government’s own decisions to grant these companies substantial incentives by way of concessions will see no tax or dividend income flowing into its coffers.
For the same reason, there will be no direct income from the PNG liquefied natural gas (LNG) project and that is only if the project agreement is signed next month to commence the construction phase next year. In the event the agreement is not signed, the budget and the economy will be further impacted negatively next year.
Although the non-mining sector is expected to grow, revenues from it will be insufficient to fund increased Government commitments next year, according to the budget strategy paper.
The Government has already run a budget deficit last year and it is expected it will report a bigger one this year, so it can ill-afford to plan another one next year against strictures imposed by the Fiscal Responsibility Act.
Commercial borrowing to fund the budget will only tend to increase debt and borrowing abroad might not be a good idea at present as the bigger economies in recession are going to the banks big time and this will increase the cost of borrowing.
PNG might be crowded out of the borrowing scene altogether given its own debt position which, although it has been dropping steadily in the Somare years, remains at uncomfortably high levels relative to the GDP.
The challenge then for Government in the preparation of this budget has been whether or not to cut ongoing expenditure substantially; to allow a temporary budget deficit or a mixture of both.
The Government has decided to go, if it goes by its budget strategy, for a balanced budget with modest expenditure cuts and a bit of concessional borrowings. The cuts and borrowings would have been far greater had the Government not saved during the boom periods. These accounts will now be relied upon heavily to bolster the heavy recurrent and new Government expenditure targets forecasted for next year.
It is going to require a delicate balancing act but if the Government is able to do it, it will speak a lot for its fiscal discipline and for its political will to stick to its targets. It is a far easier temptation to throw caution to the wind and to borrow in anticipation of future massive inflows of revenue from projects such as Ramu nickel and LNG project.
We will know today.