Economy weak in 2019

The ANZ bank on Tuesday released its latest economic update report for Papua New Guinea. Below is part of the report.

Economy remains weak

• Strong 2019 GDP is a false dawn
• Headline result driven by rebound in gas exports
• Strip away contribution of gas, economy is probably going backwards

Softer 2020

• Gas projects could not enter into FEED in 2019 as crucial P’nyang agreement still in negotiations
• So, no FID on gas projects in 2020
• Economy stuck in low gear; policy levers not working

Recovery in 2021…

•  …if P’nyang can be completed within deadlines
• Allowing FEED, FID and commencement of Papua LNG and PNG LNG expansion by mid-2021

Upswing from 2022

• We are hopeful that the P’nyang terms will be completed soon
• Setting up a strong next decade for PNG
• Failure to reach a timely agreement could put this upturn at risk

‘Honest’ budget

• First budget of Marape-Steven government tabled
• Treasurer seeking to understand true state of government finances
• Government keen to pay all outstanding bills

FX normalcy delayed

• Foreign exchange market remains undersupplied
• Improved liquidity from the central bank helping reduce the stock of outstanding payments
• Foreign direct investment will restore balance from H2 of 2021 subject to progress on gas projects

Economic Outlook
Don’t be misled by a strong GDP for 2019, the economy remains weak
We are forecasting PNG’s economy to grow by an impressive 3.8% in 2019. This will be driven by a rebound in oil and gas production following earthquake-induced disruptions in 2018 (Figure 1).
We expect gas output, which makes up 25% of GDP, to lift by 15.8% to around 8.5mt this year from 7.5mt in 2018.
However, to many observers, the PNG economy feels more like it is in a recession.
Take out the contribution of gas (ie production, taxes, royalties, dividends and consumables) and it probably is.
We anticipate the economy will remain soft in 2020, largely due to ongoing weakness in construction, in particular mining investment. We don’t expect gas output to be higher, despite the LNG plant consistently achieving higher annual production rates since 2014.
Scheduled turbine maintenance will limit the upside to the 8.5mt expected this year.
Non-mining business investment remains subdued.
With weak demand and weak profits, it doesn’t make sense for businesses to invest, especially when many still have excess capacity.
Low confidence – due to delays in accessing foreign currency and uncertainty surrounding the next round of mega-resource projects – is not encouraging firms to invest.

Policy levers not working – monetary policy is of limited effect
After keeping the policy rate at 6.25% since March 2013, the Bank of Papua New Guinea (PNG’s central bank) cut the official policy rate – the Kina Facility Rate – twice in 2019. It reduced the policy rate by 25bp in July and 50bp in August, taking the official rate to 5.5%.
We don’t believe the reduction in rates will be able to stimulate demand, as the relationship between commercial bank lending rates and policy rates is very weak.
Large surplus liquidity in the banking system prevents smooth transmission of policy rates to market rates. Hence, changing policy rates has limited, if any, impact on domestic demand.

Fiscal policy is up against a debt limit
With monetary policy having limited influence on demand, all the heavy-lifting is left to the government. However, the debt barrier provides little wriggle room to run a countercyclical fiscal program. Debt to GDP is at 42% versus a legal limit of 45%.

No FID in 2020, further delaying the long-awaited economic recovery
At the beginning of the year, we expected both the Papua LNG and the PNG LNG Expansion (P’nyang) project to be in preliminary engineering works by late 2019 before commencing construction late next year. However, the crucial P’nyang Gas Agreement hasn’t been finalised.
The target date for the P’nyang Gas Agreement was the end of November, but that didn’t materialise. If the negotiations can be completed within agreed deadlines, we believe a recovery will come in the second half of 2021 – a year later than anticipated. Obviously, a longer project dialogue will push the recovery out further, with a risk that extended negotiations could derail the economic upturn (see box article below).
Note that while the previously signed Papua LNG agreement was given a delayed green light by the Marape-Steven government, work on Papua LNG will not ramp up until the P’nyang terms are agreed to by the government. That is because elements of the Total-led Papua LNG and ExxonMobil-led P’nyang development are integrated, with the synergy delivering material capital and operating-cost savings, especially for the brownfield downstream development.

A return to balanced foreign currency market is also some way off
The stock of outstanding foreign currency payments, albeit declining, is still significant at PGK1.4bn. The recent USD300m loan from Australia will allow the central bank to provide more US dollars to the market, further lowering the overdue import invoices. But this won’t be enough. Nearly PGK2bn of capital repatriation is yet to be placed on the order book.
We believe flows associated with works on new gas discoveries will be substantial and present the best chance of returning the FX market to normalcy. So, the longer these projects take to start, the longer the FX market will be undersupplied. A structural shift to a lower currency is an option for rebalancing the market, but the central bank seems reluctant to do this, given the inflationary impact associated with a faster depreciating currency.

New treasurer does ‘soul-searching’, but little antidote in the 2020 budget
The Treasurer, Ian Ling-Stuckey, announced the Marape-Steven government’s first budget on 28 November. In tabling the budget, he emphasised the need to understand the true state of government finances before providing a plan to settle all outstanding government payments and restructuring government debt. The 2020 Budget predicts revenue of PGK14,095m, expenditure of PGK18,727m (of which PGK1,050 relates to unpaid bills from previous years) yielding a deficit of PGK4,631m – the largest in the country’s history.
The desire for honest budgeting and accounting for government arrears is admirable, but a clear plan for economic recovery, jobs and a strategy to return the budget to surplus is critical. Given concerns about debt levels, we believe a medium-term plan to return to surplus in order to pay down debt would have been a positive step.

Plan for a broad-based economy once LNG investment is under way
The 2020 budget has allocated PGK200m for small-to-medium enterprise development, mostly in the agriculture sector.
Money has also been allocated for the coffee and cocoa industry, fresh produce development and marketing, coconut downstream processing and marketing, oil palm smallholder roads, tourism sector development and livestock industry development. However, the funds are in the PGK5–10m range.
PNG has huge potential in its agriculture, tourism and manufacturing sectors. However, unlocking that requires infrastructure investment of several billion kina.
That will be more feasible from the middle of the next decade, when the new gas capacity comes online.