Moody’s affirms PNG B2 rating

This article outlines Moody’s Investors Service rating on Papua New Guinea. It has affirmed the Government of PNG B2 rating.

Moody’s Investors Service (Moody’s) has affirmed the Government of Papua New Guinea’s (PNG) issuer and senior unsecured ratings of B2 and maintained the stable outlook.
The drivers behind the rating affirmation include Moody’s expectation that mobilisation of external financing resources will mitigate government liquidity risks, despite a weaker fiscal trajectory than previously expected.
While the Government’s economic and fiscal reform plans entail some implementation risk, effectiveness will be supported by technical assistance from development partners.
The rating affirmation also takes into account renewed delays on resource investments which, being repeated, constrain PNG’s growth potential.
The stable outlook reflects balanced risks at the B2 rating level, with both upside and downside risks mainly related to the Government’s access to external financing at affordable costs and its implementation of reform plans.
Moreover, significantly longer delays in resources investment could raise government liquidity and external risks beyond Moody’s current assessment.
The local-currency bond and deposit ceilings are unchanged at Ba2.
The foreign-currency bond ceiling is unchanged at B1 and the foreign-currency deposit ceiling is unchanged at B3.
In addition, the short-term foreign-currency bond and deposit ceilings are “not prime”.

Ratings rationale
Mobilisation of external financing resources mitigates government liquidity risks, despite a weaker fiscal trajectory
Following a review of Papua New Guinea’s fiscal landscape in late last year, the government established a comprehensive economic and fiscal reform programme, which Moody’s expects will foster greater adherence to fiscal rules, increased fiscal transparency and stronger commitment towards maintaining macro-fiscal stability, while taking into account the likely implementation challenges.
With the policy anchor of an IMF staff-monitored programme aiding mobilisation of greater amounts of external, concessional financing, Moody’s expects that government liquidity risks will remain contained.
Revenue shortfalls, expenditure overruns and the build-up in government arrears led to a deterioration in PNG’s fiscal position during last year.
Delays in external financing mobilisation also led to erosion in the government and external liquidity positions.
Extraordinary financing of approximately US$300 million (K997mil) (1.2 per cent of last year GDP according to Moody’s estimates) in late last year provided immediate liquidity relief.
Moody’s expects the fiscal deficit to widen to slightly over 5 per cent of GDP this year, including the clearance of public sector arrears and as the government gradually redirects expenditure towards capital spending and social needs.
Moody’s expects a modest narrowing of fiscal deficits to around 4.5 per cent of GDP in 2021-22, as expenditure- and revenue-based measures are progressively implemented.
While Moody’s expects PNG’s debt burden to increase to around 45 per cent of GDP in 2020-21, from around an estimated 40 per cent of GDP at end of last year, and debt affordability – as measured by interest payments as a share of revenue – to weaken to around 20 per cent over the same period, PNG’s fiscal position will remain broadly in line with similarly-rated sovereigns.
Moody’s expects that the revised fiscal rules will foster greater fiscal discipline and gradually reorient expenditure towards facilitating growth in the non-resource economy.
Moreover, the Government has committed to limiting the growth in public sector emoluments and preventing any further build-up in domestic payment arrears.
Support from development partners will also provide technical and administrative capacity in implementing a revised medium-term revenue strategy (MTRS), focusing on key areas including improvements to tax administration at various agencies and review of existing state-owned entity (SOE) divided policies, and an overall governance reform package within the SOE sector.
The reform programme intends to start addressing a number of weaknesses in PNG’s fiscal policy and debt management.
Moody’s fiscal and debt projections take into account some challenges in implementing the full extent of the Government’s reform programme.
Moody’s expects the government’s annual gross borrowing requirements to peak at approximately 20 per cent of GDP in this year, before gradually declining to around 15 per cent of GDP by 2022-23.
Support for the Government’s economic and fiscal reforms will come not only from technical assistance, but also from the crowding-in of broader external, concessional financing.
Increased policy-based lending from development partners, including the World Bank, the Asian Development Bank (ADB) and the government of Australia, will help enact reforms in areas of public financial management, State-owned enterprise governance, and monetary and exchange rate reforms and raise PNG’s external financing over 2020-21.
Greater security over the availability of external financing is likely to maintain domestic liquidity pressures manageable and support greater economy-wide foreign exchange availability, notwithstanding the impact of the global economic slowdown and the coronavirus outbreak on prices of PNG’s key commodities exports.
While greater mobilisation of external, concessional financing supports government liquidity, it also raises PNG’s fiscal strength’s exposure to exchange rate risk, especially as the country’s central bank, Bank of Papua New Guinea, commits to greater exchange rate flexibility.
In line with the IMF, Moody’s estimates that at this stage, downward pressure on the exchange rate is contained and unlikely to result in a large increase in the debt burden.

Recurring delays in resource investments limit PNG’s growth potential
PNG’s sovereign rating takes into account significant susceptibility to external shocks, including prolonged periods of lower commodity prices or sudden climate events, given its small size and reliance on commodities production and exports.
Recurring delays in resource projects constrain the economy’s growth potential and capacity to build resilience ahead of potential shocks.
Moody’s expects real GDP growth of just 1.1 per cent this year and 2.3 per cent next year, reflecting renewed delays in construction and foreign direct investment flows from large resource projects entering final investment decision in the coming years.
Despite ratification of the US$15 billion (K50) Papua LNG project agreement during last year, Moody’s expects inconclusive negotiations for development of the P’Nyang gas field to delay development of the Papua LNG and the PNG LNG extension projects, given synergies across the projects.
Additionally, uncertainty over the timing of FID for Wafi-Golpu, a gold and copper mine, presents further downside risks for greater production volumes in PNG’s mining sector, a significant source of foreign exchange inflows.

Rationale for the stable outlook
The stable outlook reflects balanced risks.
Upside risks relate to increased engagement with and reform assistance from development partners that may stabilise the Government’s fiscal trajectory faster than Moody’s anticipates.
Conversely, downside risks stem from difficulties in implementing the government’s reform programme, in turn contributing to greater challenges in mobilising external financing at low costs and raising renewed Government and external liquidity risks.
Moreover, while Moody’s baseline forecasts assume a delay in the resource-sector investments pending final decision, significantly greater delays or outright abandonment would impair near-term economic growth, Government revenue and foreign-exchange inflows, raising government liquidity and external risks.

Environmental, social, governance considerations
Environmental risks are material for PNG’s credit profile, as it is both exposed to ongoing climate change, particularly extreme rainfall and heat stress, as well as longer-term carbon transition risks, given the economy’s and Government’s reliance on hydrocarbons as a source of revenue.
Economic growth is inextricably tied to potential impact from both gradual and sudden climate events.
Moreover, PNG’s resources sector, which includes oil, gas, gold and copper, among others, contributes greater than one-fourth of the economy’s total value-added and around 90 per cent of export revenue, while the government’s revenue performance fluctuates with prevailing commodity prices and the tax take on resource agreements.
Social risks are not material for PNG’s credit profile.
Access to basic services continues to constrain economic development, while other societal issues including gender-based violence, political unrest, and widespread poverty, particularly in the country’s most rural areas, remain present, although these issues are not significantly more severe than for similarly-rated sovereigns.
The Government continues to direct resources towards its long-term development plan, which prioritises raising living standards and increasing formal job opportunities.
Governance risks are material for Papua New Guinea’s credit profile.
Our assessment of PNG’s institutions and governance strength considers the country’s limited progress on institutional reforms that is reflected in its Worldwide Governance Indicator scores.
These scores include weak assessments of the rule of law and control of corruption, despite ongoing technical assistance from development partners.

Factors that could lead to an upgrade
Upward pressure on the rating would likely emanate from a durable and material reduction in refinancing risks, consistent with a significantly greater fiscal adjustment and reduction in gross borrowing requirements than Moody’s currently expects.
Moody’s would also consider upgrading the rating should a sustained increase in non-debt-creating external inflows lead to a sustained accumulation in foreign exchange reserves.
Such an improved position in external liquidity buffers would enhance PNG’s external debt servicing capacity, aid economic activity in the non-resource sector, and provide monetary and fiscal authorities with improved policy flexibility.
Over the longer term, should implementation of key resource sector investments generate positive economic spillovers in the non-resource economy, the positive impact on growth potential would contribute to upward rating pressure.

Factors that could lead to a downgrade
Significant delays in the negotiations between the Government and LNG and/or mining companies that would threaten PNG’s growth potential and external position would put downward pressure on the rating.
Moody’s would also likely downgrade the rating should a markedly weaker implementation of the government’s reform agenda contribute to higher liquidity pressure than Moody’s currently assumes.
Moody’s would also consider downgrading the rating upon a likely sustained decline in the stock of foreign exchange reserves and/or worsening foreign exchange shortages.
Such diminished external liquidity buffers would heighten risks to external debt servicing capacity and significantly restrict monetary and fiscal institutions’ policy flexibility to effectively respond to potential shocks or implement credit-profile enhancing reforms.