After managing to sidestep much of the fallout from the global financial crisis of 2008-09, Papua New Guinea (PNG) looks set to achieve its eighth consecutive year of positive GDP growth in 2012. 

Recently, there has been a noticeable improvement in governance and economic management, raising hopes that the impressive growth of the last few years will translate into higher living standards. 

PNG is resource-rich and on the radar of many foreign investors. In 2009, the country approved a US$15 billion liquefied natural gas (LNG) project that, once constructed, is expected to substantially boost PNG’s exports and help lift GDP over the project’s 30 year life. LNG production will reach full capacity in 2015 and boost real GDP by about 20%.

PNG is poorer and slower growing than the Developing Asia average, but about as creditworthy and congenial for business as the regional average.

Exporters and investors face mainly moderate-high risks in PNG, although the economy’s vulnerability to external shocks means that business cycle risk is very high. Sovereign default risks have receded.

PNG’s economy is highly dualistic – a small but relatively well-developed formal sector, based around mining, manufacturing, services and the public sector, co-exists with a large informal economy where subsistence farming accounts for the bulk of economic activity.

The global financial crisis had only a mild impact on PNG. Buoyant commodity export prices in the pre-crisis period enabled the government to build up fiscal buffers that were deployed to cushion the economic impact. The fallout was also limited by the relative insularity of the country’s banking system. The IMF expects the economy will expand by around 8% in 2012, although gross national income – roughly speaking, income earned by local residents – will rise by less because of dividend outflows.

PNG used the upswing in commodity prices to pay down public debt. As a result, the country’s public debt ratio has more than halved to around 25% of GDP since 2002 and is expected to keep falling. External debt has also fallen – from 50% of GDP in 2001 to 11% of GDP at end-2010. Debt sustainability has improved markedly in recent years – the IMF’s most recent debt sustainability analysis concludes that the country now faces a ‘low’ risk of debt distress. Nevertheless, PNG remains a sub-investment grade sovereign borrower (B1 from Moody’s and B+ from S&P).

The government has introduced a medium-term fiscal framework to insulate the budget from volatile resource revenues.  However, according to the IMF, the strategy has helped reduce public debt but has been less successful in insulating public spending from volatility in commodity prices. This is because the strategy can bias fiscal policy in a pro-cyclical direction.

In addition, the country’s public finances are structurally weak – per capita tax revenue is one of the lowest in the South Pacific, according to the Asian Development Bank. Three main factors contribute to the structural weakness of tax revenues - a small tax base, a generous fiscal regime for mining, and poor tax compliance.

As the mining boom gets underway, PNG will need to be careful not to succumb to the ‘resource curse’. History suggests emerging market economies seldom manage this. One danger is that resource revenue flows will overwhelm the economy’s absorptive capacity. The government has announced the establishment of a sovereign wealth fund as part of the overall macroeconomic strategy to address these issues. 

The country’s growth rate got a big boost from the China-driven commodity boom over 2002-08 and is now benefiting from the construction phase of the PNG LNG project. Better macroeconomic management saw the inflation rate drop to low single digits before a fiscal expansion and monetary stimulus in combination with rising food and energy prices pushed it back up.

The projected sharp widening in the current account deficit is not expected to threaten external stability, as it is driven by an upsurge in foreign direct investment into the resource sector, which should boost the economy’s productive capacity.

PNG has a long history of changes in government coalitions and leadership from within parliament during the five-year intervals between national elections. However, the last decade has seen greater stability – 2002-07 was the first five-year parliamentary period since independence that saw no change in government.

Most members of the country’s unicameral legislature are elected on a personal and clan basis within their constituencies rather than as members of a political party. As a result, personality matters more than ideology. Indeed, even though political parties abound (see Chart 8), party allegiances are fairly fluid and no single party won enough seats at the 2012 general election to form a government in its own right. 

A standoff between rival political forces in the lead-up to the last national election threatened to destabilise PNG. Right up to the start of the election, the O'Neill government's hold on power was being tested and tension between rival political groupings overshadowed the country's political life. The integrity of core institutions, including the judiciary and the security forces, was also tested during this period of rising political tensions.

The political situation has stabilised even though the election did not deliver full parliamentary control to one party. The strong showing by Peter O’Neill’s People's National Congress in the election gave him the clout to form a coalition government with several parties, including that of his former rival, Sir Michael Somare, and some independent MPs. In all, 94 MPs are in the coalition – in a 111-seat unicameral parliament. However, as PNG politics are fluid, even at the best of times, there could be further allegiance shifts as the coalition beds down its operations and appoints people to key positions.

PNG’s politics have a reputation for being volatile. PNG ranks around or just below the 25th percentile of countries on two political indicators produced by the World Bank – government effectiveness and political stability.

PNG’s challenging business climate can make things difficult for foreign investors, especially those operating in petroleum, minerals extraction and agriculture. On the surface, PNG’s legal, accounting and regulatory standards meet international standards. But investors complain that enforcement is inconsistent and can appear arbitrary. Moreover, there is no framework in place to settle disputes between resource companies and landowners, which promotes dissatisfaction and disillusionment among landowners and the landless alike.

The World Bank ranks PNG poorly for control of corruption and rule of law. It ranks PNG close to the 50th percentile on its ease of doing business measure, but enforcing contracts is a problem area. The top quartile ranking on protecting investors reflects greater perceived levels of disclosure, shareholder power and director responsibility. However, things can be vastly different in practice.

Despite substantial mineral and natural resource endowments, PNG’s per capita GDP of US$1900 has barely doubled since 1980. In contrast, per capita income in Developing Asia is more than 10 times higher than it was in 1980. 

There are large disparities – wealth is concentrated in the hands of a narrow elite while much of the population lives in poverty. In addition, much public infrastructure is in poor condition and human development indicators are low: PNG is ranked 153 out of 183 countries on the UN Human Development Index.

Annual per capita income is US$1900, making PNG one of the poorer countries in the Asia-Pacific region. Income inequality is high.

Tribal feuds over land, titles, religious beliefs, and perceived insults frequently lead to violence and deaths. Inadequate law enforcement and the increased availability of guns have exacerbated this problem. There are also periodic episodes of violence and property damage around large mines. 

The most well-known example of such violence was the conflict between miners and landowners on Bougainville Island. A series of small attacks on the copper mine that began in 1988 saw the islanders’ demands for compensation and profit-sharing grow into a low-grade secessionist war. After rebels overran the mine in 1990, CRA (now Rio Tinto) abandoned the project.

*All 2011 figures unless specified

**The HDI is composite measure of human development: long & healthy life (life expectancy), education (literacy & education enrolment) and income (GDP per capita)

***Expressed as % of GDP unless specified