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.