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By Dr Thomas Webster and Linda Duncan There is lots of good news in the 2010 Budget. First, the budget is balanced, meaning Papua New Guinea National Government will not have to borrow to finance a deficit, as in 2008 and also predicted in 2009. Second, the 2010 Budget includes a large increase in the development budget from estimates of K2.6 billion in 2009 to K3.4 billion in 2010. Domestic funding of the development budget is estimated to increase by more than 27 per cent or K385 million in 2010. This continues the Government’s commitment to funding development expenditure, which will have grown by 246 per cent between 2008 and 2010. Third, almost 60 per cent of total expenditure, and 73 per cent of government-funded development expenditure has been allocated to the priority areas identified in the Medium Term Development Strategy. Revenue growth and the LNGUnderpinning the Government’s balanced budget is a significant increase in government tax revenue of 18.8 per cent. Fuelling this increase in revenue is:
Although the Government will not receive any revenue directly from the LNG project until around 2014, the increased economic activity is forecast to generate additional personal and company income tax from increased activity in other sectors. The Government predicts that the increased economic activity associated with LNG construction in 2010, particularly in the wholesale and retail sector, will increase the country’s GDP by around 3 per cent. This will result in GDP growth of 8.5 per cent in 2010.
In announcing the budget, Minister Pruaitch acknowledged there are many inherent risks in the budget that may result in these revenue expectations not being realised. Among these risks are delays in commencement of the LNG project or lower than predicted economic activity, shutdowns in the mineral sector, crop failures, volatility or falls in commodity prices or dividends not being paid. As the budget has increased expenditure based on these revenue expectations, the Government will need to closely monitor these risk factors and adjust spending accordingly, to avoid returning a deficit. High inflationThe Papua New Guinea economy has continued to grow throughout the Global Financial Crisis and with the commencement of LNG, is set to expand even further. However, this increased economic activity has come at the cost of high inflation, with annual inflation at 10.7 per cent in 2008, and forecast for 7.4 per cent in 2009. Inflation in 2010 is expected to rise to 9.5 per cent, due to the start of construction on the LNG project and high government spending. High inflation means higher input costs for businesses as well as higher prices and weaker purchasing power for ordinary Papua New Guineans. If the central bank tightens monetary policy further to contain inflation, then interest rates would also rise and potentially have an adverse impact on investment. The Government has identified high inflation as a risk, and has labelled the estimated 2010 level as ‘uncomfortably high’. Yet a contradiction in the budget is high levels of Government spending which are likely to add to inflationary pressures. The Government spending levels outlined in the budget are likely to add to demand pressures in the economy. This represents a departure from the fiscal guidance contained in the Medium Term Fiscal Strategy (MTFS). The MTFSThe MTFS provides a framework for the Government to manage fiscal policy with guidelines designed to limit government spending to sustainable levels and prevent large fluctuations in government spending, which can be highly destabilising for the economy. The MTFS outlines guidance for the spending and allocation of additional mineral revenue. That is the portion of mineral revenue (mining and petroleum taxes, dividend withholding taxes and mining and petroleum dividends) that exceeds 4 per cent of GDP. The Government’s fast drawdown of trust funds in 2009 and the allocation of all additional mineral revenue to additional priority expenditure, represent departures from these fiscal guidelines. This could place greater pressure on an already inflated economy as explained below. Trust fund expenditureDuring the years of the commodity boom, a large amount of mineral (and other) revenue was placed in trust accounts for future spending. In Volume 1 of the budget documents, the purpose of holding funds in trust accounts is stated as ‘to spread spending over time to manage inflationary and demand pressures in the economy and to provide time for implementing agencies to properly design implementation strategies’. From January to 30 September 2009, almost K1.75 billion (8 per cent of GDP) was drawn down from trust accounts. This represents a marked increase in spending from trust accounts, and accounts for two-thirds of expenditure from trusts since 2005. Of the K1.75 billion, K1.3 billion (5.8 per cent of GDP) was spending of additional mineral revenue. This exceeded the guidance in the MTFS that no more than 4 per cent of GDP should be spent from Additional Mineral Revenue in any one year. The budget documents state that ‘spending in excess of 4 per cent of GDP from trust accounts is highly stimulatory. The stimulus will exert demand pressures on the economy, which risks increasing inflation, interest rates and imports and crowding out private investment.’ It is also noted that continued spending at this rate would see the trust funds exhausted in less than a year. This could result in a large and undesirable drop in government spending in subsequent years before any direct government revenue that is expected from the LNG project. Additional priority expenditureTo help smooth aggregate demand fluctuations and ensure debt is repaid when the opportunity arises, the MTFS provides that 70 per cent of additional mineral revenue should be allocated to public investment and 30 per cent allocated to repayment of debt. In 2009, mineral revenue was below 4 per cent of GDP and therefore there was no additional mineral revenue. In 2010, the rebound of commodity prices and increased production mean that mineral revenue is estimated to exceed 4 per cent of GDP, resulting in K502 million of additional mineral revenue. Contrary to the MTFS guidelines, all of this additional mineral revenue has been allocated as additional priority expenditure in the development budget. The reason for not allocating 30 percent of the K502 million to debt repayment is explained in the budget documents as ‘to fulfil [the Government’s] objectives of improving development outcomes and empowering the rural economy’. However, the potential inflationary effects of this increased expenditure may end up having an adverse effect on the very people that the Government is trying to help.
Government debt at the end of 2009 is estimated to be around K7.1 billion or 33 per cent of GDP. This does not take into account the Government’s unfunded superannuation liabilities. Although the debt to GDP ratio has improved substantially in recent years, the budget documents state that ‘further progress is required to reduce debt to sustainable levels’. The decision not to repay some of the Government’s debt is not in line with the MTFS guidelines. ConclusionWith economic activity set to increase and inflation already high, there is a high risk that the Papua New Guinea Government expenditure outlined in the 2010 Budget, plus additional drawdown of trust funds will put too much pressure on the economy.
This article was published with permission from National Research Institute of Papua New Guinea. NRI website can be accessed at www.nri.org.pgWhat do you think about this article? Add you comments and views below:
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