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Treasury report shows that PNG’s budget situation is over-stretched

OVER recent months, a few morsels of information have come to light suggesting that the financial situation is tightening around the government of Papua New Guinea.

Now with the benefit of the Treasury’s mid-year report we have a much clearer picture. As expected, it’s not pretty.

What we see is a government struggling to play by its own fiscal rules and to deliver on its own budget. It’s not obvious how long the country can safely continue down this path.

The Treasury report confirms that low commodity prices have caused revenues to undershoot expectations. Dwindling mining and petroleum tax revenues are the main cause.

By the end of this year, Treasury expects to receive close to K400 million less than it had forecast in the budget. This is about K50 million more than last year.

The upshot of these revisions is that targets for the debt to GDP ratio, as set out in the Fiscal Responsibility Act, will be broken for a second year running.

At the end of 2013, the legal debt limit was 30% of GDP; by the end of this year parliament will be asked to revise the target up to 40%.

The government is struggling to stick to its rules. Clearly, it realises that the Fiscal Responsibility Act is only as strong as the will to defend it. In practice, amendments like this go through parliament with little discussion or pushback.

These rules such were enshrined in law to avoid the risks associated with over-borrowing. In this latest report, Treasury admits that interest rate and refinancing risks are building. This can lead to a place where the government is unable to pay its bills, where it’s forced to default on its debt or even suffer externally imposed austerity.

PNG might not get to this point, but the longer it takes to correct the deficit, the more painful things will be.

Previous plans suggested the need to hold spending increases at less than the rate of inflation – that is, a real cut in spending. To put the country back on the track set last year, nominal cuts are now required. Theseare likely to be distasteful to cabinet.

Missing from the Treasury report is a discussion of liquefied natural gas revenues. No insight is given into the $1.2 billion UBS loan agreement used to purchase the government’s shareholding in Oil Search.

Treasury does offer a hint though: “The challenge for the government going forward… is the possibility of the initial LNG exports having minimal impact on Government Budgets in 2014 to 2023 if LNG dividends are diverted away from the budget.”

From this, one might read that the Treasury is also concerned that unclear processes and closed-door dealings have overridden sensible management of LNG revenues.

A mid-year report is based on forecasts for the end of the year and a lot can happen in six months. But, even after these latest revisions, the government is still banking on quite rapid increases in revenue that will in all likelihood prove just as unrealistic as the ones that in the 2014 budget.

The report offers a much more comprehensive summary of the compliance efforts of the government and suggests these have already raised an extra K200 million. This figure is highly uncertain but, if true, is very impressive. Nonetheless, it is unclear whether the budget target of K600 million will be reached by the end of the year.

The report further notes continued uncertainty around revenues from State-Owned Enterprise dividends (K287 million) and assets sales (K600 million). In their absence, the budget deficit would be fully a third larger than the deficit in 2013.

It is increasingly clear that, had the government used its revenue forecasts presented in September’s 2014 Budget Strategy Paper, it would be much better placed.

However, this is less a forecasting problem than a reflection of the divergence in outcomes of the technocrat-driven Budget Strategy Paper process and the politically driven budget. This is by no means a challenge unique to Papua New Guinea.

Revenue worries notwithstanding, there are still plenty of risks on the spending side that may emerge before year ends. The report points to some challenges.

Overall, it is clear that the government overstretched itself in its last budget. Central Bank financing of the deficit continues to provide the government life support- hopefully not at the expense of the Bank of Papua New Guinea’s own objectives of financial stability and low inflation.

Unfortunately, those who hope to see LNG revenues come charging in at the eleventh hour are likely to be disappointed.

Back in 2012, with the construction phase of the PNG LNG project nearing completion, economic activity tailing off, and pots of gold still far off on the horizon, the government stepped on the accelerator and rapidly expanded spending.

Admittedly, there was a certain logic to this: it provided needed economic stimulus, and fed efforts to drive change in Papua New Guinea’s ailing public services.

Yet here we find a lesson for future advocates of fiscal stimulus: if a government presses the accelerator, it better make sure the brakes are functioning.

In Papua New Guinea, we have seen time and time again that, although necessary, unwinding such a stimulus is politically nearly impossible.

The government knows that it has to reel in the budget deficit before financing challenges become too large to manage. It is for this reason that September’s 2015 Budget Strategy Paper will tell the same story as last year and plan a clear-headed effort at reducing the budget deficit.

PNG’s new Minister for Treasury, Patrick Pruaitch, has demonstrated his ability to identify and deal with similar challenges. However, he will be weighing his actions against a desire to maintain the National Alliance’s standing within the coalition government. This will partly be a balancing act, partly a test of resolve.

The first test will come in the careful formation of the next budget and second in sticking to it. Six months into 2014, the government appears to have fallen short in both.

This article was written by Mark Evans from PNG Attitude.