An edited version of my The PNG Woman column published in the Sunday Chronicle on 7 May 2017
The O’Neill’s Government’s debt to GDP (Gross Domestic Product) statistics are a myth, to paraphrase James Marape’s illuminating quote – “LNG is a myth”. We now see on the campaign trail reports that O’Neill and PNC (People’s National Congress Party) promises the country that it will borrow more and burden us more public debt if returned to office. Alas Papua New Guinea cannot be built on a mountain of debt.
It is an understandable stance from the government to talk up the economy and its budgetary position to lift the confidence of our people, investors, consumers and the private sector generally. But more so the siren call of the electoral cycle compels the inconvenience of the truth to be unceremoniously pushed to one side by Peter O’Neill and PNC.
O’Neill presents a defence of the sharp increase in debt levels over the last Parliament term by nearly K15 billion (see Figure 1 and use the left-hand scale) by pointing out that the ratio of national government debt to GDP has fallen. But the soothing words of the O’Neill Government are undone by its own official statistics in successive national budget including its most recent, the 2017 National Budget. There are errors of omission and commission.
Whilst the debt to GDP ratio is the standard metric of solvency and debt sustainability there are several problems with the O’Neill Government’s measure. The first is that the wrong numbers are being used for the deficit, debt and for GDP. Secondly, GDP is the wrong measure for PNG as this captures income made in the country – but not all of this income is retained within our borders – that is not all this money belongs to Papua New Guinea. In any case GDP cannot be used to pay off debt as it is the annual income of the whole country not that of government alone. We can also assess debt sustainability by looking at the government’s ability to repay its debt by also using the ratio of government debt to government revenue. We see in Figure 1 (use the right-hand scale) that the line has grown from when O’Neill first took office to around 260% of that starting level. In words, the government now has debt levels that are just short of three times the level of annual government income it has to pay it off. This is the poisoned chalice that awaits the 10th National Parliament.
GNI (gross national income) not GDP measures the health of our domestic economy. What we are interested in is the money that is made by Papua New Guineans and retained in the country – GNI. The $20 billion PNG LNG Project is jointly owned by the government, around 20%, and the rest by investors listed on stock exchanges overseas. So we can expect anything up to 80% of total dividends from PNG LNG to leave the country – repatriated as profits, as well as additional amounts as project debt repayments by PNG LNG. The tax income from PNG LNG is reduced by the complete amount of royalties paid to Project landowners and part of the amounts paid for development levy, effectively taxpayers pay for this and not the PNG LNG Project (see my article here) . So GNI will exclude from GDP the net income accruing to foreign companies that have invested in PNG. GNI will be less than GDP. This will increase the debt ratio of the government if the correct measure is used.
The new government nominal GDP statistics have been challenged by the IMF (International Monetary Fund) who undertakes an annual economic review of each country including Papua New Guinea. The IMF’s assessment was that the GDP statistics are overstated. Independent commentators have pointed out that for 2017 the value of the economy is inflated by K6.3 billion (see here). When corrections are made to the GDP statistics the O’Neill government is shown to be breaching law by exceeding the debt ratio limit of 30%. The breach is greater if GNI is used.
To gauge the disarray with the Government’s GDP statistics we need only look the 2017 National Budget documents. In Volume 1 of the budget document set, the Government presents its estimates of spending, revenue, borrowing and of economic growth. This official government document presents explicitly four different sets of a nominal GDP series when there should only be one. The choice of the series makes a big difference in whether the government has breached the debt ratio set by law and the use of one set of numbers points to an economic contraction in 2016 (see my earlier blog post here).
The new fiscal accounting standard adopted by the government moves towards an accrual based accounting framework with a balance sheet approach. The second innovation, as explained in the government’s national budget documents, is to expand coverage to include accounting for all government entities such as state owned enterprises to get a comprehensive picture of the government’s total fiscal impact and debt position.
Over the years we have witnessed incorrect presentation as revenue several items that are correctly classified as balance sheet movements. We have also seen large spending done off-budget. The consequence of this has been an overstating of revenue and an understating of expenditure to allow the appearance of a budget deficit smaller than it actually is. A larger deficit generally leads to more debt.
The second error with the fiscal accounts is that the gross debt numbers do not account for off-budget transactions like the UBS loan of A$1.2 billion. We see on this that our Supreme Court has ruled at the end of last month that Peter O’Neill had a case to answer to in relation to breach of processes authorizing the borrowing of A$1.2 billion and the manner in which consultants and advisors were engaged.
The more pressing problem relates to the financing of the large budget deficits. For several years the Government has expressed optimism about accessing the international capital markets to issue a debut sovereign bond. This has not happened although several other countries with similar credit ratings to PNG have issued bonds. A sovereign bond is a loan that has periodic interest payment but the loan itself will be repaid in a single payment at the end of the term, usually around 10 years. In a decade, the government’s dividend streams from the gas project should allow the bond to be repaid or it could simply be refinanced with another sovereign bond issue. The lack of appetite for the debut bond issuance may suggest a lack of confidence in the PNG’s fiscal management and governance.
For all the talk of high domestic liquidity we see that there is little ability by investors in the government domestic debt market to buy huge additional amounts of government paper. The two key participants in the market are the commercial banks and the pension funds, which have prudential limits on the amount of government debt it can hold.
Many businesses have endured periods where a cash crunch forces them into liquidation even though their balance sheets were strong. Unlike PNG businesses struggling to find sufficient working capital the government has recourse to a very large sympathetic bank – the Bank of Papua New Guinea. Without Central Bank financing the O’Neill Government would have run out of money – it truly had a cash crunch and would have defaulted on various obligations including presumably the pay of its employees – public servants. In 2014, when the oil price shock hit, the BPNG bailed the government out with a loan of K1.5 billion, of which K0.7 billion was repaid in 2015. Then last year, Bank of PNG again provided the O’Neill government with a K1.8 billion loan. This funding papered over the deep structural problems of the budget that will need repair sooner rather than later. The K1.8 billion of injection in the monetary system by the BPNG does raise grave questions about its conduct of monetary policy and the independence of the central bank.
PNC has now declared the establishment of an endowment fund for education as well as an agriculture fund. An endowment fund is simply a savings fund. Some initial capital is deposited into the fund and this is then invested. Typically this seed capital is not drawn down but only the returns from investment of the capital. The credibility of these PNC election commitments is greatly undermined by two failures of O’Neill’s PNC in their term in government. The first is that the government has not established the PNG Sovereign Wealth Fund over the last five years.
Secondly, the O’Neill has failed to achieve any budget surpluses which is required if you want to set up a true savings fund. Additionally, the returns from the investments of the savings funds will need to be greater than the cost of government borrowing. Both need to be satisfied if the net worth of government is to improve with a savings funds.
A key condition for a declining debt ratio is for economic growth rates to be greater than real interest rates of government debt. The 2017 National budget shows that this condition is projected to be satisfied but relies on negative real interest rates. Much of government domestic borrowing is from our superannuation funds and because of their need to maintain a portfolio of safe liquid assets these funds will continue to be invested in Treasury Bills. Negative real interest rates lead to a transfer of wealth from our workers, who are superannuation contributors, to government through reduced purchasing power.
The second risk of negative real interest rates is for risky or low return public investment as the borrowing costs are cheaper. The long-term consequence of this is to reduce the growth dividend that would otherwise be expected with the right investments in public infrastructure for example.
The immediate real cost of the O’Neill Government’s addiction to debt is a tax by stealth on economic growth.
Note 1 : The Sunday Chronicle article was finalized before the 2016 Final Budget Outturn Report was released by the Minister for Treasury (see here). The Government’s own report shows that the O’Neill Government breached the 30% debt ratio limit set by law.
Note 2: In my published Sunday Chronicle article I was critical of National Statistical Office for not producing real GDP estimates, which I have removed from this edited version. In the following edition of the Sunday Chronicle I corrected this and commended NSO for the update (available here).