Moody’s Investor Services downgraded PNG’s sovereign credit rating just over one year ago citing two key reasons of (1) foreign currency reserves being inadequate resulting in balance of payments pressures; and (2) the government’s difficulties in financing the large budget deficit, especially domestically. The Moody’s media release announcing the credit downgrade in 2016 can be found here.
It is clear in Moody’s recent announcement (available here) that those twin challenges remained unchanged, the release states that the “B2 rating and stable outlook reflect significant pressure on government financing and external liquidity amid structurally low commodity prices and continued weak GDP growth.”
Moody’s neatly summarizes (see here) that the key macroeconomic problems are with the Government’s fiscal policy management and the Bank of PNG’s poor performance in managing the balance of payments and exchange rate:
- “A backlog of foreign-exchange payments highlights a greater degree of balance of payments stress than PNG’s metrics capture. Clearing this backlog will continue to place high demands on the country’s foreign reserves.”
- “The rise in government debt since 2011, in contravention to fiscal rules, is an indication of limited fiscal policy effectiveness. Such debt breached the legislated limit of 30% of GDP in 2016.”
O’Neill’s statement in response was that his “government has worked tirelessly, since the ratings downgrade two years ago in April 2015, to address the challenges the country faces, and we have maintained economic stability” and that this “exposes the lies and misinformation peddled” by various commentators (see here).
A careful read of the Moody’s statement when the downgrade happened last year (not 2015 as O’Neill states) laid out the conditions necessary for the rating to be upgraded. It specifically stated that:
- external borrowing by the government will not materially help the pressure on exchange rate reserves and improve the credit rating;
- a real enduring change in the government’s fiscal position measured by falling debt ratios would improve the credit rating; and
- the development of new resource projects or expansion of existing projects would uplift the credit rating.
So let’s untangle each of these three points and see what progress has been made.
PNG’s creditworthiness remains dependent on the extractive resources industries
The last bullet point above applies irrespective of any government. This in fact, is the crucial element of both the Moody’s and IMF’s debt sustainability analysis. New resource projects or an additional train to PNG LNG or the mine life extension of Ok Tedi will boost economic activity and raise the level of public revenue. This will enable PNG to grow out of the debt problem it currently has. Major tax receipts and dividend flows from PNG LNG are not expected until the end of this decade and the economic boost from the construction phase of the project has now dissipated.
Off-Shore borrowing by the Government will not help
External borrowing by the government is not the remedy to the Bank of PNG’s foreign reserves problem. It will need to be repaid in the same currency that it is received in and there will be interest payments to meet as well. The pressure for an exchange rate depreciation could lead to a ballooning of debt in Kina terms. The foreign currency rationing has allocative effects that impact the different sectors in the economy. As there is a queue for foreign currency, the Bank of PNG makes sure that the government gets first call on limited foreign currency to meet its debt obligations reducing the amount available for the private sector and individuals.
Moody’s diplomatically point out that the indicators (or metrics) used by Bank of PNG to defend the health of foreign exchange position are incorrect. It’s the closest an international organization will come to calling the indicators lies. It’s a big statement and one that O’Neill (and Bakani) deliberately chooses to ignore.
One of the reason why we should doubt Bank of PNG’s indicators like foreign currency import cover is that the level of imports has been artificially reduced by the Bank of PNG. Imports are not coming into the country at the levels demanded – this is because Bank of PNG is not putting liquidity into the foreign currency market to allow this. The demand, however, for foreign currency is not being reduced because the Kina price of foreign exchange isn’t moving to match the scarcity of foreign exchange. When buai is in short supply then the price goes up – the foreign exchange market works in a similar manner or at least it would if the Bank of PNG wasn’t imposing controls on the quantity and price of foreign exchange. There needs to be a steady and measured adjustment but I agree with Bakani that you can’t allow the external value of the Kina to go into free-fall and a managed depreciation is required.
The Government’s fiscal position has not improved
The headline indicator of the Government’s fiscal position is the level of public debt and ratios using GDP. Has this improved under O’Neill as Prime Minister and Pruaitch as Treasurer? It hasn’t. The deficit continues to widen with public revenue now falling two years in succession and expenditure continues to be sticky downwards. The deficit level in 2015 was K2.5 billion (4.1% of GDP) and in 2016 K3.1 billion (4.6% of GDP) – it has grown.
Debt levels continue to grow and O’Neill seemingly wears this dismal performance as a badge of honour and not only that but he promises to borrow more (see here). It is the Department of Treasury that flags the breach by the O’Neill Government of the debt ratio legal limit of 30% in the 2016 Final Budget Outturn Report (see here).
But what does Moody’s say? It tells us in its 2016 statement (see here) that Moody’s preferred measured of debt affordability is public interest payments as a share of government revenue. Under the O’Neill Government this ratio has progressively climbed – meaning that our debt indicator is worsening not improving, as shown in Figure 2. I’m not sure where in Figure 2 O’Neill sees “success”. The performance is not credit rating enhancing – quite the opposite.
Not quite there yet…
So of the three conditions necessary for a credit rating upgrade only one (a pipeline of projects that will go into development) is likely to be satisfied and this is not greatly dependent on which government is formed. The twin challenges of budget difficulties and international reserve pressures are going to need some steel by the new Parliament to take the tough decisions to repair our budget and strengthen the external position of our economy.
Perhaps O’Neill and his spin-doctors should try some introspection before issuing statements about “exposing lies and misinformation”.
