Papua New Guinea 'B/B' Ratings Affirmed; Outlook Stable


Foreign and Local Currency: B/Stable/B
For further details see Ratings List.

Overview

  • We expect Papua New Guinea's fiscal performance to improve during the period to 2022, owing to favorable resource tax collection and a tightening of expenditure.
  • We are affirming our 'B' foreign- and local-currency long-term ratings and 'B' respective short-term rating on PNG.
  • The stable outlook balances our view that PNG will remain a low-income economy with weak institutions and limited monetary flexibility, with our expectation that fiscal imbalances will improve during the next 12 months.

Rating Action

On April 23, 2019, S&P Global Ratings affirmed its 'B' foreign- and local-currency long-term ratings and 'B' respective short-term rating on Papua New Guinea (PNG). The outlook on the long-term rating remains stable. At the same time, we have lowered our transfer and convertibility assessment to 'B' from 'BB-'.

Outlook

The stable outlook balances our view that PNG will remain a low-income economy with weak institutions and limited monetary flexibility, with our expectation that fiscal and external imbalances will continue to improve during the next 12 months.
Upside pressure on the rating could build if the economy were to significantly outperform our current projections or if fiscal and debt metrics improve more rapidly than we expect.
Downward pressure could emerge if PNG's fiscal deficits weaken during the coming year. For example, this could happen if export revenues are lower than we expected, leading to diminished resource related dividends and tax collection or if there were an unexpected rapid increase in government spending without commensurate growth in revenues.

Rationale

The sovereign ratings on PNG reflect structural constraints inherent in a low-income economy dependent on extractive industries and served by weak institutions. The government has made headway in improving its fiscal position, cutting superfluous expenditure in recent years. The government has also benefitted from improving gas exports, supporting higher resource tax collections in 2018. However, weak payroll controls have hindered some of that progress. PNG's fiscal deficits, along with relatively weak economic growth, have propelled its general government debt, according to our calculations, above its soft ceiling of 30% of gross domestic product (GDP), and we forecast it will remain above 35% until 2022.
Institutional and economic profile: PNG's economic growth potential centers around upcoming resource developments
  • We expect economic growth to be relatively subdued until 2021, then to increase sharply to 5% in 2022 and beyond due to the construction of the Papua liquefied natural gas (LNG) project.
Economic growth suffered in 2018 due to an earthquake that hit the Hela and Southern Highlands province in February, leading to property destruction and fatalities. The economic impact was partially offset by PNG hosting the Asia Pacific Economic Cooperation (APEC) annual meetings, boosting construction and services in the country. We estimate real GDP growth was stagnant in 2018, from an average of 2.1% in 2016-2017.
The APEC meetings resulted in pledges of sizable future infrastructure investment projects. The United States, Australia, and Japan unveiled a US$1.7 billion project, increasing electricity supply across PNG. China elected to participate in the Ramu 2 hydroelectric power project, which we expect to commence this year.
We expect increased investments and a recovery in LNG production, as well as exports in other resource sectors, to boost GDP growth. Real GDP growth is set to improve to an average of 3.6% during 2019-2022. This includes our expectation of several new LNG projects, construction of which we expect to commence in 2021-2022. This production will come on stream in 2022, leading to a sharp acceleration in economic growth. PNG expects Papua LNG, the PNG LNG extension, and P'Nyang gas fields to drive LNG production to around five times current levels. In addition, PNG is conducting feasibility studies on the gold-copper mines of Wafi Golpu and Frieda River, and it expects both to be large-scale mining projects. While these provide a resource boost to the economy in the form of exports, increased infrastructure investment provides additional benefits for these rural areas, not only ones that are project-specific.
PNG continues to face pressing development needs. We estimate per capita GDP to be about US$2,600 in 2019, and the country is ranked 153 out of 188 countries on the United Nations Development Program's Human Development Index. PNG's real per capita GDP growth remains low compared with its peers. Moreover, the prevalence of crime in major cities deters investment, while governmental institutions are weak, in our view. Economic data inconsistency is another credit weakness. Despite some recent improvements, gaps and lags in economic and external data remain.
Public-sector transparency remains an issue, but is generally on an improving trend. The government has stated its intention to narrow the fiscal deficit and focus on PNG's longer-term strategy of economic diversification. The government's medium-term revenue and expenditure strategies provide a strong commitment to maintaining manageable debt levels. The government has introduced an Integrated Financial Management Information System that combines various public department accounts. We expect this to help boost government oversight, transparency, and potentially unlock revenue gains.
PNG has a moratorium that prevents new governments from disallowing no-confidence motions during the first 18 months of a prime minister's term. The moratorium expired in February 2019, and no challenges have yet arisen. Leadership challenges are common in PNG politics, but we expect no deviations from the policy continuum if one were to occur.
Flexibility and performance profile: We expect fiscal imbalances to improve
  • We expect fiscal deficits to narrow and net general government indebtedness to remain flat, at about 30% of GDP.
  • Debt composition is shifting more toward external debt.
The government has stated its commitment to narrowing fiscal deficits. New legislation that state-owned enterprises are required to remit 90% of revenue to the central government should strengthen collection revenues. Tax revenues should also improve after the expiration of tax exemptions in the mid-2020s. In the second half of 2018, increased LNG volumes boosted revenues higher than we expected, but higher commodity prices do not fully translate to increased government revenues due to the concessional arrangements of the PNG LNG project.
The government intends to consolidate its public finances, and we expect general government deficits to more than halve, averaging 1.5% of GDP during 2019-2022 from an average of 3.9% between 2015 and 2018. Through its 2018-2022 Medium-Term Fiscal Strategy, the government is focusing on bringing its nonresource primary balance to zero. PNG is targeting declining deficits to keep debt within its target of 30% of GDP. We project PNG's general government gross debt to peak at 39% of GDP in 2020. Our ratio differs from that of the government because we use a lower level of nominal GDP, sourced from the National Statistics Office, while the government uses its own estimate. We also include higher debt accumulation, above the government's finance needs, related to our assumption of a 6.7% depreciation of the kina, the national currency, during 2019-2022.
The government is increasing its reliance on external borrowings, with its debt strategy targeting a 50:50 split between domestic and external financing by 2022. Wider fiscal deficits in recent years have strained the ability of the domestic financial system to absorb large amounts of government debt, which is reflected in higher local interest rates. Diversifying the funding base has been achieved via a US$500 million draw down from PNG's Credit Suisse credit facility, budget support loans from the World Bank and Asian Development Bank, as well as the US$500 million sovereign bond issuance ("Papua New Guinea's Proposed Unsecured Notes Assigned 'B' Long-Term Foreign Currency Rating," published Sept. 4, 2018). The government has been able to use some of these proceeds to retire short-term domestic expensive debt, lowering the government's debt-servicing costs. We anticipate interest payments to remain broadly stable, but relatively high, at about 14% of general government revenues until 2022.
PNG's external position remains weak, despite signs of improvement. External debt ballooned between 2010 and 2013 during the LNG project's construction phase, with large current account deficits--financed by a combination of external debt and foreign direct investment--that averaged about 30% of GDP. The country's external imbalances have contracted during the past few years, with LNG production since 2014 resulting in repayment of external liabilities. We note that future LNG projects' could exacerbate external imbalances again during the construction phase, but we currently project a moderation in current account surpluses in 2021-2022, rather than the double-digit current account deficits of 2010-2013.
We forecast net external debt will fall to about 105% of current account receipts (CARs) in 2019, before increasing on the back of the new LNG project commencement. This comes after PNG's net external indebtedness peaked at 370% of CARs in 2012. We consider PNG's strong current account surpluses to overstate its external position. Project development agreements allow developers of extractive industry projects to keep export receipts in offshore foreign currency accounts. These U.S. dollar revenues deflate our external ratios, presenting a stronger external picture than would otherwise be the case. We expect net external indebtedness to peak at about 145% of CARs in 2022.
Stronger foreign-exchange inflows from new external loans and issuance have helped to increase reserves during the past 12 months to about US$2.2 billion. PNG held around US$4.4 billion in international reserves in 2011, declining to US$1.7 billion in 2017. This has also resulted in an easing of the shortage in U.S. dollars in PNG, helping to lower the value and shorten the clearing time of outstanding foreign-exchange orders. However, we believe PNG maintains extensive foreign-exchange restrictions. This is symptomatic of a currency that persists above the market-clearing exchange rate. PNG's exchange-rate arrangements are "crawl-like," according to the International Monetary Fund. During the past few years, the PNG kina has depreciated substantially against the U.S. dollar, falling 12% since 2015. This has contributed to elevated levels of inflation. More broadly, the Bank of PNG's weak monetary policy flexibility is a rating constraint. This weakness mainly reflects the limited transmission of monetary policy settings to the interest rates faced by borrowers, largely because of the high level of liquidity in the banking system.
PNG's banking system is stable, with limited competition. It relies heavily on deposit funding, which is supported by high levels of liquidity. It also has a small net external asset position and limited linkages to global markets. That said, the country's low income levels and credit concentrations increase banking system risks. Legal infrastructure and judicial system delays also pose challenges to enforcing creditor rights. Our Banking Industry Credit Risk Assessment for PNG is 9 (with 1 being the highest assessment and 10 being the lowest).
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