Economic Analysis - No Rate Cuts On The Horizon - DEC 2017


BMI View: The BPNG kept its monetary policy on hold in its September bi-annual statement, and while it sounded relatively dovish, we expect the central bank to remain on hold through 2018. Persistent fiscal deficits, higher inflation, and a recharged fed hiking cycle will likely leave little policy room for BPNG to ease any further to support growth.

The Bank of Papua New Guinea (BPNG) left its benchmark Kina Facility Rate (KFR) unchanged at 6.25% in its bi-annual monetary policy statement released on September 30, and indicated that it will keep interest rates on hold through March 2018. This was in line with our expectations for the central bank to stand pat on its interest rate decision through end-2017 to support growth ( see ' Neutral Policy For Now But Risks Remain Tilted To Upside ' , April 13). In its statement, the BPNG cited a downtrend in inflation and an improvement in the external sector as key reasons for its decision.

Although the central bank sounded relatively dovish in its monetary policy statement, which was accompanied by a downward revision to its inflation forecast to 6.0% in 2017 (from 6.5% previously) and 5.5% (from 6.0%) in 2018, our view is for the central bank to remain on hold through 2018. Persistent fiscal deficit, a pickup in inflationary pressures, and a renewed fed rate hiking cycle will likely restrict policy room for BPNG to cut rates any further over the coming quarters or risk triggering more selling pressure on the kina.

Money Printing To Feed Into Higher Inflation

BPNG has been effectively printing money to fund the government's fiscal deficit, and we caution that this could lead to a sharp rise in inflation over the coming quarters, even though it does not seem to be the case at present. Headline inflation declined to 5.8% y-o-y in Q217, from 6.0% in Q117, aided by favourable base effects from lower food prices as the effect of El Nino drought ended and lower import prices. However, we believe that all that money printing and high government credit growth will eventually feed into higher inflationary pressures in the coming quarters, and have revised our forecast for inflation to average 6.2% in 2018, from 5.7% previously.

To be sure, the central bank said in its statement that "in light of the government's tight cash flow and domestic financiers reaching their reaching their limit on sovereign exposure, the Central Bank had to assist the Government by buying Government Securities (Treasury bills and bonds) when the auctions were undersubscribed" - better known as the "Slack Arrangement". This is simply providing the government with the needed funds, removing any pressure on the government to make the much-needed adjustments to increase tax revenue and cut expenditure.

Sterilisation Will Lead To Undermine Private Sector

Although the central bank argues that it has actively sterilised the PGK1.6bn worth of liquidity generated by the Slack Arrangement through issuing central bank bills (CBBs) totalling PGK1.588bn to the market, implying that the direct funding of government deficit will not be inflationary, we note that this amounts to taking away credit from the private sector. It is also unclear how treasury and bills issued by the government can be undersubscribed, but the sale of CBBs by the BPNG would entice private sector buyers, unless the yields of the CBBs are significantly higher. Even if the sterilisation is successful, the act of redirecting credit from the private sector to the government itself is likely to undermine efficient resource allocation given the lack of transparency with regards to public procurement, and this could hamper PNG's long-term economic growth prospects.

Indeed, corruption is rampant in Papua New Guinea as shown by its dismal ranking of 136 out of 176 countries in Transparency International's Corruption Perception Index in 2016. Even though the O'Neill administration pledged to tackle graft in its early days in August 2012, anti-corruption efforts in the country faded in 2014 when the Prime Minister himself was entwined in a corruption scandal regarding illicit state payments to a law firm ( see 'Anti-Corruption Efforts On The Backburner, More Violence To Ensue', May 24 2017).

Kina To See Further Downside Pressure

We expect rising inflationary pressures globally, supported by the ongoing commodity price rally, to push the US Federal Reserve to gradually hike interest rates in the coming quarters. As the BPNG remains on hold and continues to print money to fund the government's deficit, narrowing real interest margins will likely weigh on the kina over the coming quarters, eventually forcing it to loosen its currency peg. Although the central bank said it has entered into a currency arrangement with Oil Search and Puma Energy respectively, whereby 50% of the purchases of crude oil will be settled in Kina, thus temporarily easing some of the demand in the market, this is unlikely to be a permanent solution.

Macroeconomic Forecasts (Papua New Guinea 2013-2019)
Indicator 2013e 2014e 2015e 2016e 2017f 2018f 2019f
National Sources/BMI
Population, mn 7.59 7.76 7.92 8.08 8.25 8.42 8.59
Nominal GDP, USDbn 20.9 21.5 20.7 20.5 21.5 23.4 26.3
GDP per capita, USD 2,847 2,874 2,708 2,631 2,703 2,876 3,166
Real GDP growth, % y-o-y 4.9 8.4 11.8 2.5 2.7 4.3 6.7
Consumer price inflation, % y-o-y, ave 4.4 4.7 6.5 6.5 6.7 5.7 4.5
Consumer price inflation, % y-o-y, eop 2.9 6.6 6.4 6.6 6.8 4.5 4.5
Exchange rate PGK/USD, ave 2.28 2.54 2.85 3.14 3.28 3.33 3.30
Exchange rate PGK/USD, eop 2.48 2.60 3.10 3.20 3.35 3.30 3.30
Budget balance, PGKbn -2.7 -3.0 -2.5 -3.1 -3.0 -3.1 -3.2
Budget balance, % of GDP -5.6 -5.5 -4.3 -4.8 -4.2 -4.0 -3.7
Goods and services exports, USDbn 6.4 9.1 8.4 8.7 9.1 9.4 10.4
Goods and services imports, USDbn 10.0 6.4 3.4 3.6 3.7 3.8 4.1
Current account balance, USDbn -3.5 2.9 4.8 7.8 8.1 8.3 9.2
Current account balance, % of GDP -16.6 13.4 23.3 37.9 37.5 35.6 34.9
Foreign reserves ex gold, USDbn 2.9 2.3 1.9 1.8 1.9 2.0 2.1
Import cover, months 3.4 4.4 6.5 6.1 6.1 6.2 6.0
Total external debt stock, USDbn 21.6 20.9 16.7 10.9 7.0 4.6 3.0
Total external debt stock, % of GDP 103.6 97.2 80.5 53.1 32.5 19.6 11.5
Crude, NGPL & other liquids prod, 000b/d 31.0 34.2 53.0 56.0 51.5 48.4 49.4
Total net oil exports (crude & products), 000b/d -8.1 -2.0 20.4 14.9 9.6 4.8 3.6
Dry natural gas production, bcm 0.1 4.6 8.9 10.7 10.9 10.9 13.1
Dry natural gas consumption, bcm 0.1 0.1 0.1 0.1 0.1 0.1 0.1