News Analysis: PNG needs structural changes before sovereign bond issuance

Papua New Guinea needs to devalue its currency and undertake structural changes within its economy to get the highest value of its first sovereign bond issuance that's needed to alleviate foreign exchange shortages, said economic watchers.

Papua New Guinea (PNG) has been shopping for buyers of a potential new sovereign bond fund in Boston, New York and London to raise one billion U.S. dollars after it failed to obtain a loan from the World Bank to help contain its economic problems due the petrodollar downturn.

The central government claims they have 1.6 billion U.S. dollars in reserve, enough to cover 9 months of imports, however the International Monetary Fund (IMF), which uses a different measuring method, said it will cover just three.

The IMF has been working with PNG to review its debt management strategy over the medium term, such as rolling short-term debt into longer dated bonds, however systemic issues in the PNG economy need addressing, rather than a stopgap measure likened to a "Band-Aid".

"PNG should have gone out with these bonds two years ago, that was the initial plan (in 2013)," Paul Flanagan, a former senior Australian and PNG treasury official told Xinhua.

"That would have been a balanced way with trying to deal with very, very large deficits."

CHANGES URGENTLY NEEDED

PNG needs to decrease the value of its currency before the bond issuance to give more money for core health and education spending, but also address underlying problems in their budget and balance of payments, analysts said.

Business confidence has been rocked by the impact of the severe El Nino induced drought and slumping oil and gas prices that have collapsed state revenues, causing an official downgrade in forecasted growth from 9.8 percent to 4.3 percent for 2016. The Asian Development Bank forecasts growth to slow to 2.4 percent by 2017.

The expected revenue from the Papua LNG project coming on-line in 2014 hasn't flowed either, as revenue from its mining an petroleum tax fall from an estimated 580 million U.S. dollars to just 102 million U.S. dollars in 2015.

As such, the central government has undertaken an austerity program more aggressive than that of Greece, seeking to adjust government expenditure by 13.5 percent of GDP, including slashing key priorities of health and education by over 40 percent by 2017. Greece and PNG have similar nominal expenditure cuts, however the Pacific nation's fiscal problems are not as severe.

"(PNG) needs to reduce their expenditure... in a phased way that protects key priorities (health and education)," Flanagan said.

"They should focus more (expenditure reduction) on things such as the politically motivated district support improvement program as well as items such as public administration."

But the foreign exchange crisis triggered in June 2014 when the central bank moved from a free-floating currency to a central trading range on fears of excessive profit taking by retail banks, is a major concern.

"It was the 17 percent appreciation on the 6th of June in 2014 that precipitated the problems PNG is facing now with a really bad shortage of foreign exchange," Flanagan said.

"The currency needs to (devalue) to deal with that issue (as well)."

The PNG Kina has fallen 14.6 percent per year since July 2014 to trade at 31.10 U.S. cents on Thursday from a strengthening greenback in the U.S. Federal Reserve's tightening cycle, however analysts believe the currency needs to fall another 40 percent for exports to become competitive.

BOND ISSUANCE MAY BE CHALLENGED THROUGH COURTS

The bond issuance however will also find internal political problems as Prime Minister Peter O'Neill's political opposition seeks to challenge the debt raising validity through the courts.

Government legislation stipulates the country's debt to GDP limit cannot exceed 35 percent, however the 2016 budget papers showed due to the country deficit over the past three years, the ratio is now at 35.2 percent.

"I am waiting for the government to get a loan and I'll take them to court as this is illegal," opposition leader Don Polye said in a statement.

But the PNG government may have an out after revising its 2006 GDP estimates up by 43 percent, therefore significantly reducing the debt to GDP ratio to 28.8 percent, on a very narrow definition of what constitutes official debt.

PNG economic watchers are skeptical of the revisions and are awaiting IMF confirmation. Currently the IMF calculates the ratio at 39.7 percent of GDP, which does include some state-owned enterprise debt.

PNG Prime Minister Peter O'Neill currently has the numbers to ram legislation through to raise the debt ceiling, just as he did for a 1.3 billion U.S. dollar loan from investment bank UBS for a 10-percent stake in PNG oil and gas producer Oil Search Ltd. That matter is being challenged in the courts.

DISTRESSED DEBT BUYERS ARE CIRCLING

Global credit agencies Moody's and Standard & Poor's currently have PNG's sovereign debt rated at B+/B (outlook negative), five levels below junk status, noting the low global oil and gas prices, slumping government revenues and governance issues as a drag on the economy.

But some emerging market, or "frontier economy" investors who purchase distressed debt are circling.

Though capital raising in "frontier" economies slowed in 2015 after Ghana accepted double digit yields, according to the Financial Times, there are promising signs for PNG after Mongolia and Sri Lanka, a similar situation to the Pacific heavyweight, managed to raise capital earlier this year.

For this issue, however, the effective interest rate would be at least 11 percent, and there is potentially a lot more on foreign exchange risk if the Kina isn't depreciated, Flanagan said.

"I could see the cost being up to 25 percent per year, and that's too high for them," Flanagan said.

Political instability stemming from a corruption investigation linking O'Neill has also increased risk significantly over the past month after student protests and retaliatory attacks sparking a tribal war in the north of the country.

That's not to say the sovereign bond would not be a positive step for the Pacific's strongest economy, but there are still lots to do and risks to be managed for the government. Endit