PA P U A NE W GU I N E A

PAPUA NEW GUINEA PAPUA NEW GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 CONTENTS I. General Characteristics 1.1 Introduction 1.2 A Brief History 1.3 The Bougainville Secession 1.4 The Law and Order Dilemma 1.5 A Review of Current Conditions II. Macroeconomic Review 2.1 Introduction 2.2 A Macroeconomic Appraisal: GDP & Its Components 2.3 Fiscal Management 2.4 Monetary Policy 2.5 PNG’s External Accounts 2.6 PNG’s Debt and Payments 8 13 III. Economy by Sector 3.1 Agriculture, Forestry and Fisheries 3.1.1 Forests and Forest Resources 3.2 Oil and Minerals 3.2.1 Oil & Minerals and Economic Development 3.3 Manufacturing, Construction and Power 3.4 Commerce, Transport and Financial Services 3.5 Services 18 IV. 23 What Lies Ahead ACKNOWLEDGMENTS This report was written by Wali M. Osman, with grateful acknowledgment to the following: Bank of Papua New Guinea, US Embassy, Port Moresby, Papua New Guinea Chamber of Manufacturers, Papua New Guinea Forest Industries Association, Inc., Institute of National Affairs, Investment Promotion Authority, Department of Lands, PNG Chamber of Mines and Petroleum, Australian High Commission, and especially Bank of Hawaii (PNG) Ltd., and a number of business and public leaders for their insight and assistance. Cover Photos: Aerial view of Port Moresby, Papua New Guinea, Rocky Roe, Rocky Roe Photographics, Papua New Guinea In-Text Photos: Rocky Roe, Rocky Roe Photographics, Papua New Guinea ©1998 Bank of Hawaii. All rights reserved. PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 TO OUR FRIENDS AND ASSOCIATES: Lawrence M. Johnson Richard J. Dahl We are pleased to present our first report on the economy of Papua New Guinea, a study of current conditions and an analysis of factors that will shape the economic future of this South Pacific nation. Bank of Hawaii established a presence in Papua New Guinea in March 1997, with the acquisition of the former Indosuez Niugini Bank Ltd., now known as Bank of Hawaii (PNG) Ltd. With branches in Port Moresby and Lea, Bank of Hawaii is positioned to offer a full range of quality financial services to the people and businesses of PNG, just as we do in the South Pacific economies of Fiji, French Polynesia, New Caledonia, Vanuatu, Solomon Islands and elsewhere throughout the Pacific region. Papua New Guinea is endowed with abundant resources and holds great promise. As the 21st century, the Pacific century, unfolds we believe PNG has the potential to become a regional economy. We at Bank of Hawaii look forward to playing a part in the growth and development of this promising economy. We offer this report as a resource to those who share our interest in and commitment to the Pacific region. We invite you to visit the Bank of Hawaii web site at <www.boh.com> to view reports on other Pacific economies and to contact any Bank of Hawaii branch to learn more about our full range of financial services. Sincerely, Lawrence M. Johnson Chairman and CEO Richard J. Dahl President and COO PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 Dotted lines group islands under the same political jurisdiction. Unbroken lines denote cultural affiliations. Adapted from The Pacific Islands, 1992, courtesy of the East-West Center’s Pacific Islands Development Center and the Hawai’i Geographic Society. 2 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 PAPUA NEW GUINEA DISTANCE FROM Australia: 1,200 miles Honolulu: 4,100 miles Los Angeles: 6,600 miles CURRENCY 1997 exchange rate: 1.433 Kina per US dollar ECONOMY Income sources: agriculture, forestry, fishing, mining, manufacturing Gross Domestic Product (GDP) in 1997: K6,108.4 million US$4,260.6 million LAND AREA Total islands: over 600 Total land area: 465,000 square kilometers (179,490 square miles) Largest island: New Guinea Capital: Port Moresby POLITICAL STATUS Parliamentary Democracy POPULATION 1997 estimate: 4.23 million 1990-97 growth rate: 1.9 percent a year Average life expectancy: 57 years Reprinted from AusAID, Economic Survey of Papua New Guinea, August 1997 3 PACIFIC ISLANDS FACT SHEET US DOLLAR-DENOMINATED ECONOMIES Capital/ Distance from (miles) Agana/ Honolulu 3,800 Tokyo 1,600 153,700 Land Area (square miles) 212 Notable Geographic Characteristics One island. Major US naval base and regional transshipment center at Apra Harbor. In hurricane path. COMMONWEALTH OF THE NORTHERN MARIANA ISLANDS (CNMI) 63,000 177 Saipan the largest island, Tinian and Rota next, 14 others in the chain. 125 miles north of Guam. US territory closest to Asia. Garapan, Saipan/ Honolulu 3,700 Tokyo 1,500 US dollar FEDERATED STATES OF MICRONESIA (FSM) 105,506 270 607 islands and atolls, Pohnpei 130 square miles, other major islands Kosrae, Yap and Chuuk. The 4 FSM states span 1,700 miles from east to west. Kolonia, Pohnpei/ Honolulu 3,100 Hong Kong 3,100 US dollar REPUBLIC OF PALAU 18,146 170 343 islands, the main group encircled by a hundred mile reef. Babeldaob 136 square miles. 8 other inhabited islands. Rock Islands. Koror/ Honolulu 4,600 Tokyo 2,000 Hong Kong 1,700 US dollar REPUBLIC OF THE MARSHALL ISLANDS (RMI) 62,924 70 34 coral islands, 870 reefs, highest elevation 33 feet above sea level, average elevation 7 feet. Majuro/ Honolulu 2,300 Guam 1,800 US dollar AMERICAN SAMOA 58,900 76 5 islands, 2 atolls. Pago Pago Harbor. Home of newest US national park. In hurricane path. Pago Pago, Tutuila/ Honolulu 2,600 Los Angeles 4,800 US dollar 462,176 975 130 islands, mostly atolls in 5 archipelagoes. Tahiti the largest island, 400 miles square, maximum elevation 7,464 feet. Main island, Grande Terre 250 miles by 30 miles (larger than the Hawaiian Islands together), mostly mountainous. Several small islands. Papeete, Tahiti/ Honolulu 2,700 Los Angeles 4,100 Paris 10,400 Tokyo 5,900 Noumea/ Honolulu 3,900 Paris 10,400 Brisbane 900 French Pacific franc (F CFP) 2 main islands, highest elevation 2,493 feet. Wallis Island/ Honolulu 2,700 Paris 10,000 French Pacific franc Eastern half of the island of New Guinea. Largest by far Pacific island-state land mass. Other main islands New Ireland, New Britain and Bougainville. Port Moresby/ Honolulu 4,300 Cape York, Australia 300 Tokyo 3,100 Hong Kong 3,100 Kina Population GUAM TOTAL/AVERAGE Currency US dollar NON-DOLLAR ECONOMIES FRENCH POLYNESIA 220,524 1,609 NEW CALEDONIA 196,836 7,376 WALLIS AND FUTUNA 14,800 106 PAPUA NEW GUINEA (PNG) 4,150,000 179,490 4 French Pacific franc GDP (US$ million current) 3,109.0 Per Capita GDP (US$) 20,228 English, Chamorro, Carolinian 650.6 10,327 Tourism, garment manufacturing, trade and services English, 8 major local languages 215.8 2,045 US payments, government services, fisheries, tourism English, Palauan, SonsoroleseTobian 159.8 8,806 US Compact payments, tourism English, Marshallese dialects 102.1 1,623 US payments, Kwajalein Missile Range, government services, copra, fisheries English, Samoan 253.0 4,295 Tuna canneries, government services, remittances from Samoans overseas 4,490.3 9,716 French, Tahitian 3,655.8 16,578 Payments from Metropolitan France, tourism, Tahitian pearls French, 30 Kanak dialects 3,717.5 18,886 25.0 1,689 Payments from Metropolitan France, nickel, agriculture and ranching, tourism, aquaculture French transfer payments, trochus shells 4,957.0 1,194 Major Languages English, Chamorro, also Tagalog, Japanese French, East Uvean, East Futunan English, Tok Pigin, Hiri Motu, hundreds of vernaculars Major Income Sources Tourism, military, trade and services Political Status US territory since 1898. Guam Organic Act of 1950 conferred US citizenship. Some push for commonwealth status. After WWI under Japanese mandate. In 1947 became part of US Trust Territory of the Pacific. Since 1978 a Commonwealth of the US. Islanders are US citizens. After WWI under Japanese mandate. In 1947 became part of US Trust Territory. Became sovereign in 1979. In compact of free association with US as of 1986. After WWI under Japanese mandate. In 1947 became part of US Trust Territory. Became sovereign in 1994, in compact of free association as of 1994. Compact ends 2044. After WWI under Japanese mandate. In 1947 became part of US Trust Territory. Became sovereign in 1979. In compact of free association since 1986. US territory since 1899. Samoans are US nationals. French controlled from the 19th century. Overseas territory of France since 1957. Active independence movement. 1853 became a French possession. Overseas territory of France since 1946. Relation to France under review. French controlled from the 19th century. Overseas territory of France since 1961. Under Australian & German control before WWI. Administered by Australia after WWII. Independent within the British Commonwealth since 1975. The Bougainville secessionist movement ended by a formal treaty in April 1998. Minerals, oil and gas, forestry, agriculture, tourism 5 Major Sources of External Investment US, Japan, Korea Major Sources of Future Income Tourism, services Japan, Korea, Hong Kong, US Tourism, services US, Japan Compact status uncertain as of 2001. Fisheries development, tourism Compact money, tourism Japan, US US, Japan US US military. Compact status uncertain as of 2001. Fisheries. Canneries, remittances, US entitlements Metropolitan France French transfers, tourism, pearls Metropolitan France French transfers, nickel, tourism, agriculture, aquaculture French transfers Metropolitan France Australia, UK Minerals, oil, timber, fisheries, tourism PACIFIC ISLANDS FACT SHEET (continued) Population COOK ISLANDS 19,600 Land Area (square miles) 92 SAMOA 170,000 1,158 FIJI 815,045 7,055 82,400 266 393,000 11,197 99,000 386 185,000 4,707 11,200 8 NIUE 2,500 101 TOKELAU 1,800 4 10,200 10 TOTAL/AVERAGE 6,371,905 213,565 GRAND TOTAL/AVERAGE 6,834,081 214,540 HAWAII 1,205,126 6,423 KIRIBATI SOLOMON ISLANDS TONGA VANUATU NAURU TUVALU Notable Geographic Characteristics 15 widely dispersed islands including volcanic peaks and atolls. Rarotonga the largest island 26 miles square. In hurricane path. 4 inhabited islands, 5 uninhabited. Highest point 6,100 feet, Mt. Silisili on Savai‘i. In hurricane path. 320 islands. Viti Levu 4,000 miles square, Vanua Levu 2,100 miles square. Major islands are mountainous and forested to windward. 33 islands scattered 2,400 miles east to west, 1,300 miles north to south. Almost entirely low-lying atolls, Christmas Island the largest. 850 mile long double island chain. 6 mountainous main islands, Guadalcanal 2,080 miles square. Main islands volcanic, some 150 coral atolls, 36 permanently inhabited. 80 scattered islands, several active volcanoes. Largest island Espiritu Santo 1,500 miles square, highest point 6,158 feet. A single island with a 100 foot high central plateau of now nearly exhausted phosphate-bearing rock. Coral island rising 65 feet from the ocean and another 130 feet to a central plateau. 3 atolls with islets 10 to 16 feet above sea level. In hurricane path. Capital/ Distance from (miles) Rarotonga/ Honolulu 3,000 Wellington 2,000 Currency New Zealand dollar Apia/ Honolulu 2,600 Suva 700 Brisbane 2,500 Tala Suva/ Honolulu 3,100 Sydney 2,000 Tokyo 4,500 Fiji dollar Tarawa/ Honolulu 1,300 Tokyo 3,900 Australian dollar Honiara, Guadalcanal/ Honolulu 3,960 Port Moresby 900 Nukualofa/ Honolulu 3,100 Brisbane 2,000 Port Vila, Efate/ Honolulu 3,500 Tokyo 4,100 Solomon Island dollar Nauru/ Honolulu 2,800 Banaba, Kiribati 200 Alofi/ Wellington 1,800 Suva 800 Nukunonu/ Honolulu 2,300 Wellington 3,800 Australian dollar Pa‘anga Vatu New Zealand dollar New Zealand dollar 5 atolls, 4 coral islands, maximum elevation 16 feet above sea level. Funafuti/ Suva 700 Sydney 2,500 Australian dollar 4 main islands. Island of Hawaii 4,028 miles square, highest point of Mauna Kea 13,796 feet. Mauna Loa and Kilauea on Hawaii both active volcanoes. Maui 727 miles square, Oahu 597 (Waikiki), Kauai 552. In hurricane path. Honolulu/ San Francisco 2,400 Los Angeles 2,600 Washington 4,800 Tokyo 2,500 US dollar SOURCES: Central Intelligence Agency, The World Factbook, 1994; Norman and Ngaire Douglas, editors, Pacific Islands Yearbook, 17th edition, Suva, 1994; Europa, The Far East and Australasia, 1994; Gary L. Fitzpatrick and Marilyn J. Medlin, Direct-line Distances, International Edition, New Jersey, 1986; International Monetary Fund, International Financial Statistics, June 1996; David Stanley, Micronesia Handbook, Chico, California, 1989; David Stanley, South Pacific Handbook, 5th Edition, Chico, California, 1993; State of Hawaii Department of Business and 6 GDP (US$ million current) 50.9 Per Capita GDP (US$) 2,596 English, Samoan 170.0 1,000 Agriculture, remittances from abroad, tourism, manufacturing English, Fijian, Hindi 2,148.9 2,637 54.6 662 Sugar and other agriculture, tourism, forestry, fishing, mining, garment industry Agriculture (copra), remittances, aid English, Solomon Islands Pijin, more than 80 vernaculars Tongan 343.7 875 124.9 1,262 French, English, Bislama 247.0 1,335 English, Nauruan 80.7 7,205 English, Niuean 7.1 2,825 English, Tokelauan 1.2 667 English, Tuvaluan 3.8 373 15,588.0 2,446 Major Languages English, Cook Islands Maori English, Micronesian English 20,078.3 2,938 35,146.4 29,164 Major Income Sources Government aid, services, tourism Political Status Self-governing since 1965 in association with New Zealand. Cook Islanders are citizens of both Cook Islands and New Zealand. Under German control before WWI, New Zealand after. New Zealand trusteeship after WWII. Independent since 1962. Annexed by Great Britain in 1874. Became independent within the Commonwealth in 1970, rejoined the Commonwealth in 1997. Annexed by Britain in 1919. A republic within the British Commonwealth since 1979. Agriculture, timber sales, fishing and fish canneries, aid Agriculture, tourism Major Sources of External Investment New Zealand Major Sources of Future Income Tourism New Zealand, Japan Agriculture, tourism, light manufacturing Agriculture, tourism, mining, light manufacturing Fisheries development Australia, New Zealand, EU, Japan NA Agriculture and ranching, tourism, Offshore Finance Center, services Phosphates and investments from phosphates Subsistence activity, government aid Subsistence activity, government aid British protectorate as of 1873. Politically independent within the Commonwealth since 1978. British protectorate as of 1900. Independent monarchy within the Commonwealth. Anglo-French New Hebrides Condominium in 1906. Republic of Vanuatu within the British Commonwealth established in 1980. From 1919 administered by Australia. Became an independent republic in 1968. Self-governing since 1974 in free association with New Zealand. Non-self-governing territory administered by New Zealand beginning 1925. Australia, Japan Agriculture, fisheries, tourism NA Tourism, agriculture Australia, Japan Tourism, agriculture NA Investments from phosphate NA Tourism NA Subsistence activities, government aid Subsistence activities, government aid Subsistence activity, government aid Independent state within British Commonwealth since 1978. NA Tourism, services, trade, government Annexed in 1898, became a US territory in 1900, became a state in 1959. US, Japan, Australia Tourism, defense, services, trade, government Economic Development, Data Book 1995, Honolulu, 1996; Peter W. Thomson, Trade and Investment in the South Pacific Islands, Honolulu, 1989; World Bank, World Development Report, 1996; various Bank of Hawaii economic reports, 1992–97, and other sources. (Rev. 4/22/98) For further information, contact Bank of Hawaii Regional Economist Wali M. Osman at 808-537-8349 (phone), 808-536-9433 (fax) or wmosman@boh.com (e-mail). 7 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 I. GENERAL CHARACTERISTICS 1.1 INTRODUCTION of just over $800. PNG’s GDPfell from an estimated US $5 billion in the mid-1990s mainly due to the effects of recent exchange rate fluctuations. Its current per capita GDP (in US dollars) places PNG in the bottom 12 percent of the 40 economies classified by the World Bank as middle-income economies whose per capita GDPranges from $770 to $2,900. PNG is in the same per capita GDP category as Bolivia, Macedonia, Indonesia and the Philippines. In recent years, as many as 30,000-35,000 expatriates, mostly Australians, have lived in PNG to advise its government and businesses in their efforts to modernize PNG and achieve higher standards of living. Although relatively well endowed with land, minerals and a large exclusive economic zone, PNG’s economy has grown slowly and developed erratically after independence in 1975. Observers expected more rapid and consistent economic growth because, theoretically, a large land mass rich in minerals and natural resources plus a relatively small population is an ideal combination for rapid economic growth. Such a mix is rare in developing regions, especially the Pacific. However, despite this abundance of land, mineral and ocean resources, without adequate skilled labor and an institutional structure essential to an efficient market economy, PNG could not produce sustained economic prosperity. Domestic strife, especially the secessionist rebellion in Bougainville that started in 1988 and did not formally end until April 1998, contributed to PNG’s inconsistent economic growth. However, closure of the Bougainville Copper Mine in 1989 did not lead to production cutbacks in overall mining and oil output as expected. In fact, mining and oil production increased from other sources in the 1990s to make up for the loss of the Bougainville production. PNG’s sometimes rapid growth in GDP, though inconsistent, was barely sufficient to keep real per capita GDP (averaging 2.2 percent in 1990-97) in pace with population growth (averaging 1.9 percent in 1990-97). PNG has been one of the few Pacific economies in the 1990s to do so, suggesting no erosion in real purchasing power. However, given PNG’s much larger population and resources compared to other Pacific islands, this performance is below its long-term potential output level. As the Asian economic and financial turmoil of the past 12-15 months subsides, and some of the area’s major economies resume normal production and distribution activities in the months ahead, PNG must begin adopting institutional and market reforms that would make it a more open and efficient economy. PNG is in a far better position The independent nation of Papua New Guinea (PNG) is one of the South Pacific’s largest island countries. Comprised of some 600 islands, atolls and coral reefs with a total land area of 465,000 square kilometers (179,490 square miles), PNG is 15 percent larger than California and nearly 28 times the land area of Hawaii. The Island of New Guinea, whose western half is the Indonesian province of Irian Jaya, accounts for over 80 percent of PNG’s total land area, and is the world’s second largest island after Greenland. Smaller islands include the Bismarck Archipelago (mainly New Britain, New Ireland and Manus) and the northern part of the Solomon Islands (mainly Bougainville and Buka). PNG’s climate is consistently hot and humid throughout the year, with average temperatures ranging from 22 degrees C (72 degrees F) to 33 degrees C (91 degrees F). Of the 700 languages spoken in PNG, Melanesian Pidgin and Hiri Motu are the two most widely used, especially in urban areas such as Port Moresby, the capital. English, however, is the language of business and government. PNG is widely influenced by Australia due to decades of close political, economic and business ties. Australia provides PNG the bulk of its foreign economic assistance, and is among its major trading partners and sources of both physical and human capital. Although more than half of its population is illiterate and only a fraction of the literate population has primary or high school education, PNG is a functioning democracy. Thus an open dialogue on national priorities for economic development is feasible. The number of skilled PNG citizens, though growing rapidly, is small. It is not keeping pace with the demand for skilled labor, which is rising even more rapidly. Currently, PNG is last among all Pacific economies, in terms of most social and economic indicators. Life expectancy at birth is 57 years, one of the lowest in the South Pacific. In 1997, PNG had an estimated population of 4.23 million, mainly Melanesians. In 1990-97 PNG’s population grew from 3.70 million to 4.23 million, with an average growth rate of 1.9 percent annually. These gains are moderate in comparison to other Pacific Island economies where population growth rates of 3-4 percent are normal. If PNG maintains a moderate population growth rate of less than two percent annually, it can easily attain a higher standard of living once its resources are put to more productive uses. PNG generates a total gross domestic product (GDP) of about US $3.5 billion a year, yielding a per capita GDP 8 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 than any other developing economy in the Pacific to achieve a consistently higher standard of living because of its many positive characteristics. Market demand already exists for most of its products, especially minerals and energy. Settlement of the Bougainville conflict, signed into a binding treaty in late April this year, is a major step toward reconciliation, putting PNG back on track to growth and prosperity. The PNG government and commerce can now concentrate on economic development. 1.2 ABRIEFHISTORY Newer methods of identification, dating and analysis of historic patterns of human settlement in conjunction with new archeological findings in PNG may better determine the date of the earliest human occupation in that part of the world. However, existing evidence suggests that PNG is among the oldest societies in the world. Human occupation evidently began some 45,00050,000 years ago on the Huon Peninsula on the north coast of the main island. The first settlers are believed to have arrived from Southeast Asia in small numbers “involuntarily” because their watercraft, which were mostly solid logs and bamboo rafts, are considered too primitive to have been chosen for deliberate crossing.1 Since the earlier indigenous people of PNG lived in societies without written script, accurately Native Papua New Guinean wearing a traditional, colorful headdress establishing all social, political and economic links hinges on the results of current archeological efforts in combination with other physical The earliest evidence of gardening in PNG dates evidence. back some 9,000 years at Kuk, near Mount Hagen in the The earliest settlers were hunters, fishers and Western Highlands, making the highlanders among the gatherers of wild plants. There is no clear understanding of world’s earliest gardeners. what food plants and animals were native to the area, and Ancestors of present-day PNG inhabitants may also which were later introduced from the outside world. be among the earliest traders and seafarers, as there is Important food plants at the time of European contact in the evidence of trade with areas as far west as Southeast Asia early 16th century were sago palm, taro, yams, cassava, and as far east as New Caledonia, plus an exchange system sweet potato, breadfruit, coconuts, bananas and green leafy in practice, all tracing back 4,000 years. Apart from the vegetables. Animals present in PNG at that time include early signs of trade in bronze and obsidian between wallabies, snakes, crocodiles, pigs, dogs, fish, birds and Southeast Asia and parts of today’s PNG some 3,000 years insects. Among animals to have been introduced to PNG ago, there is little evidence of contact between PNG and following contact with the outside world are domesticated that region before the 19th century. However, there is chickens, pigs and dogs. reasonable likelihood that trade between Indonesia and the 1 John Dademo Waiko, AShort History of Papua New Guinea, Oxford University Press, 1993, p. 2. 9 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 western half of the Island of New Guinea existed as far Following the Australian (British) model, PNG back as the 13th century. There is also the likelihood that is a parliamentary democracy. The House of Assembly, before the arrival of the first Europeans, some coastal renamed the National Parliament when PNG became people from today’s PNG were captured by Asian raiding independent, was first formed in 1972. Given the many parties for sale as slaves. However, no new settlements diverse ethnic and linguistic groups that make up the were established and the contacts between New Guinea and people of PNG, a functioning representative democracy is Southeast Asians ended when Europeans arrived and practically the only optimal political model that can keep its colonized the area. economy from fragmentation. Available sources indicate that at the time of first The diversity of interests inherent in numerous European contact, the 700 or so different languages of the ethnic and linguistic groups, especially in a developing peoples that today make up the PNG nation already existed. economy where political and market institutions are These languages represent the many different communities evolving, however, sometimes makes it difficult to establish that lived in isolation from each other until recent times. a strong and decisive central government. But as is evident Thus PNG’s present communication challenges and elsewhere, better education and more mature social, structural fragmentation can be traced back to this early political and economic institutions can pave the way for a period. stronger democracy with a dynamic market system. PNG was first visited by European navigators in the early 16th century but explorations and colonial settlement 1.3 THE BOUGAINVILLE SECESSION did not occur until mid-19th century. In 1884, the northern part of eastern New Guinea came under German Political instability of some degree arising from administration and later became known as German New ethnic, linguistic and territorial differences existed long Guinea. In 1914, Australian troops removed the Germans before independence in 1975. With political independence, from the territory and Australia subsequently ruled the area PNG also inherited from Australia a centralized and under a League of Nations mandate until 1942, when much bureaucratic federal government in Port Moresby. In some of it fell under Japanese occupation. In 1945, the territory instances citizens and governments in provinces felt they returned to Australian rule under a UN trusteeship. did not receive their fair shares of income and wealth from The western half of New Guinea was a part of the the central government. This sense of inequity, whether Netherlands East Indies until 1949 and from 1949 to 1962 influenced by ethnic or linguistic differences, led to the was known as the Netherlands Nieuw Guinea. In 1963, rebellion in Bougainville that started in 1988. after military action by Indonesia, it became its province of Irian Jaya. The southern part of eastern New Guinea became British New Guinea in 1906, following the establishment of a British protectorate in 1884 and annexation in 1886. Australia administered what became the Territory of Papua New Guinea until 1949 when it was joined with the Trust Territory of New Guinea. In December 1973, the Territory of Papua New Guinea became internally self-governing and on September 16, 1975 became the independent nation of A mining facility located at Porgera, Enga province Papua New Guinea. 10 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 In April 1988, landowners on Bougainville submitted compensation claims for more than was being paid by the Bougainville Copper Limited at Panguna, which had been mining since 1972. With no additional payments forthcoming, a group of citizens calling itself the Bougainville Revolutionary Army (BRA) committed acts of sabotage in late 1988, sparking the beginning of the secessionist movement. The rebels demanded both higher payments for the copper mined on the island, and independence from PNG for the North Solomons Province, of which the Island of Bougainville is a major part. With violence escalating, mining activity practically came to a halt in 1989-90. For most of the 1990s, the Bougainville conflict was among the few globally known continuing hostilities. It paralyzed Bougainville’s economy and later destroyed most of the island’s infrastructure, including schools. With violence escalating and no victory in sight for either the BRAor the PNG government, they finally opted for reconciliation through talks sponsored by New Zealand in 1997. The 500 miles between Port Moresby and Bougainville made both war and peace harder. While hostilities have ended, this reconciliation does not guarantee that other parts of PNG may not also rise against the central government, especially if there is a continuing perception that the provinces do not receive their fair shares of national income and wealth. It was not until the Bougainville rebellion that PNG’s integrity as a nation came into question. However, to the PNG government’s credit, the uprising did not spread to other parts of the country as might have been expected, given the country’s ethnic diversity and dispersed island landscape. The BRAachieved nothing more than keeping the conflict current in regional and global news for a decade. The details of rebuilding the Bougainville economy and subsequent political and economic arrangements are to be worked out over the months and years ahead. Major unanswered issues include Bougainville’s desire for more autonomy, resumption of gold and copper production, revenue allocation and, finally, the cost of rebuilding the severely damaged Bougainville economy. Settling the Bougainville conflict paves the way for overall political and economic stability in PNG. Preventing future rebellions, however, calls for a more active dialogue between the federal and 19 provincial governments. Also, more rapid economic growth that raises both the stock of national wealth and the flow of national income can facilitate a more equitable distribution of both, thereby further diminishing the potential for economic and social conflicts. The National Parliament recently passed laws that encourage dialogues to address questions relating to more equitable distribution of wealth and income, as well as other provincial grievances. Meanwhile, as peace and stability, better education and more contacts with the outside world strengthen PNG’s political and market institutions, the pressure on the central government to deliver major development programs should lessen over time. 1.4 THE LAWAND ORDER (L&O) DILEMMA Concurrent with the Bougainville conflict, crime in the late 1980s and 1990s, especially in urban areas, also became a major problem in PNG. In 1991, the National Parliament passed a program of severe measures to combat crime, including the introduction of the death penalty and tattooing the foreheads of convicted criminals. Still, crime and general disregard for law and order (L&O) remain major concerns in urban areas, especially the national capital district including Port Moresby. Random violence in Port Moresby and other urban areas has, from time to time, generated adverse publicity in both regional and global media. Security is a growing component of total cost for businesses and expatriate residents. In fact, increased security costs is often cited by businesses to be among the main disadvantages of doing business in PNG. As in other multi-cultural societies, there are different perceptions of crime and, therefore, different implementations of law enforcement. Anecdotal reports indicate that only three percent of criminal suspects are indicted and less than half of them get convicted. In the end, fewer than one percent receive punishment. A1997 study showed that while the direct cost of the L&O problem may be only three percent of total cost, indirect cost is a much higher component of total business cost. The study found that, “the indirect costs appear to be several times higher than the direct costs.” 2 Direct L&O cost includes costs of security personnel and equipment while indirect costs encompass constrained markets and management time devoted to preventive and remedial actions. Although generally effective, private security has become a notable extra cost that businesses in Institute of National Affairs, “Cost Structures in Papua New Guinea,” Discussion PaperNo. 69, SalPress, Boroko, NCD, Papua New Guinea, April 1997, p. 1. 2 11 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 PNG must bear, aside from other costs and constraints imposed by either institutional or market factors. Another recent study of known criminal activity sheds additional light on the extent of the L&O problem in urban areas. Based on a 1995 survey, over 32,000 persons in urban centers depended “on crime as their main source of income, representing 14.8 percent of the urban work force.”3 The study found that the earnings of criminals did not differ significantly from the relatively high wages of unskilled labor in the formal sector. Although this study did not find a correlation between urban unemployment (which averaged 29.3 percent in 1995) and urban criminal activity, such a correlation has been shown to exist in other markets. Port Moresby’s crime problem will most likely continue until rural migration to the city subsides, which will happen only when more rural people have reason to stay where they are. Aslowdown in rural-urban migration and improvement in the job market can be achieved as the country’s resources such as minerals, oil and gas are put to higher and better uses. The crime problem will then diminish but may not disappear. With improvements in the job markets, the L&O concern in PNG may subside to the levels of other urban areas of similar size in the region. Despite the L&O problem, most businesses were expanding until the Asian crisis ensued. The central government has indicated its commitment to dealing with the L&O problem, but like governments in other democracies, it cannot focus on it at the expense of other major concerns. The government will not eradicate the L&O problem any time soon. However, its commitment to dealing with the problem is a major first step in restoring a measure of safety and security to PNG’s cities. because of rapid migration to the cities. PNG’s resources, mainly oil, gas and other minerals, fish and forests will help pay for urbanization of cities and towns scattered all over this largely inaccessible country. In the years ahead, tourism will become an increasingly important sector. The full impact of the Asian crisis and devaluation is not known, but it has destabilized the economy and disrupted production and distribution activities throughout the country. Further damage to the economy has been inflicted by tropical storms and the 1997 drought attributed to El Nino. Among those things affected by the drought was copra export, which dropped 9.0 percent to 90,300 tons. In addition, a storm in early 1997 severely impaired cocoa production in the East New Britain Province. Total cocoa exports through December 1997 amounted to 36,700 tons, down 10.5 percent from the previous year. Also affected was coffee production and exports, which fell 5.6 percent below 1996 levels to 58,000 tons. The total export of logs, which amounted to 2.4 million tons in 1997, was also down 8.9 percent from the previous year. But unlike other agricultural exports that were affected by natural disasters, the fall in log exports was entirely due to weak demand in Asia, the main market for South Pacific hardwood logs. Further problems in Asia, especially in Japan starting late in 1997, have caused substantial declines in both export quantities and prices of logs. The economic recession has gradually worsened since the middle of this year. In mid-July a tidal wave (tsunami) that hit the north central coast of the main island added to the ongoing economic problems. Occurring without warning, the tidal wave wiped out a number of villages along the coast, causing several thousand deaths. Due to the large number of human casualties and severe economic loss in the area, it will be some time before a sense of normalcy returns to that coastal region. Growing, although modestly, in the midst of these declines was palm oil. Exports through December amounted to 274,000 tons, up 3.0 percent from 1996. Palm oil is now approaching the level of coffee in terms of market value of exports. With global demand for the versatile palm oil rising, PNG, Solomon Islands and other South Pacific producers stand to gain more market share as their high quality oil is produced by relatively low-cost labor abundant in these markets. Although total production costs (including labor) in other producing areas such as the Philippines, 1.5 AREVIEW OFCURRENT CONDITIONS With the Bougainville settlement and the World Bank & IMF providing transitional (restructuring) aid, the PNG economy will improve gradually but steadily in the months and years ahead. Political, economic and business conditions are now ideal for restoring confidence in the economy and respect for law and order. There is no alternative if the country is to take full advantage of its resources and become self-sufficient. PNG’s economy has been in recession since mid1997, mainly because of commodity price drops and devaluation. However, business in urban areas is growing 3 Theodore Levantis, “Urban Unemployment in Papua New Guinea - It’s Criminal,” Pacific Economic Bulletin, National Centerfor Development Studies, The Australian National University, Volume 12, Number 2, 1997, p. 73. 12 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 Malaysia and Indonesia may not be much higher, PNG’s advantage lies in adopting newer production and extraction methods and in opening up new markets such as Europe. PNG’s economy is not flexible or mechanized enough to increase exports of commodities rapidly, aside from oil and minerals, at globally favorable prices. Most of PNG’s exports, including oil, are commodities available in other markets. At the same time, devaluation has raised import prices, especially wages of ubiquitous expatriate labor, some of which is critical to getting the economy back on track. This unsettling period will last at least another 6-12 months before the economy begins to recover and stability returns to financial (currency) markets and exchange rates. Although the end of the Bougainville conflict frees the government to focus on rebuilding and revitalizing both Bougainville and PNG as a whole, this formidable task will take time. Re-opening the Bougainville mines to resume gold and copper production may take months, possibly years, as agreements still must be reached on revenue allocation among landowners, national and provincial governments. It was this issue that led to the protracted conflict in the first place. The PNG government is also under pressure by business, investors, creditors and the large expatriate labor force to deal effectively with infrastructure concerns. Lack of adequate transport, educational facilities and other basic infrastructure hampers PNG’s production and distribution capacities. Coffee, for instance, is grown in some areas without adequate transport links to markets. Even good harvests will not translate to good income if the products do not reach markets in a timely manner. Anational economic summit convened in February by the new coalition government, which came into power last year, was a significant step toward a national economic dialogue. It enabled the business community to make recommendations about reconstruction and installation of a consistent national political and economic management policy. With the proper mix of institutional and market reforms in place, PNG can generate a much higher standard of living for its population than any other South Pacific Island economy and in relatively shorter time. PNG’s vast resources make setting a consistent national economic growth goal of at least 10-percent a year over several years feasible. Commercial ranching and agriculture particularly hold large potentials for the country, especially in tropical crops and fruits that may be exported as fresh and processed products. By the year 2000, once the Asian crisis has subsided, expansion of mineral and oil production as main revenue (foreign exchange) sources could set PNG on an accelerated growth track. Logistically, however, growth in this market will be more costly than in others because the main towns and cities are so far apart from each other. Some 15 million hectares of harvestable forests exist in PNG, of which 4-5 million have been designated for cut. Only about three million hectares have been cut to date, some of which have already been replanted and sustainable harvest begun. Recent geological surveys indicate that PNG is perhaps more of a gas reservoir than an oil one. Known gas reserves are large, and more may be found. Under the auspices of US-based Chevron which has a presence in PNG, work on a $4-5 billion dollar gas pipeline to Queensland is to start in the next 12 months. When finished in 2001, the pipeline will carry natural gas from PNG to Queensland. Known petroleum reserves are modest, but large ones may still exist. Avariety of minerals can be found in varying quantities and concentrations underground in PNG, and its 1.2 million square miles (3.1 million square kilometers) of surrounding ocean may yield deposits of undersea minerals, in addition to fish and other seafood. During the first quarter of 1998, a local firm announced that it had put together a financing package of US $600 million to build a new tuna processing plant in an outer province. Financing, according to media sources, would come from European Union banks and the firm was confident of its plan and financing. Currently, PNG receives fewer than 60,000 visitors a year, of whom about 20,000 are tourists. With fear of violence receding, tourism holds vast potential for PNG, mostly in areas outside Port Moresby. PNG has all the aesthetic resources to make it a major tourist destination, for leisure and business travelers, once the proper infrastructure is in place. Its new airport terminal, which opened in March, is a major asset in expanding tourism. The newer section of the capital district (Waigani) on the mountain side of downtown Port Moresby, is undergoing expansion. It will supply much needed new commercial space. II. MACROECONOMIC REVIEW 2.1 INTRODUCTION Macroeconomic instability in PNG arises from two main sources: (a) economic structure and its performance, that is, the economy’s makeup and production and distribution activities of goods and services, and (b) liquidity 13 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 problems arising from both internal and external conditions that hamper government’s and business’s ability to meet their financial needs. Internal liquidity problems impede economic growth, but external liquidity dilemmas often have far more serious implications, especially if imports (export earnings) are critical to keeping the economy going. As recent developments in Asia have shown, the interdependence of the region’s economies on each other has become a double-edged sword. During economic booms, interdependence helps regional economies expand. During an economic downturn, it exacerbates economic contractions. An example of instability arising from PNG’s economic structure is its reliance on exports of primary commodities, including crude oil, which command low and widely fluctuating prices in regional and global markets. An example of liquidity risk arising from external conditions, often beyond the control of national government and markets, is the recent drop in commodity prices, especially when coupled with devaluation caused by regional and global economic forces. In fact, the adverse impact of recent commodity price declines (contributing to revenue loss) and devaluation (contributing to wage and price inflation) has been so severe in PNG that it prompted the World Bank and IMF to make special provisions in their proposed structural adjustment loans. Current and accurate information is unavailable on most of the critical macroeconomic aspects of PNG in terms of assessing its economic performance and prospects. However, there is enough relevant information to make an informed appraisal. commodity price drops, devaluation caused by global and regional conditions and weak global demand for commodities already existing prior to recent price changes. Just before the 1995-96 recession, real GDP growth averaged 10.2 percent (1991-94), mainly because of gains in minerals and petroleum production which commenced in 1992. According to the Australian Agency for International Development (AusAid), oil exports started at K301 million in 1992, rose to K818 million in 1993, but dropped to K703 in 1994, then rose back to K828 million in 1995 before peaking at K1.074 billion in 1996.4 It is unlikely that PNG will realize its petroleum sales goals in 1998 based on earlier price and quantity projections, as oil prices dropped in recent months, reaching a low of $13.4 a barrel in April. Though crude oil has been an important part of export earnings since 1992, the recent drop in price can only signal further erosion in export earnings. At the same time, low energy prices may help PNG fight inflation, which rose from 3.0 percent in 1994 to 17.0 percent in 1995. Although it dropped to 12.0 percent in 1996, PNG’s inflation in 1995-96 was one of the highest in the Pacific. Amain factor contributing to price inflation in the last few years in PNG has been devaluation of the Kina that started in 1992 and continued through 1997. As measured by official exchange rates, the Kina dropped 41.4 percent in 1992-97 against the US dollar. While inflation may be a problem in the near term and even mistaken for a false signal of surging aggregate demand, another useful measure of economic performance is employment. Employment and labor force data, however, are sketchy for PNG. An employment index, which the PNG Central Bank derives from a quarterly employment survey of the private sector, is reported for the economy and the various industries. The index’s base year is 1989 (1989=100). As measured by this index, employment in PNG in 1996 was only slightly higher (0.5 percent) than 1989. In the interim, the index was as low as 91.1 percent in 1991 and 91.4 percent in 1993 when real GDP, according to AusAid, rose 13.3 percent. The index rose to 98.1 percent of the 1989 average in 1994 while real GDPgain dropped to 4.1 percent. In 1995, the index fell to 93.5 while real GDPdropped too but only slightly (0.9 percent). As GDPsank another 5.0 percent in 1996, the employment index rose 7.5 percent to its all-time high of 100.5 percent of the 1989 average. As a lagging indicator, it is possible for employment to 2.2 AMACROECONOMIC APPRAISAL: GDP& ITS COMPONENTS In 1997, PNG generated a GDPof US $4.3 billion, yielding a per capita GDP of US $1,008. These US dollar GDP figures are consistent with other published ones, but examining PNG’s GDPand other macroeconomic quantities in Kina, its own currency, provides a more realistic review of economic conditions and performance. Real GDP(adjusted for inflation) peaked at K4.526 billion in 1994, dropping only slightly (0.9 percent) to K4.486 billion in 1995 and another estimated 5.0 percent to K4.261 billion in 1996. All indications are that the 1995-96 recession continued in 1997, and spilled over to 1998. The main causes of economic decline in 1997-98 have been 4 Australian Agency forInternational Development (AusAid), Economic Survey of Papua New Guinea, Commonwealth of Australia, August 1997, p. 171. 14 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 remain high while the economy is slowing down. However, employment and total income growth rates going in opposite directions for more than one year is not customary. In 1990-96, real GDP and employment growth rates crossed paths five times. The likely explanation is that the employment index does not reflect the extent of employment, unemployment and underemployment, which is common in the Pacific economies. The country’s labor force (persons aged 15-64) numbers over two million. However, only about 220,000 people work in the so-called formal sector (those on formal payroll), of whom about 60,000 work in the public sector. Thus, payroll employment is available to only 10 percent of the labor force. The full extent of Agricultural field employment in the subsistence economy is not known, except that 80-90 percent of PNG’s population depends in one way or another on subsistence farming, some of PNG’s other oil and mineral resources including gathering and fishing. Given these parameters, gold and copper from Bougainville may contribute to employment data should be viewed cautiously. export earnings. As far as shifts in the makeup of GDPare concerned, Agriculture, forestry and fishing have remained a notable change occurred in 1990-96 with the start of oil relatively stable as a share of GDP, averaging 27 percent in production and export in 1992. It raised mining and 1990-96. This sector’s share, too, may increase with the petroleum as a share of GDPfrom 21.9 percent in 1992 to completion of a proposed fish cannery as well as other 28.1 in 1993 and 31.4 percent in 1995, but fell back to 26.3 seafood processing operations in PNG by 2001. percent in 1996. Without production changes (resumption Also reasonably stable as a share of GDPin 1990-96 of production in Bougainville or other new mines), mining was construction and manufacturing at 15 percent, followed and petroleum as a share of GDPmay range from 25.0 to by commerce, transport and financial services averaging 30.0 percent (averaging 26.6 percent in 1992-96). another 15 percent, and services, which averaged nearly 20 With the building of the natural gas pipeline percent. Given this GDP makeup, instability arising from proposed by Chevron to carry gas from PNG to commodity price and exchange rate changes will be more Queensland, the share of mining and petroleum will rise. It serious, while those linked to structure will remain is also reasonable to expect that between 1999 and 2001, relatively straightforward. 2.3 FISCALMANAGEMENT INDEXES OF FORMAL PRIVATE EMPLOYMENT (JUNE 1989=100) Formal private employment Employment by industry Retail Wholesale Manufacturing Building and construction Transport Agriculture, forest and fishing Financial and business Mining 1989 1990 1991 1992 1993 1994 1995 1996 99 95 91 94 91 98 93 100 101 96 99 106 106 96 104 101 88 87 95 107 112 89 109 101 86 81 95 82 104 89 103 100 85 86 102 77 94 97 105 107 84 84 104 74 91 95 104 106 88 91 120 78 95 101 102 105 92 82 109 70 89 87 111 112 95 82 115 89 96 91 116 116 Source: AusAID, Economic Survey of Papua New Guinea, August 1997, p. 158 15 PNG’s fiscal management has been questionable for most of this decade. The country has had a fiscal deficit almost every year during the 1990s. The deficit grew rapidly in the early 1990s, reaching a record K296 million in 1993. It dropped just as rapidly, turning into a K37 million surplus in 1996, only to be followed by another deficit in 1997. As a share of GDP, PNG’s deficits have been relatively small in comparison to other developing economies, where public infrastructure consumes large sums of PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 PNG ECONOMIC AND FINANCIAL INDICATORS 1990 1991 1992 1993 1994 1995 1996 1997 1998 Nominal GDP ($US million) Nominal GDP Per Capita ($US) 3,219.6 870.2 3,787.7 1,004.7 4,378.0 1,137.1 5,030.8 1,283.4 5,383.9 1,346.0 4,809.1 1,181.6 4,957.2 1,195.3 4,260.6 1,008.2 3,479.8 808.0 Nominal GDP (Millions of Kina) Nominal GDP Growth (%) Nominal GDP Per Capita (K) Real GDP (1990 Prices, K mill) Real GDP Growth (%) Real GDP Per Capita (K) 3,076.0 1.0 831.4 3,076.0 (3.0) 831.4 3,606.0 17.2 956.5 3,370.0 9.6 893.9 4,223.0 17.1 1,096.9 3,836.0 13.8 996.4 4,922.0 16.6 1,255.6 4,348.0 13.3 1,109.2 5,411.0 9.9 1,352.8 4,526.3 4.1 1,131.6 6,138.0 13.4 1,508.1 4,485.5 (0.9) 1,102.1 6,533.0 6.4 1,575.2 4,261.3 (5.0) 1,027.5 6,108.4 (6.5) 1,445.4 4,176.0 (2.0) 988.1 6,517.6 6.7 1,513.5 3,758.4 (10.0) 872.7 GDP by Expenditure (K mill) Private Consumption Government Consumption Gross Fixed Investment Exports of Goods & Services Imports of Goods & Services 3,076.0 1,816.0 764.0 752.0 1,250.0 1,506.0 3,606.0 2,121.0 854.0 988.0 1,524.0 1,881.0 4,223.0 2,143.0 1,005.0 984.0 2,021.0 1,930.0 4,922.0 2,195.0 1,199.0 843.0 2,605.0 1,920.0 5,411.0 2,969.0 1,082.0 884.0 2,456.0 1,980.0 6,138.0 3,400.0 952.0 1,084.0 2,987.0 2,285.0 6,533.0 3,613.0 1,012.0 1,156.0 3,182.0 2,430.0 6,108.4 — — — — — 6,517.6 — — — — — GDP by Expenditure (%) Private Consumption Government Consumption Gross Fixed Investment Exports of Goods & Services Imports of Goods & Services 100.0 59.0 24.8 24.4 40.6 49.0 100.0 58.8 23.7 27.4 42.3 52.2 100.0 50.7 23.8 23.3 47.9 45.7 100.0 44.6 24.4 17.1 52.9 39.0 100.0 54.9 20.0 16.3 45.4 36.6 100.0 55.4 15.5 17.7 48.7 37.2 100.0 55.3 15.5 17.7 48.7 37.2 — — — — — — — — — — — — GDP by Industry (K mill) Agriculture, Forestry & Fisheries Mining & Petroleum Manufacturing, Construction & Power Commerce, Transport & Fin. Services Services & Import Duties 3,076.0 891.0 452.0 483.0 511.0 739.0 3,606.0 937.0 613.0 628.0 639.0 789.0 4,140.0 1,020.0 925.0 666.0 666.0 863.0 5,016.0 1,335.0 1,381.0 667.0 724.0 909.0 5,409.0 1,546.0 1,366.0 714.0 749.0 1,034.0 6,442.0 1,693.0 1,927.0 773.0 896.0 1,153.0 6,533.0 1,731.0 1,719.0 885.0 984.0 1,214.0 6,108.4 — — — — — 6,517.6 — — — — — GDP by Industry (%) Agriculture, Forestry & Fisheries Mining & Petroleum Manufacturing, Construction & Power Commerce, Transport & Fin. Services Services & Import Duties 100.0 29.0 14.7 15.7 16.6 24.0 100.0 26.0 17.0 17.4 17.7 21.9 100.0 24.6 22.3 16.1 16.1 20.8 100.0 26.6 27.5 13.3 14.4 18.1 100.0 28.6 25.3 13.2 13.8 19.1 100.0 26.3 29.9 12.0 13.9 17.9 100.0 26.5 26.3 13.5 15.1 18.6 — — — — — — — — — — — — Fiscal Indicators Government Revenues & Grants (K mill) Government Spending (K mill) Budget Balance (Revenue less Spending) 998.0 1,089.0 (91.0) 1,026.0 1,188.0 (162.0) 1,126.0 1,358.0 (232.0) 1,309.0 1,605.0 (296.0) 1,446.0 1,570.0 (124.0) 1,722.0 1,755.0 (33.0) 1,898.0 1,861.0 37.0 2,202.9 2,188.5 14.4 2,411.3 2,499.9 (88.6) Money, Rates, Prices & Exchange Rates M1 (Narrow Money, K mill) M3 (Broad Money, K mill) 6-Month Treasury Bill Rate (%) Consumer Price Inflation (%) Official Exchange Rate: $US/Kina 353.3 1,334.4 10.5 7.0 1.047 458.0 1,505.9 10.5 7.0 1.050 509.1 1,647.9 6.5 4.0 1.037 527.5 1,812.5 6.0 5.0 1.022 571.3 1,860.1 10.8 3.0 0.995 645.9 2,068.0 21.5 17.0 0.784 864.9 2,736.8 14.4 11.6 0.759 — 3,068.8 10.5 3.9 0.698 — — 18.1 11.5 0.5339 3.70 1.9 94.6 (4.7) 3.77 1.9 91.1 (3.7) 3.85 2.1 94.0 3.2 4.00 2.0 98.1 7.3 4.07 1.8 93.5 (4.7) 4.15 1.9 100.5 7.5 4.23 1.9 101.5 1.0 4.31 1.9 — — (88.0) 86.0 (287.0) 113.0 207.0 (111.0) 8.0 (144.0) 75.0 (466.0) 247.0 60.0 3.0 (81.0) Population & Employment Population (million) Population Growth (% per year) Employment Index (1989 = 100) Employment Growth (%) Balance of Payments (K mill) Current Account Balance Trade Balance Services Balance Transfers Capital Account Balance Errors & Omissions Overall Balance International Reserves Minus Gold ($US m) Total Public Debt Outstanding (K mill) Domestic Debt (K mill) Foreign Debt (K mill) Total Debt as Share of GDP (%) 94.0 607.0 (699.0) 186.0 (146.0) (16.0) (68.0) 3.92 1.8 91.4 (2.8) 632.0 1,437.0 (847.0) 42.0 (701.0) (27.0) (96.0) 576.0 1,346.0 (781.0) 11.0 (627.0) 3.0 (48.0) 859.0 1,800.0 (1,034.0) 93.0 (556.0) (19.0) 284.0 411.0 1,338.0 (1,011.0) 41.0 58.0 (38.0) 431.0 (148.0) 965.0 — — 2.0 — (154.0) — — — — — — — 403.0 323.1 238.6 141.5 96.1 261.4 583.9 362.7 — 1,470.0 406.0 1,064.0 47.8 1,567.0 556.0 1,011.0 43.5 1,945.0 824.0 1,121.0 46.1 2,320.0 1,037.0 1,283.0 47.1 2,935.0 1,425.0 1,510.0 54.2 3,284.0 1,606.0 1,678.0 53.5 3,763.3 1,969.3 1,794.0 57.6 — 2,251.7 — — — — — — Note: Most 1997-98 quantities are based on projections, forecasts and preliminary numbers subject to revision and change. Sources: International Monetary Fund, International Financial Statistics (yearbook), Bank of Papua New Guinea, Quarterly Economic Bulletins (various), AusAid, Economic Survey of Papua New Guinea, August 1997; Monthly Economic Monitor, April 10, 1998, Economic Policy Unit, Treasury and Corporate Affairs, Waigani, PNG. 16 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 national resources. Even in some developed economies, budget deficits have amounted to relatively large percentages of GDP, depending on the circumstances. While PNG’s budget deficit ranged from 0.5 percent of GDP to 6.0 percent (averaging 3.0 percent in 1990-96), a small 0.6 percent surplus was achieved in 1996. With the conclusion of the Bougainville conflict which consumed public funds, especially in 1992-95 when the government attempted to quell the rebellion with force, PNG’s fiscal health should improve in the years ahead. Also contributing positively to fiscal health in the future will be royalties and taxes from new mines, including those on Bougainville when they reopen. Further pressure on the government to manage its finances arises from conditions attached to structural adjustment loans from the World Bank and IMF. As the economy emerges from the present crisis caused by natural disasters, global commodity price drops and devaluation, prospects for PNG’s financial health are strengthened by its return to stability and the steady flow of foreign aid, especially from Australia. (K692 million) during the two-year period was in the form of short-term securities. Taking advantage of increased liquidity and the availability of other external funds such as foreign aid, the Bank of Papua New Guinea eased monetary policy in mid1996, which helped reduce interest rates. The 182-day T-Bill rate dropped from a record 21.5 percent in February 1996 to 9.2 percent in December 1996. In September 1997, the rate was down to 8.8 percent. The weighted average of loan advances dropped from 15.4 percent in January 1996 to 10.2 percent in December the same year. In September 1997, the rate was slightly higher at 10.5 percent. At the end of the first quarter 1998, the 182-day bill rate was back up to 18.1 percent and expected to rise further, partially as a result of tighter monetary policy necessitated by price inflation connected to devaluation. With the 182-day bill rates rising, the spread between it and the average of other commercial lending rates is widening, making underwriting T-bills more attractive, especially for commercial banks. This consequence of market changes was largely unexpected, thus further complicating the financial market’s behavior. It will be some time before a clearer picture of PNG’s financial markets emerges, especially in light of other developments connected to regional economic and financial dilemmas, including pressure on the Kina to depreciate even more. 2.4 MONETARYPOLICY Allowing market conditions to play a larger role in determining interest rates has been the main feature of PNG’s monetary policy until the current recession. This policy has been consistent with others that aim to make the PNG economy more market-oriented and bring both fiscal and monetary policies in line with similar movements in the region. This is a significant movement, especially in a developing economy where the central bank has traditionally been less independent than in developed economies. More market orientation is expected as PNG puts better fiscal and economic management methods in place and gets ready for major projects such as the natural gas pipeline to Queensland. The total money supply in PNG (M3) consists of the so-called narrow money (M1) encompassing notes, coins and demand deposits, and quasi-money (M2) which includes savings, term deposits and other items. In 1996, total money supply (M3) was K2.7 billion of which 31.6 percent was M1, 45.9 percent was term deposits and 11.4 percent was saving deposits. M3 increased 11.2 percent in 1995 and 32.3 percent in 1996. Large balance of payment surpluses contributed to the enormous gains in money supply. Another contributing factor was increased funding of government debt by commercial banks, which rose from K756 million in 1995 to K1.132 billion in 1996. More than half of this total 2.5 PNG’S EXTERNALACCOUNTS The importance of external trade to PNG can be seen in its external transactions as shares of GDP. Exports of goods and services averaged 46.6 percent of GDPin 1990-96, ranging from a low of 40.6 percent in 1990 to a high of 52.9 percent in 1993. (In the United States, exports of goods and services amounted to 11.9 percent of the GDP in 1997.) Imports of goods and services have likewise been critical to PNG’s economic health. They averaged 42.4 percent of GDP, ranging from a high of 52.2 percent in 1991 to a low of 36.6 percent in 1994. (The comparable number for the United States in 1997 was 13.1 percent.) Australia remains PNG’s largest trading partner, accounting for half of its imports and a third of its exports. Japan is the second largest trading partner for PNG, supplying about 20 percent of its imports and a slightly higher share of exports. Imports from the United States account for about 10 percent, while exports to Korea represent 10 percent also. The rest of Asia and the European Union are relatively minor participants in PNG’s international trade. PNG’s wide variety of exports, although mostly 17 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 commodities, has enabled it to have current account surpluses during most of this decade, mainly as a result of trade surpluses which have compensated for service and capital account deficits. The capital account has fluctuated between small surpluses and relatively large deficits. Surpluses occurred when foreign interests made large investments or loans in the mineral sector, and deficits occurred when some of the loans related to minerals were repaid. This will most likely be the pattern in the years ahead as PNG begins to utilize more of its mineral resources. PNG’s external accounts exhibit a more positive picture than one would expect from a developing economy in the early stages of change. Credit is attributed to its exports in minerals (gold, copper and oil), logs, palm oil, coffee and other commodities as well as capital inflows. In addition, foreign aid contributes significantly to the overall external sector. focused on making the economy more market-oriented and efficient. Unforeseen and uncontrollable commodity price changes will continue to generate uncertainty in PNG, for both foreign investors and the government of PNG. Efforts may be needed in the future to minimize fluctuations, though no effort will completely eliminate commodity price changes. III. ECONOMY BY SECTOR PNG is a developing economy in the true sense, thus accurate and current data are scarce. The government is making a serious effort to implement accurate and timely information-gathering and dissemination methods. In the meantime, overseas observers must rely on a mix of anecdotal evidence, field visits to the country and information sources among government, business and traditional leaders in order to assess realistically PNG’s vast resources, its productive potential, income and prospects for growth. PNG’s tourism slogan, “PNG, the Unexpected,” reflects both its present structure and future promise. 2.6 PNG’S DEBTAND PAYMENTS Total public debt has risen recently, reflecting government’s larger burden, especially in borrowing to finance both basic infrastructure and other needs. Total outstanding public debt rose from K1.470 billion in 1990 to K3.764 billion in 1996. The foreign portion of public debt rose more slowly, increasing from K1.064 billion in 1990 to K1.794 billion in 1996, while the domestic portion increased more rapidly, going up from K406 million in 1990 to K1.970 billion in 1996. As a share of GDPtoo, total public debt has steadily increased in the 1990s. It rose from 47.8 percent of GDPin 1990 to a record 57.6 percent of GDP in 1996. (In the United States, for example, total federal debt was 66.4 percent of GDP in 1997). Total external debt, both private and public, stood at K5.554 billion, 82.4 percent of GDP. According to AusAid, the overall cost of servicing total external debt, including loan repayments, fell from 40 percent of current account receipts in 1993-94 to 24 percent in 1996. The big drop was the result of large loan repayments by the mineral sector. PNG’s public debt, total external debt and servicing costs are in line with a somewhat healthier external sector. As mineral, oil and even undersea mining explorations pick up in the years ahead, public and total external debt will be expected to rise. The question is whether or not PNG will be able to service its debt consistently to attract more capital. Apositive answer is likely because PNG’s resource use has yet to approach an optimal level. PNG’s debt service obligations and prospects cannot be separated from its overall strategy for economic change 18 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 3.1 AGRICULTURE, FORESTRYAND FISHERIES (AFF) AGRICULTURAL EXPORTS: QUANTITIES OF MAJOR COMMODITIES Agriculture, forestry and fishing (AFF) provide work, income and livelihood for over 85 percent of PNG’s population.5 As in other developing economies of the Pacific, the vast majority of the rural population relies on subsistence production both as a source of sustenance and cash income. Outside urban areas such as Port Moresby, Lae, Kimbe and a few other towns, subsistence production, including gathering and hunting, is the primary source of sustenance. In terms of GDP accounts (valuing products with market prices), AFF averaged a rather steady 26.8 percent of GDP in 1990-96, ranging from 29.0 percent in 1990 to 26.5 percent in 1996. Stability, even a rise, in AFF as a share of total national income is typical of developing economies in the early stages of change. AFF becomes a progressively smaller share of GDPonce the economy enters a stage of more rapid, sustained change as sectors such as manufacturing and services absorb more resources. AFF’s increasingly smaller share of GDPalso signals an important shift in the economy toward sectors that generate money wages and higher market employment. This shift has not yet occurred in PNG, suggesting that it essentially remains an economy dependent on traditional subsistence production. 1992 1993 1994 1995 1996 1997p Cocoa Coffee Tea Copra Copra Oil Palm Oil Rubber 38.6 53 5.6 47.5 34.8 206.1 2.7 37.8 62.8 6.4 59 45.5 245.7 3.6 26 64.7 3.4 50.3 34.7 230.8 3.4 30.6 55.1 4.2 64.2 33.1 186.6 2.7 41 62.3 9.3 99.2 49.6 267 2.8 36.7 58.8 6.5 90.3 48.6 274.9 4.4 Source: Bank of Papua New Guinea, Quarterly Economic Bulletin, December 1997, p. S34 Since the true market value of subsistence production is not known, especially in rural areas where there is little information on production and distribution quantities, the true share (market value) of AFF is most likely larger. This claim is based primarily on the fact that subsistence living provides sustenance and employment for 80-90 percent of PNG’s population. Again, without accurate data on subsistence production and distribution, the extent of its true impact on employment (the equivalent of money wages) is not understood clearly. However, it is reasonable to assume that because subsistence living provides work for 80-90 percent of the population and labor force, substantial levels of unemployment and underemployment exist, mostly in rural areas. The vast body of literature on economic development and change that has been developed since the 1960s shows that rural-urban migration which increases the demand on limited urban infrastructure can most effectively be alleviated by creating more employment opportunities in rural areas. Further, in large developing economies such as PNG where unemployment and underemployment (again, in terms of money wages) are serious problems, the need to create more jobs in rural areas is far greater. PNG’s vast land and forest resources can contribute significantly to PNG’s economic change strategy to create more work in rural areas, drawing the rural labor force back from already-congested cities. Agricultural commodities with commercial scale work and export earning potentials are coffee (and tea), palm oil, cocoa, copra and rubber. The total market value of agricultural exports (excluding forest, fish and fish products) in 1996 was K574 million, of which coffee alone was K190 million, followed by palm oil with K178 million, cocoa at K66 million, copra oil with K51 million, copra at K49 million Laborer with coffee bean crop 5 (thousand tons) Ibid., p. 63. 19 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 and tea with K13 million. Coffee, palm oil and tea have especially large potential since all are global commodities for which world demand increases with population growth. Production and distribution of agricultural products require moderate levels of technical skills while providing employment to large numbers of unskilled workers, especially in rural areas. By investing in farming skills and technology, agricultural cooperatives and other means of promoting commercial agricultural production and distribution, PNG can create a bigger skilled labor force while expanding production, income and overall national productivity. In economies such as PNG where unskilled labor is relatively abundant, labor-intensive activities, especially agriculture, forestry, fishing and other natural resource production areas offer good potential for work, domestic food supplies and foreign exchange earnings. With rapid change in computer technology enhancing production and distribution capabilities in advanced economies, the skill and income gaps between advanced and developing economies is widening more rapidly than ever. One way to raise income levels in developing economies, especially in economies rich in resources such as PNG, is to focus on internal production possibilities. AFF product exports offer the best prospect for this. II (1944-45) and those taken in the 1960s. The extent to which this area has since been cleared for farming, mining, logging and urbanization cannot be clearly determined. Atotal of 4.6 million hectares (30.7 percent of the commercially viable forests) has been set aside for cut, of which roughly 3.0 million hectares have been cut. Since forests are a common property resource in PNG (owned by all of the people and divided within certain boundaries among the various tribes), formally established rules and regulations guide harvesting. Harvesting is allowed only by formal license, and the maximum annual cut under all concessions is limited to 4.5 million cubic meters. The actual annual cut, however, is reported to have been much less for years. In 1988, total harvest was about 1.8 million cubic meters, of which log exports made up 80 percent or 1.4 million cubic meters. In 1994, total harvest was 2.4 million cubic meters and log exports amounted to 2.0 million cubic meters. In 1997, log exports were 2.4 million cubic meters and total harvest was an estimated 3.0 million cubic meters. In terms of income and export earnings, forest products earned as much as K15-105 million in 1974-1990. Log exports, accounting for over 80 percent of forest product exports, became an important source of income and export earnings in the late 1980s and most of the 1990s. In 3.1.1 FORESTS AND FOREST RESOURCES some rural areas, logging is the most important (and only) major source of work and income. Export value increased PNG has a total land area of 46.2 million hectares of in the middle to late 1990s until prices collapsed in late which 97 percent is customarily (communally) owned. By 1997 after the Asian crisis erupted. Still, total export value one account, forests cover 78 percent of PNG (36.125 of logs was K496.1 million (US $351.1 million) in 1997, million hectares), ranging from mangrove forests along the roughly 14-15 percent of all exports. coasts to alpine forests at higher elevations.6 About 15 The Asian financial crisis caused log prices to drop million hectares (nearly one-third of PNG’s land area) are substantially in 1997-98. At the end of the first quarter of considered commercially viable forests, although the figure 1998, log price was US $60, down 50 percent from a year is subject to some debate since it is based on aerial earlier. Unfortunately, log prices will not recover any time photographs taken by Australian military during World War soon, as a substantial rebound in the demand for hard wood in Asia is highly unlikely at this stage. Only when the demand for PNG and NON-AGRICULTURAL EXPORTS other South Pacific hard wood returns to normal levels will a robust forest products 1992 1993 1994 1995 1996 1997 market resume. The critical issue then Logs 000 m 1,601.0 2,374.9 2,943.9 2,512.5 2,607.4 2,375.9 will be that of optimizing sustainable Marine Products 000 tons 1.5 2.8 4.7 5.7 2.8 2.2 harvests so the total inventory remains Crude Oil barrels (‘000) 14,547.9 45,842.6 43,456.3 36,990.2 39,307.7 27,972.2 Copper tons (‘000) 187.9 192.2 207.2 215.7 127.7 77.8 commercially viable while minimizing Gold tons 67.0 59.3 55.8 55.2 46.9 44.3 the negative environmental impacts of Source: Bank of Papua New Guinea, Quarterly Economic Bulletin, March 1998, p. S34. deforestation. Soil erosion and 3 6 Simon Saulei, “Forest Exploitation in Papua New Guinea,” The Contemporary Pacific (A Journal of Island Affairs), Vol. 9, number 1, Spring 1997, p. 25. 20 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 destabilization of ecosystems in areas cleared by cutting forests is a concern, not only in PNG but other places where clear cutting of forests is common. Determination of an optimal cut level, coupled with a vigorous reforestation program, can turn an exhaustible resource into a renewable one, thereby promoting both economic growth and preservation of the ecosystem. Taking the rough measure of 25 cubic meters of timber per hectare as the standard measurement7, the available 4.6 million hectares yields 115 million cubic meters of timber, of which 3.0 million hectares or 75 million cubic meters have been harvested. The remaining 2.6 million hectares of forests designated for cut would yield 40 million cubic meters of timber which, at the present rate of 3.0 million cubic meters, would last 13.3 years even before additional virgin forests are designated for cut. Considering the depressed demand for logs in Asia at this time, current inventory may last even longer. The important question for policy analysis is what form of forest product, given limits on cut, would generate the most market value for PNG. The answer lies in options that would make it possible to add the most value to PNG’s forest products. Apart from crop and livestock production whose potential is large in PNG, forestry can provide both work and income for rural areas and export income for the nation. New channels of productivity such as assembly and manufacturing of specialty furniture and other processing generate more value than merely exporting logs and other basic raw materials such as wood chips whose prices, while basically low, fluctuate widely. By focusing on diverse forest products, from raw material to various stages of finished goods, forest resources can generate more than one type of work and more than one source of income for PNG for a long time. in the second half of 1997 and the first quarter of 1998, the share of mining and petroleum also fell. At the end of the first quarter of 1998, the price of Kutubu crude oil was US $13.4. For all of 1997, crude production from Kutubu was 28.0 million barrels, down 28.8 percent from 1996 exports. Crude production is expected to pick up in 1998 as production from the fields in Gobe and Moran begins. Also down in 1997 was the production of copper, mainly because of the drought that affected the Fly River used for shipping. Total copper exports in 1997 amounted to 77,800 tons, down 29 percent from 1996. Total gold exports in 1996 were K774 million, followed by copper with K387 million and silver with K10 million. Total mineral and oil exports were K1.005 billion in 1991, the last year before oil production in PNG commenced. In 1992, oil exports earned PNG K301 million. In 1996, the amount was up to K1.074 billion which raised total oil and mineral exports to K2.245 billion, up 123.4 percent in a relatively short period of time. As other oil and gas operations start producing, PNG’s share of oil and gas exports will rise. Also, since oil and gas are world commodities, their prices will change with world prices. These changes will often influence production and revenue streams over time, subjecting PNG to sometimes disruptive price and revenue fluctuations, as members of OPEC have experienced over the years. Once oil and gas production reaches its optimal level, it will begin to contribute to the development of other areas of the economy as it has in other mineral-rich economies. 3.2 OILAND MINERALS Mining and petroleum gained rather rapidly as a share of GDP in 1990-96, rising from 14.7 percent of GDP to 26.3 percent, and as high as 29.9 percent in 1995. Since crude prices, like other commodity prices, dropped 7 A mining operation in the highlands of Papua New Guinea Ibid., p. 34. 21 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 3.2.1 OIL& MINERALS AND ECONOMIC DEVELOPMENT caused not only political turmoil, but more damage to the rest of the economy and the financial system than initially believed. The most valuable lesson from the Indonesian experience for PNG is to invest in as many productive areas of the economy and in as many geographic locations as possible to improve both production and provincial equity. PNG should focus more on economic development rather than mere economic growth (raising national income and output). Though higher per capita income may mean people are getting richer, it does not necessarily make an economy more productive. The small oil-rich economies of the Middle East offer good examples of economic wealth with little domestic productive capacity. Their small populations and large proven oil reserves make it possible to be rich without being productive. Mexico, a developing oil producing country, is at the other end of the spectrum because of its large population. While Mexico has used its oil revenues to deal effectively with financial emergencies, it has been less effective in enhancing the economy’s overall productive capacity. In PNG where the majority of the population relies on subsistence, increasing productive capacity in line with population growth and basic needs should receive higher priority. This strategy also means more emphasis on better education and skills in production and distribution as well as management of the nation’s resources. Development of oil, gas and other minerals and their impact on PNG deserves careful study in the context of a national economic development strategy because of their importance to PNG’s future economy. Arecent study suggests that there may be a lesson in the experience of Indonesia where oil wealth contributed enormously to raising standards of living, but also caused serious problems later because of certain inefficiencies.8 This, however, is not to suggest that all recent problems in Indonesia can be traced to poor management and use of oil revenues. The study of Indonesia’s oil wealth indicates that “the mineral sector has never proven to be a ‘leader’in the economic development process of emerging developing economies; if Papua New Guinea is to move up the ladder of economic development, it must look elsewhere.”9 Indonesia used its seemingly inexhaustible oil wealth to pursue a vigorous but outmoded import-substitution regime. Observing Japan, Taiwan, Singapore and Korea, Indonesian leaders were convinced that spending oil wealth on establishing manufacturing facilities would create highvalue exports such as automobiles and consumer electronics, plus a modern financial sector, all with relatively low-cost labor. This mix, the thinking was, would make Indonesia an industrial power, and its large labor force would make it possible to achieve this ambitious goal. The belief was that the combination of oil wealth and a large labor force was sufficient to make Indonesia an exporter of high-value products. Indonesia focused primarily on oil production to pay for its ambitious import substitution and industrialization schemes. In the absence of the proper institutional structure, inefficiencies in these two areas and underinvesting in other areas of the economy led to haphazard economic change and highly irregular modernization results. Apart from the regional crisis that has lingered since the middle of 1997, Indonesia suffered a major disruption in both production and distribution activities once oil revenues and the Indonesian currency dropped. Indonesia’s support of the oil industry and reliance on its income to fund other economic change schemes also contributed to overvaluation in the industry. Weakened oil prices and the collapse of the Indonesian currency market 3.3 MANUFACTURING, CONSTRUCTION AND POWER Manufacturing, construction and power (MC&P) dropped slowly from a high of 17.4 of GDPin 1991 to 13.5 percent in 1996. The drop represents negative development only if it continues. Even in a developing economy such as PNG, MC&P not only represent investment in goodsproduction but an overall improvement in the living standards. Increased power consumption is an especially telling sign of overall improvement, as the vast majority of villages in PNG do not have power. Detailed information on the components of MC&P is unavailable. However, it is clear that this particular sector has huge potential as the economy kicks into higher gear in the months and years ahead. 8 Michael Plummer, “APEC and Implications for Papua New Guinea,” Pacific Economic Bulletin, National Center of Development Studies, The Australian National University, Vol. 12, No. 2. 9 Ibid., p. 36. 22 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 3.4 COMMERCE, TRANSPORTAND FINANCIAL SERVICES some conclusion in the next 12 months, PNG should be in a position to create better employment opportunities for a growing labor force and embark on a new path to steadier economic growth. But when the Asian economies emerge from the financial crisis, they will be more efficient and thus more competitive, partially as a result of the reforms IMF and the global village have imposed on them. This will raise competitive pressures on the smaller economies, including PNG. To participate in the emerging regional economy, PNG needs not only a more efficient and competitive economy, but also one that is more open. In the long run, PNG will benefit more from market dynamism than the smaller island economies in the Pacific, which lack the resources and labor force of PNG. The critical question is what would it take to achieve this ambitious goal? Returning to political stability is not enough for economic growth or development. Even under the most unfavorable conditions, some segments of the economy will function. PNG faces challenges on two fronts: investing in and expanding the nation’s production of essential goods and services, and achieving the proper mix of resource use (sustainable rate). Conditions that would help create larger levels of output and employment include government’s commitment to dealing with the law and order problem, reforms that will eliminate cumbersome bureaucracy over time, managing foreign aid effectively and gradually changing the existing land tenure (use) system into a functional quasi-market system without alienating lands and landowners. The US-affiliated Commonwealth of the Northern Mariana Islands and the Republic of Palau in the Western Pacific have put in place land use exchange systems that preserve the traditional communal ownership while making provisions for long-term leases that businesses need. This middle ground arrangement, half-communal and half market, is less than ideal, but one that has been shown to work. Those doing business in these markets have come to understand and learn to work with it. PNG’s economy as a whole will most likely grow in a haphazard manner for at least a few more years until an integrated national development strategy is in place. Certain sectors such as mining and oil production will continue to do well because government, which needs the income they generate, will protect them. Port Moresby will continue to function because it is the country’s capital. A measurable reduction in law and order incidents in the national capital district will also encourage other areas to adopt similar policies. PNG’s economy currently appears fragmented. The Commerce, transport and financial services (CTFS), like MC&P, also reflect advancement in the economy’s secondary areas which follow gains in the primary areas. The contribution of CTFS to national income also dropped over the 1990-96 period but only slightly. In that time, CTFS dropped as a share of GDPfrom a high of 17.7 percent in 1991 to 13.8 percent in 1994 but rose to 15.1 percent in 1996. While changes from year to year do not signal new trends, a steady drop over a number of years suggests at least sluggishness, which is considered unfavorable, especially in an important area such as CTFS to a developing economy. CTFS is the equivalent of arteries whose health is critical to sound circulation. Without progress in CTFS, the economy’s ability to move goods, services and capital efficiently will be hampered. As the production economy improves in the months and years ahead, this critical area of economic activity should also improve. 3.5 SERVICES Services, which include public administration, dropped gradually but steadily in 1990-96, decreasing from 24.0 percent of GDP in 1990 to 18.6 percent in 1996, having been as low as 17.9 percent in 1995. It is not clear what specific segment of services dropped, but the overall decline in services is not necessarily an unfavorable sign in an economy that needs more emphasis on production of goods, especially essential goods. However, cutbacks in areas as vital to economic development as social progress (i.e. education) can have both short- and long-term impact. As with other secondary and tertiary areas of the economy, services should play a more important role in an expanding economy. IV. WHAT LIES AHEAD Settlement of the Bougainville conflict, which caused social, political and economic disruption in PNG for a decade is the most important step toward establishing a more effective national economic development strategy. It was clear during the February economic summit in Port Moresby that the business community strongly supports this effort, as do government and labor, the other major constituent groups. Provided that the Asian financial turmoil comes to 23 PA P U AN E W GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 phenomenon called “dualistic economy,” two economies in one but disconnected in terms of production, consumption and distribution channels, is the major cause of economic fragmentation and often social and political tensions, even in developed economies. PNG has a more visible dualistic economy with detached urban and rural sectors not connected by a production and distribution network. Even in areas that may some day become suburbs or residential communities of Port Moresby and Lae, there is no power, modern water storage and distribution system nor other facilities that make production and consumption more convenient and efficient. In most inland regions, especially the central highlands, large communities are still totally detached from urban areas as well as from each other. Even remote coastal areas are disconnected because of lack of roads and other means of transport and communication critical to linking peoples and markets. In the absence of such a national network of production and distribution channels, the only movement is that of rural people migrating to cities in search of work. The most effective remedy for dualistic economies is to establish as many links as possible, thus enabling them to quickly increase the production and distribution capacity in many areas. Through strong emphasis on agricultural production and saving the profits from selling surplus output in open markets, the government of the People’s Republic of China, for example, has successfully established a production and distribution network that effectively connects urban and rural areas. Once the basic production economy kicks into higher gear, the need for more widespread availability of essential services such as health care, education, trade, and provision of basic infrastructure in remote areas can be addressed more effectively. Whether or not the economy grows rapidly, PNG’s urban economy is growing, and the need for better banking and other financial services is rising. To reduce the disruptive impact of rural-urban migration, more work needs to be created in the villages. Directing productive capacity growth toward rural areas also applies to tourism where the country has vast potential. PNG receives fewer than 60,000 visitors a year, of whom only 20,000 are typical leisure and business tourists. Some coastal areas outside Port Moresby have the potential to attract eco-tourism, adventure tourism and other specialty tourist markets. Connecting the various scenic points in the countryside in the immediate future will be feasible only by air transport since ground transport facilities such as roads and highways take a long time to build. Due to PNG’s detached island masses, transport by air or water remain the only choices. International air carriers, especially from Australia, may enter into some agreements with PNG’s national and commuter carriers to connect the various emerging tourist markets. To achieve a rate of growth that enables sustained economic vitality, PNG will need assistance from both global and regional aid organizations. Australia will remain PNG’s strongest donor of aid as well as one of its major trade markets because of historical ties and the dominant presence of Australian businesses and government in the country. Asian firms have found their ways to PNG’s forest resources. American Chevron is thus far the only producer of oil in PNG, and is busy exploring other reserves of both gas and oil. Despite its relatively small economy, PNG is a member of the big and powerful Asia-Pacific Economic Cooperation (APEC). PNG’s membership in APEC, dominated by economies such as the United States, Japan, China, Australia and others in the region, tells of its commitment to liberalizing regional trade and investment flows. Since PNG needs foreign physical and human capital to develop its own vast resources, participation in regional trade will benefit the economy in the future. For PNG, the road ahead to economic prosperity is dotted with both minor and major obstacles, internally and externally. However, PNG’s location in the midst of the globe’s biggest and most dynamic market, the Pacific, also gives the economy certain advantages most countries in the developing world do not have. Among the most important is easy access to technology, skills and capital. Combining PNG’s labor and its resources with the necessary skills (which may be provided by expatriate labor in the short run) under an open market structure will attract the investment needed to increase the pace of change and economic development. Ongoing dialogues between central and provincial governments should facilitate enhancement of the average standard of living while expanding the nation’s overall productive capacity. GDP should begin to rise in the second half of 1998, perhaps as much as 4-5 percent annually, with growth accelerating to 6-7 percent in 1999 and beyond. Employment will begin to increase by early next year and government finances should also improve. With the conclusion of the Asian crisis in the next 12-18 months, the stage will be set for the region to progress again, and PNG should receive its share of prosperity. 24 PAPUA NEW GUINEA (PNG) ECONOMIC REPORT • SEPTEMBER 1998 HEADQUARTERS Financial Plaza of the Pacific 130 Merchant Street Honolulu, Hawaii 96813 Phone: (888) 643-3888 PACIFIC CENTURY TRUST Phone: (808) 538-4444 Fax: (808) 533-1573 INTERNATIONAL BANKING GROUP Phone: (808) 537-8377 Fax: (808) 536-5733 WEST PACIFIC DIVISION PO Box BH Agana, Guam 96910 Phone: (671) 477-2863 Fax: (671) 477-9496 SOUTH PACIFIC DIVISION PO Box 2900 Honolulu, Hawaii 96846 Phone: (808) 537-8223 Fax: (808) 537-8079 W. Michael Ord, Senior Vice President & Chief Manager INTERNATIONAL OFFICES/BRANCHES HONG KONG THE PHILIPPINES Manila, Cebu, Davao NASSAU NEW YORK SEOUL SINGAPORE TAIPEI TOKYO WEST PACIFIC BRANCHES COMMONWEALTH OF THE NORTHERN MARIANA ISLANDS (CNMI) Garapan Susupe FEDERATED STATES OF MICRONESIA (FSM) Kosrae Pohnpei Yap GUAM Agana Dededo Tamuning REPUBLIC OF THE MARSHALL ISLANDS (RMI) Majuro REPUBLIC OF PALAU Koror SOUTH PACIFIC BRANCHES AMERICAN SAMOA Pago Pago Pava‘ia‘a FIJI Lautoka Nadi Suva SUBSIDIARY BANKS FRENCH POLYNESIA Banque de Tahiti NEW CALEDONIA Bank of Hawaii—Nouvelle Calédonie VANUATU Banque d’Hawaii (Vanuatu) Ltd. PAPUA NEW GUINEA Bank of Hawaii (PNG), Ltd. SOLOMON ISLANDS National Bank of Solomon Islands, Ltd. AFFILIATE BANKS TONGA Bank of Tonga SAMOA Pacific Commercial Bank, Ltd. To contact Bank of Hawaii about Papua New Guinea: W. Michael Ord, Senior Vice President & Chief Manager Bank of Hawaii South Pacific Division PO Box 2900 Honolulu, Hawaii 96846 Phone: (808) 537-8223 Fax: (808) 537-8079 John Sheather, Deputy Managing Director Bank of Hawaii (PNG), Ltd. PO Box 1390 Port Moresby, Papua New Guinea Phone: (675) 321-3533 Fax: (675) 321-3115 Additional copies of this report and other Bank of Hawaii economic reports can be obtained from Bank of Hawaii, POBox 2900, Honolulu, Hawaii 96846 Phone: (808) 537-8307 Fax: (808) 536-9433 Internet: http://www.boh.com Wali M. Osman, Bank of Hawaii Regional Economist and author of this report, can be reached at Phone: (808) 537-8349 or E-mail: (wmosman@boh.com). With locations all over the Pacific and Asia, Bank of Hawaii is uniquely positioned to serve the needs of businesses throughout the entire Pacific Rim. To find out more, call us at (675) 321-3533 or fax us at (675) 321-3115 for more information. ASIAN RIM: Hong Kong, Philippines (Cebu, Davao, Manila), Seoul, Singapore, Taipei and Tokyo. PACIFIC ISLANDS: American Samoa, Fiji, French Polynesia, Guam, Marshall Islands (Majuro), Micronesia (Kosrae, Pohnpei, Yap), New Caledonia, Northern Marianas (Saipan), Palau (Koror), Papua New Guinea, Solomon Islands, Tonga, Vanuatu and Western Samoa. www.boh.com

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