But S and P reaffirms its ‘B' short-term ratings on the country and believes the outlook is stable.
"The stable outlook reflects our view that economic growth and fiscal deficits will remain under pressure in the next 12 to 18 months. However, the weaker metrics are unlikely to lead to a sovereign default during this period.
"We could lower our ratings if we assess fiscal pressures and external imbalances have deteriorated beyond our expectations, leading to a decline in foreign-exchange reserves and casting doubts on PNG's ability to service its debt.
"We would consider raising the rating if economic growth were to significantly outperform our current projections, leading us to materially improve our view of PNG's fiscal and debt trajectories," S and P said in its latest ‘global ratings' report.
This is an edited version of the report:
The 2019 supplementary budget passed by the new government exposed wider fiscal deficits than we had expected. Lower than expected revenues coupled with larger recurrent expenditure are a feature of the fiscal landscape. These larger fiscal deficits, along with weak economic growth, have propelled its general government net debt, according to our calculations, to above 38% of GDP in 2020 and we forecast it will reach around 42% in 2023 as the government's fiscal consolidation efforts are delayed the fallout from Covid-19.
The sovereign ratings on PNG reflect structural constraints inherent in a low-income economy dependent on the mining industry, and served by weak institutions.
Flexibility and performance profile: Public debt burden is increasing while fiscal pressures grows:
• Fiscal deficits are forecast to be weaker in the immediate future.
• Debt is rising and is shifting more toward external debt.
• Foreign exchange shortages continue to suppress business activity.
In November 2019, the new government revised the previous 2019 budget, outlining a significant reduction in revenue projections and increased expenditures for the rest of the fiscal year. The government hopes this supplementary budget depicts the country's fiscal situation more accurately than in previous years. Additionally, we expect recent Covid-19 developments to put further strain on government finances.
Weaker tax revenues and dividends from state-owned corporations substantially lowered the revenue expectations from our previous base case. On the expenditure side, significant overruns were incurred from the public sector wage bill, both as a result of increased wages and additional staff numbers. In response, the government has cut capital expenditure, partially offsetting the weaker revenues. But this does not address vulnerabilities linked to PNG's narrow tax base and it will weigh on future growth.
We estimate the general government deficits to rise to an average 5.4% of GDP between 2019 and 2021. Additionally, the spread of Covid-19 could have larger effects, as potential containment measures could dampen domestic economic activity and constrain tax collection, amid an expected hike in health and social expenditure to tackle the consequences of the pandemic.
We expect multilateral and bilateral partner loans will step up to finance fiscal deficits, with net debt increasing to about 42% of GDP in 2020. The government has revised its debt measure to include state-owned enterprise (SOE) debt, which is higher than our standard definition of general government debt. A lack of disclosure means we are unable to separate the debt of SOEs from the general government's.
The government continues to increase its reliance on external borrowing, with its debt strategy targeting a 50:50 split between domestic and external financing. Wider fiscal deficits in recent years have strained the ability of the domestic financial system to absorb large amounts of government debt, which is reflected in higher local interest rates.
PNG has diversified its funding base via drawdowns from its Credit Suisse, Asian Development Bank, and World Bank credit facilities, a $A300 million budget support loan from Australia, as well as its $US500 million sovereign bond issuance.
The government has been able to use some of these proceeds to retire short-term expensive domestic debt, lowering the government's average cost of debt domestically. We anticipate interest payments to rise as debt stock increases to about 17% of general government revenues by 2023.
PNG's external position remains weak. The country's terms of trade volatility has subsided over the past few years. External debt ballooned between 2010 and 2013 during the LNG project's construction phase, with large current account deficits--financed by a combination of external debt and foreign direct investment--that averaged about 30% of GDP.
The country's external imbalances have contracted during the past few years, with LNG production since 2014 resulting in repayment of external liabilities. Future LNG projects could exacerbate external imbalances again during the construction phase, when and if they occur. We currently project a moderation in current account surpluses in 2022-2023, rather than the double-digit current account deficits of 2010-2013.
We forecast net external debt to be about 121% of current account receipts (CARs) in 2019. This comes after PNG's net external indebtedness peaked at 370% of CARs in 2012. We consider PNG's strong current account surpluses to overstate its external position. Project development agreements allow developers of mining projects to keep export receipts in offshore foreign currency accounts.
These US dollar revenues deflate our external ratios, presenting a stronger external picture than would otherwise be the case. We expect net external indebtedness to peak at about 174% of CARs in 2023.
Stronger foreign-exchange inflows from new external loans and issuance have helped to increase foreign-exchange reserves during the past 12 months to about $US2.3 billion by the end of 2019. PNG held about $US4.4 billion in international reserves in 2011, declining to $US1.7 billion in 2017.
This has also resulted in an easing of the shortage in US dollars in PNG, helping to lower the value and shorten the clearing time of outstanding foreign-exchange orders. However, we believe PNG maintains extensive foreign-exchange restrictions. This is symptomatic of a currency that persists above the market-clearing exchange rate. PNG's exchange-rate arrangements are "crawl-like," according to the International Monetary Fund.
During the past few years, the PNG kina has depreciated against the US dollar, falling 13% since 2015. More broadly, the Bank of PNG's weak monetary policy flexibility is a rating constraint. This weakness mainly reflects the limited transmission of monetary policy settings to the interest rates faced by borrowers, largely because of the high level of liquidity in the banking system.
PNG's banking system is stable, with limited competition. It relies heavily on deposit funding, which is supported by high levels of liquidity. It also has a small net external asset position and limited linkages to global markets.
But the country's low income levels and credit concentrations increase banking system risks. Legal infrastructure and judicial system delays also pose challenges to enforcing creditor rights. Our Banking Industry Credit Risk Assessment for PNG is 9 (with 1 being the highest assessment and 10 being the lowest).
Institutional and economic profile: PNG's economic growth prospects dim on collapsing energy prices:
• We expect economic growth to contract in 2020, before recovering when the Papua LNG project starts.
• Collapsing energy prices could delay prospective projects and drag on PNG's future growth prospects.
As the Covid-19 pandemic escalates against a backdrop of volatile markets and growing credit stress, we expect a global recession for calendar year 2020. There are several downside risks to economic growth specific to PNG going forward.
The global slowdown and quarantine restrictions are negatively affecting oil and gas prices. This will have an effect on PNG government revenues and economic growth forecasts. Covid-19 is likely to weigh on GDP by weakening private investment and domestic consumption in the country. Therefore, we are forecasting real GDP to slump to -0.2% in 2020.
Weighing on the economic growth outlook is the protracted negotiations in upcoming resource related projects. While construction of several new LNG projects and extensions are expected to lead to a sharp acceleration in economic growth, the continued delay in negotiations means this benefit is being pushed out.
Further, the recent collapse in energy prices could result in investment decisions being delayed for a number of years weighing on PNG's economy.
