PNG Kina overvalued

Photo: Australian Policy and History Network

Papua New Guinea foreign exchange (FX) shortages have repeatedly been identified by business leaders in PNG as the most serious impediment to private sector development in the country, according to the International Monetary Fund (IMF).

Under a three-year programme supported by the IMF, the PNG authorities have set a target to gradually resolve the longstanding and persistent FX shortages and return to kina convertibility.

IMF country representative Sohrab Rafiq told the Post Courier that a major root cause of FX shortages in the country is the overvaluation of the kina.

Rafiq said as long as the kina is overvalued, there will be a persistent mismatch on the FX market between (higher) demand and (more limited) supply of foreign currencies, leading to an accumulation of unmet FX orders.

“Tackling this backlog of orders requires FX interventions by the Bank of Papua New Guinea (BPNG), which puts high pressure on its limited FX reserves,” Rafiq said.

“There is no other way: resolving FX shortages for good requires tackling the overvaluation by gradually bringing the kina to its market-clearing rate, which would enable kina convertibility. Doing so would bring about many economic benefits.

“Reducing the overvaluation will benefit exporters by making PNG exports more competitive.”

Rafiq said for global commodities, such as coffee, cocoa, and palm oil, given that PNG is a price taker on the commodities it exports, domestic exporters will receive more kina for the same unit of export.

This will also enable commodity producers to have a stronger incentive to harvest or produce more to respond to higher prices in kina and increase in demand for PNG exports.

This will benefit the agricultural sector and rural areas, where most Papua New Guineans live, boosting inclusive growth, and reducing poverty.

“On the import side, while reducing overvaluation could lead to short-term increases in the price of imports, the economic benefits from removing the overvaluation of the kina to tackle FX shortages should outweigh these costs.

“Resolving FX shortages will be favorable to import-intensive activities as well. Because of FX shortages, some importers have shut down their activities altogether, given their inability to access FX in due time.

“Others have been facing high-cost premia from their suppliers because of the risk of payment delays.

“Resolving FX shortages will allow importers to normalise operational conditions and develop new activities, which will in turn have a positive impact on investment, non-resource growth and jobs.

In the medium term, eliminating the overvaluation will contribute to the development of domestic manufacturing and downstreaming, a key priority for PNG, according to the IMF representative.

“To put it bluntly, the overvaluation of the kina is akin to a subsidy to foreign-produced goods (or to a tax on domestically produced goods).

“By eliminating the overvaluation, domestically produced goods, such as agricultural products, will become more attractive, enabling the development of a domestic manufacturing capacity. This would contribute to the growth in the non-resource sector and diversification of the PNG’s economy.”

Rafiq further suggests that the impact on PNG’s business attractiveness may be significant.

Given persistent FX shortages, many foreign investors have not been able to repatriate their dividends for many years.

This has discouraged new foreign direct investment (FDI) inflows, hurting growth and jobs. By bringing the kina to its market-clearing rate and gradually removing restrictions on access to FX, full dividend repatriation will become possible.

“This will encourage FDI into PNG, which would then have positive spillover effects on the local economy, including Small and Medium Enterprises (SMEs) as they may find new business opportunities,” Rafiq said.

“For these benefits to materialize, a carefully planned reform strategy is required. After almost 10 years of persistent FX shortages and kina overvaluation, transitioning back to kina convertibility is not easy.

“The PNG authorities are preparing a comprehensive roadmap of concrete and sequenced actions to enhance the exchange rate and monetary policy frameworks to address FX shortages over the medium term.

Meanwhile, Kina devaluation discussions are creating real nervousness for many as it can result in Papua New Guineans paying more for goods and services, says Brian Bell Group chairman Ian Clough.

“I need to disclaim that I’m not an economist but I do have concerns that any suggestion of a devaluation needs to be carefully considered and planned,” he said.

“If this was to be managed badly, and there are many examples across the world where countries have seen significant issues from similar actions, then PNG could face serious repercussions that would take generations to repair.”

Policy advisers have suggested that the Kina is overvalued and a devaluation in the range of 15 to 20 percent is needed due to recent International Monetary Fund (IMF) funding to PNG.

“Rapidly rising inflation is only one fear,” Clough said.

If the Kina devalues, goods and services will cost our people much more.”

“If this happens, then wages ultimately need to rise for communities and businesses to survive and then you potentially end up with inflation becoming out of control.

“We need the experts to think about this very carefully.”

Clough said the economy was facing significant headwinds as inflation levels and unemployment rose and delays in the reopening of the Porgera mine as well as the commencement of other key investment projects created uncertainty in the market.

“Consumer and business confidence would be at some of the lowest levels seen in recent years.

“When consumers and businesses aren’t confident, they stop spending on goods, key capital projects are put on hold and as a result PNG’s economy worsens.”

Clough said the country needed to fix its productivity issues and ensure that there were other important economic activities underway before the Kina was unpegged.

“This way the Kina doesn’t fall instead remains stable,” he said.

“This seems to be a more prudent approach that ensures we avoid any disasters from badly managing this critical process.

“Remember, in the 80s and early 90s, the Kina was valued at higher than the US dollar.

“We had a strong economy, a number of key resource projects were driving confidence and the country was growing.”

“Businesses were investing and the global economy had confidence in PNG. “We need to work harder to fix the symptoms of our problems to get a sustainable result rather than just make rash decisions that make things worse,” he said.