PNG Economic Update A revised outlook for business in 2012

Aaron Batten, Country EconomistPort Moresby Resident Mission

July 18th 2012

The state of the economy and its near term outlook

Business confidence is riding a wave of optimism…

Substantially more than 2011

Slightly more than 2011

Same as 2011

Slightly less than 2011

Substantially less than 2011

Substantially more than 2011

Slightly more than 2011

Same as 2011

Slightly less than 2011

Substantially less than 2011

Expected Capital Investment in 2012 Profit Expectations for 2012

…and the ‘Pacific tiger’ is likely to again exceed growth forecasts…

0

1

2

3

4

5

6

7

8

9

10

0

50

100

150

200

250

300

350

400

450

500

Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

GDP growth, annual, rhsJapan car imports, 3 month moving average, lhsFuel imports, volume, lhs

Number cars per month/ Fuel imports, tonnes (100's) % p.a

…with surging private sector employment growth so far in 2012.

-5%

0%

5%

10%

15%

20%

0

40

80

120

160

200

1978 81 84 87 90 93 96 99 02 05 08 11

GDP growth (real, %), rhs Total employment (Index), lhs

Why has this period of economic growth been so good for business?

Growth has supported a wide range of businesses because it has been led by the

non-mineral sector…

GDP Growth by sector (per cent per annum, average)

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

1995-2000 2001-2005 2006-2012

Industry incl. mining

Agriculture

Services

Employment Growth by Sub-Sector (%, per annum)

-6%

-4%

-2%

0%

2%

4%

6%

8%

Total Transport & Comms

Finance Wholesale Retail

2001-2005 2006-2012

…but non-mining sector has reached the peak of this economic cycle…

-20

-15

-10

-5

0

5

10

15

20

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Mining GDP Non-Mining GDP

GDP

GDP Growth by sector (%)

…as the FDI funded construction binge winds down…

0

5

10

15

20

25

30

35

40

45

50

2003 2005 2007 2009 2011 2013 2015

Construction Transport and communications

GDP Growth by sub-sector (%)

…which will change the composition of future growth.

-2

0

2

4

6

8

10

12

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Other Non-mineral Transport and communicationsConstructionAgriculture, Forestry and FisheryMining and Petroleum

(Contributions to growth by sector)

What macroeconomic trends will impact on business conditions over the next 2-3 years?

Euro instability is unlikely to affect already stagnating commercial lending.

(Private sector lending growth, Quarterly, %)

-20

-10

0

10

20

30

40

50

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

(Private sector credit, % GDP)

But commodity exports make economies vulnerable. PNG is no exception.

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

0

2,000

4,000

6,000

8,000

10,000

12,000

Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

Copper ($/mt), lhs2012 Budget Forecast - Copper ($/mt), lhsGold ($/toz), rhs2013 Budget Forecast - Gold ($/toz), rhs

(Commodity prices, Monthly, $US)

Lower agricultural prices will hurt rural incomes in particular.

0

200

400

600

800

1,000

1,200

1,400

1,600

Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

Cocoa (cents/kg)

Coffee, arabica (cents/kg)

Copra ($/mt)

Palm oil ($/mt)

Logs, ($/cubic metre)

(Agricultural commodity prices, Monthly, $US)

FDI will remain strong in the short term, but may be offset by increasing offshore

investment…(Foreign Direct Investment, USD, millions)

-200

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2001 02 03 04 05 06 07 08 09 10 11 12

Inward FDI - Total (IMF)

Inward FDI - from Australia (ABS)

Outward FDI - to Australia (ABS)

The Kina will stay high but has likely peaked.

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12

AUD

USD

(Kina exchange rate, FX/Kina)

Official inflation has dropped significantly this year…

(Official Consumer Price Index growth, Quarterly, %)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2008 Q1

2008 Q3

2009 Q1

2009 Q3

2010 Q1

2010 Q3

2011 Q1

2011 Q3

2012 Q1

Moresby Goroka

Lae Madang

…but these figures probably exaggerate the real situation.

(Official and alternative Consumer Price Index growth, Quarterly, %)

-5

0

5

10

15

20

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12

OfficialAdjusted for rents, housing weight and education subsidy

What macroeconomic policies should business support?

BPNG has been effective in sterilizing large capital inflows...

Source: IMF Article IV, 2012

…but business should expect a more austere government over the next 2-3 years…

4,000

5,000

6,000

7,000

8,000

9,000

10,000

2000 02 04 06 08 10 12f 14f 16f

2012 Budget, original target

(Government Revenue, Kina, millions, constant prices)

10%

15%

20%

25%

30%

35%

2006 2008 2010 2012 2014 2016

(Government revenue to GDP, %)

..and support government’s need to correct its declining revenue base…

(Government revenue, per capita)

..to help foster greater levels of public investment.

0

400

800

1,200

1,600

2,000LNG contribution by 2028LNG contribution by 2015Foreign AidDomestic Revenue

USD per capita

Ultimately, non-mineral growth requires a reinvigoration of microeconomic reform.

3 3.5 4 4.5

Corruption

Red tape

Government capacity

Rental costs

Employment

Expertise

Logistics

Law and order

Skills shortage

(Critical issues facing business, CEO Survey)

The outlook

PNG’s macroeconomic fundamentals remain sound but the next 12-24 months will see a more moderate rate of economic growth.

More importantly for business, the underlying sources of economic growth are about to change quite significantly.

This will have an impact on business conditions and growth in the non-mineral sector.

Eurozone instability and slowing China is lowering commodity prices creating pressure on Government spending.– This will restrict much needed revenue growth but

unlikely to jeopardize macroeconomic stability. The exchange rate has likely peaked whilst short

term inflationary pressures are also easing. As revenues shrink, greater austerity is needed to

protect funding for existing assets and prevent another round of inflationary pressures.

The outlook

Thank you.

Asian Development Bank6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines

Tel + 632 632 4444

Port Moresby Resident Mission Level 13, Deloitte Tower

Port Moresby, PNG