The Macro-Economic Environment in Papua New Guinea

PNG has a dual economy. Most people work in the large subsistence sector, producing food for consumption, raising animals and building their own shelter, as well as producing agricultural commodities for sale in domestic and international markets. A smaller number of people work solely in the monetary sector, which is concentrated in urban areas and mining enclaves. The level of national income generated from these activities was, until recently, sufficient to place PNG in the World Bank category of ‘Lower Middle Income Countries’. This category includes Thailand, Fiji and Sri Lanka. However, social indicators (for example, literacy rates, life expectancy at birth, infant mortality, school enrolment) in PNG are typical of countries in the ‘Lower Income Countries’ category.
This category includes most of sub-Saharan Africa. In part, this situation can be attributed to the macroeconomic environment in which the agricultural sector operates. This environment is determined by a combination of exchange rate, fiscal, monetary and trade policies.

The exchange rate is a key determinant of agricultural competitiveness, both for domestic and export markets. Before 1994, PNG maintained what was known as a ‘hard kina’ exchange rate policy, in which the exchange rate between the kina and major international currencies was deliberately maintained at a high level, which kept the cost of imports low. The aim of the ‘hard kina’ policy was to contain wages. This was achieved by improving the purchasing power of urban workers through the low-cost imports. In 1994 the kina was allowed to float and it immediately fell in value (Figure 1). Following the Asian financial crisis and mismanagement of the economy in 1997, it fell even lower.

Figure 1 Exchange rate for one PNG kina against the Australian dollar and United States dollar, 1975–2005.

The high value of the kina adversely affected the agricultural sector in several ways. People selling locally grown food found it difficult to compete with low-priced imports. For example, in 1993 it cost K0.66 to purchase cabbages worth A$1.00 imported from Australia. But in 2005, cabbages worth A$1.00 cost about K2.40, which encouraged domestic production to such an extent that PNG is now selfsufficient in cabbages.

The hard kina policy also depressed incomes earned by growers of export tree crops. For example, in 1993 the average delivered-in-store (DIS) price of coffee in PNG was K0.57/kg. Ten years later, in 2003, the DIS had increased to K1.23/kg. This occurred despite the average world price of coffee falling from US$1.28/kg to US$0.70/kg during that decade. Although the value of the kina in 2003 was lower than what it was under the hard kina policy, under international exchange rates, a US dollar bought more kina, which was good for PNG exporters.

The decision to float the kina in 1994 did more to stimulate agriculture than all the direct interventions into the sector by the PNG Government and foreign donors. The decline of the kina swung the terms of trade back in favour of rural areas, where more than 80% of Papua New Guineans live, although it disadvantaged urban dwellers.

The rapid expansion of the mining industry through the late 1970s and 1980s provided a major boost to the PNG economy. However, the income from mining was not managed in a way that encouraged the development of agricultural and other industries. Instead, it was used to create unsustainable government structures that resulted in a large public debt and an over-valued kina. Agricultural commodity earnings fell and the standard of living of growers declined. This would not necessarily have been a problem if other industries had been developed to replace the mines when they eventually close, but replacement industries have not been developed.

The commercial agricultural sector has been hampered by high interest rates and lack of finance. This was caused by the way large budget deficits have been financed. Government expenditure has consistently exceeded income, often by substantial margins. These budget deficits could have been financed by borrowing either internationally or locally. PNG governments chose to borrow locally by selling Treasury bills to the commercial banks. This avoided the build-up of a high level of foreign debt, however, with only a small local market for the sale of Treasury bills, interest rates were driven to exceptionally high levels. In August 1999, the Treasury bill interest rate peaked at 28% per year. This made borrowing for investment in agriculture uneconomical. Since the commercial banks were able to earn very high profits by lending to the government, there was no incentive for them to lend to productive sectors like agriculture. In 2004, for the first time in 13 years, a budget surplus was achieved. As a consequence, the Treasury bill interest rate fell below 5%, making it worthwhile for banks to consider other lending opportunities. The challenge for PNG fiscal and monetary policy is to balance public debt, to find an appropriate method of financing the debt, and to invest in infrastructure to support productive sectors such as agriculture.

Previous trade policy placed restrictions on the import of food and agricultural products to encourage import replacement. Prior to PNG joining the World Trade Organization in 1995, local fruit and vegetables were protected from imports by a combination of high tariffs, quotas and outright bans. In 1995, these measures were replaced by a 75% tariff on all imports, which has been gradually reduced as a part of the Tariff Reduction Program. The Tariff Reduction Program has had a positive impact on the economy and has reduced the costs of imported food for urban Papua New Guineans.

Despite the Tariff Reduction Program, inconsistencies and inequities still exist in the tariff structure that hinder overall agricultural development. Self-sufficiency in poultry and pig products, which has been achieved in recent years, was the outcome of a high level of protection, with imported poultry products incurring a tariff of 57%. But the additional value to the economy of a local poultry industry is substantially reduced by an almost total reliance on imported feed grains. Locally produced maize, copra meal and fish meal must compete with imported feed grains that have no tariff. The pig and beef industries receive a lower rate of protection than poultry (a 15% tariff). The cattle industry, which relies on local pastures and not imported grains, pays high import duties (50%) on essential inputs such as fencing wire. The agricultural sector would be better served if the same low level of protection applied to all industries.

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