STRUCTURAL REFORM PROGRAM IN PAPUA NEW GUINEA

Overview

During the late 1990s, Papua New Guinea’s economy was adversely affected by a severe
drought, the Asian crisis, and falls in prices of mineral exports. The decline in the economic
activity and exports led to a deterioration of the fiscal position, resulting in heavy borrowing by
the Government from the Central Bank to finance the large budget deficits. This led to losses of
international reserves, a protracted depreciation of the Kina and a sharp increase in inflation.

Coincident with the poor economic performance, the economy was on the verge of an
economic and financial crisis due to years of deteriorating economic management, lax fiscal
discipline, and a breakdown in budget processes and implementation, resulting in declining
business and investor confidence, and breakdown in public service delivery.

While Papua New Guinea (PNG) has proven itself adept at stabilizing the economy in the
face of domestic and external shocks, the platform for a resilient economy has been continuously
undermined by the absence of sound institutions and administrative systems.

The current Structural Reform Program, undertaken over the last five years, introduced
measures to address macroeconomic stability, international competitiveness, price and trade
liberalization, taxation reforms, investment policy reforms, public expenditure management,
control and effectiveness, and decentralization of responsibilities and finances from the national to
the provincial and district levels. In addition, the reform agenda advanced further to address the
more difficult assignment of improving the overall governance framework.

In all respect, the Government believes that continued adherence to the structural reform
represents the best means for economic and human development. The Government has
committed itself to four core Objectives of the reform program, which are: (i) Promoting Good
Governance; (ii) Sustaining Macroeconomic Stability; (iii) Improving Public Sector Performance;
and (iv) Removing Barriers to Investment and Economic Development. These four Objectives
continue to remain as the focus of the reform agenda, as reiterated in the 2000 to 2004 Budgets.

The Government had a successful dialogue with the international financial institutions,
particularly the IMF (Stand-By Arrangement), World Bank (Governance Promotion Adjustment
Loan) and Asian Development Bank (Structural Adjustment Loan) to secure financing to support
its reform program. In addition, the Governments of Australia and Japan provided concessional
loans, while the European Union and the Government of the People’s Republic of China
committed grants to assist with the reform program.

The introduction of the reform agenda in the middle of 1999 saw export prices rebounding
and output recovering strongly from the effects of the 1997 drought. The improved fiscal
management and continued favorable commodity prices allowed the government to present
budgets that envisaged a substantial reduction of deficit to under two per cent of GDP. Financial
markets reacted favorably to the reform initiatives, and the local currency (Kina) has stabilized
against the U.S. dollar and the other selected currencies.

The reforms are the beginning, and not the end, of a process of evolutionary development to
put PNG back on economic recovery and growth.

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1. Promoting Good Governance

The promotion of good governance is a necessary ingredient in supporting and sustaining

other structural reforms that have been and that are being implemented. The reforms under this
objective seek to improve good governance framework by cultivating institutions and
administrative systems that will nurture and encourage proper management of public resources,
and a stable and transparent economic and regulatory climate. The initiatives under this area
range from reforms within the political sphere, strengthening of decision-making processes, and
strengthening capacity of oversight agencies.

1.1 Improve Political Stability

The uncertainty surrounding the political environment in PNG has often proved to be detrimental
to the objectives of economic and human development. In particular, the unstable political regime
through constant change of governments has caused uncertainty amongst the business (both
within and abroad) and donor communities, resulting in low level of investment and economic
activities.

To increase political stability, the Integrity of Political Parties Act was passed by the Parliament
to be effected after the 2002 General Elections.

1.2 Electoral reform to broaden Electoral Base

It has been recognized that the first-past-the-post voting system adopted in 1977 was unfair
and unrepresentative. In most instances, Members of the Parliament were elected on the basis
of electoral shares of no more than 10 per cent.

The reforms to the Electoral system were approved by the Parliament in 2002, with the
introduction of the Limited Preferential Voting (LPV) system to overcome the parochial
voting patterns and the discriminatory distribution of public resources in electorates. It is
anticipated that the LPV system will:
• produce a wining candidate having much wider support than just that of his/her clan or
tribe, resulting in fairer and broader representation;
• encourage candidates and political parties to address national issues and not just matters
concerning their supporters; and
• create unity amongst different ethnic groups, strengthen political parties and provides an
opportunity for women and minorities to win seats.

1.3 Strengthening of probity and oversight agencies (Ombudsman Commission,

Auditor General etc)

The Government recognizes the need to continue with the efforts to reinstitute good governance
in the public sector by revitalizing accountability and probity. The Government has implemented
a number of reforms in a concerted effort to minimize the impact of corruption on governance.

The Ombudsmen Commission, Auditor General and other State agencies responsible for detection
and investigation of possible cases of corruption have established a National Anti-corruption
Alliance to co-ordinate activities of the oversight agencies.

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 The Parliamentary Public Accounts Committee (PAC) has also been revitalized in 2002 to
review budgets and expenditures of government agencies, statutory authorities and provincial
governments. The revitalization of PAC is a major step towards improving the transparency and
accountability of the public sector and PAC will continue with its oversight of public bodies and
follow up on its directions to agencies that have already being reviewed.

1.4 Strengthening Government Procurement Practices and Procedures

The legislation governing government procurement framework is unduly complex and

limits competition, thus, restricting the government’s ability to obtain “value for money. In
addition, the lack of transparency in government procurement framework results in
government not receiving competitive pricing and appropriate quality in the goods and
services. It also affects PNG’s ability to negotiate effective government procurement chapters
in the free trade agreements because countries do not understand PNG’s government
procurement policies and practice.

As part of the procurement reform, the Government commissioned the Department of

Finance to review the government’s procurement arrangements in 2000. The outcome of this
review resulted in the amendment to the Public Finance Management Act (sections relating to
government procurement) in 2003.

In particular, the legislation was amended to restructure the government’s Supply and
Tender Boards (which now operate under the new Amended Act) to achieve the following:
• new procedures of appointment and revocation of members to the Central Supply and
Tenders Board (CSTB) to ensure that appointments are made on merit and those
appointed will act impartially;
• all national boards to be consolidated under the CSTB, except for those boards dealing
with Bougainville Infrastructure, Gazelle Restoration Authority, and Pharmaceutical
supplies;
• reduce Ministerial direction to create national boards to those circumstances where
provinces have a clearly defined need to respond to natural or man made disasters;
• major institutional and structural reform in the CSTB to ensure that the basic
principles of transparency, equity, and accountability are embodied in the tendering
and procurement process, so that ‘value for money’ is realized; and
• CSTB to produce annual reports.

The government plans to undertake further reforms to the government procurement

framework that will create network opportunities with the business sector and the
international community. This requires the development of a simple, clear legislation
governing procurement that does not restrict access to government procurement market.

The continuation of information sharing on best practice procurement initiatives,

including the adoption of e-procurement systems, and assistance in capacity building will
benefit PNG in its ambition to incorporate elements of transparency and ‘value for money’ in
the procurement activities.

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Outcome/Benefits

The current term of Parliament (2002-2007) saw for the first time, the political party with
the highest number of elected members forming the Government and its Party Leader nominated
and elected as the Prime Minister.

There have been a number of political upheavals in the current term of Parliament, testing
the effectiveness of the new Act, but it seems that the new Act is withstanding the challenge. In
particular, the Act is making it difficult for parties to move No-Confidence motions without the
absolute support of the party members. In addition, where there are accusations of bribery to
entice party members, those accusations are being investigated for possible prosecution.

The new preferential voting system is now being implemented in a number of

by-elections conducted recently for the current term of Parliament. The full extent of
whether the new voting system has achieved its objective is yet to be determined but
preliminary outcome of the by-elections indicated voter satisfactory on the Member elected
and appeals against the election results has been minimal or none.

The PAC directed a number of public bodies to improve their accountability after reviews of
their budgets and expenditures indicated non-compliance with procedures and processes of the
government accounting system. Warnings of administrative sanctions with the possibility of
further investigation by the Auditor General Office and Ombudsmen Commission for prosecution
were imposed on agencies that did not comply with the directions of the PAC.

2. Sustaining Macroeconomic Stability

The reforms under this Objective focus on improving fiscal management and transparency
of budgeting, and improving debt management function.

2.1 Strengthening Fiscal Discipline

Too often, policy and planning decisions are insufficiently disciplined by the realities of the
budget constraint over the medium term. In PNG’s experience, the absence of restraint early in
the budgeting cycle results in weak expenditure control further down the line.

As of 2003, the Government changed its budgetary planning from an annual process to a
medium term approach by adopting a Medium Term Fiscal Strategy (MTFS). The MTFS is an
important part of the sound public expenditure management that accommodates both the countries
economic needs and its fiscal realities. It allows the Government to address national priorities,
while improving the budget balance and reducing government debt over time.

Government expenditure is currently being controlled through monthly warrant ceilings,

which is determined by the monthly revenue forecast. The on-going expenditure and revenue
performances are monitored on a daily and weekly basis, while the reports are produced on a
monthly basis.

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2.2 Improving Allocation of Resources (Public Expenditure Review and
Rationalization Exercise)

The Public Expenditure Review and Rationalization (PERR) exercise was carried out in
early March 2003 to review public expenditure and identify adjustment policies that will help to
address both the 2004 and medium term (2004-2008) requirements for fiscal adjustment; provide
a scope and opportunity for significant rationalization of expenditures over the medium term; and
eventually identify reforms that will provide SAVINGS, which can then be used to:
(i) retire debt to reduce debt level; and
(ii) provide additional resources to priority and productive activities that would yield
returns in the medium to long term.

The PERR exercise noted that governance measures should be supplemented by a detailed
exercise in adjustment and prioritization of expenditure. A detailed time-bound action plan is
currently being implemented as the highest priority reforms for 2004 to restore fiscal stability,
regain control of civil service employment size and payroll, restore the integrity of budget systems,
adjust and reprioritize expenditure, and improve service delivery in health and education.

2.3 Improving Debt Management

The Government has often been criticized for borrowing heavily from the financial market
through the issuance of treasury bills to finance its fiscal operations, resulting in “crowding out”
liquidity. On the other hand, the Government is also concerned about the size of its short-term
domestic debt portfolio and the inherent risks involved, particularly the interest costs and roll-over
risks.

In this regard, the Government developed a debt strategy to restructure its debt portfolio by
lengthening the maturity of domestic debt portfolio with the introduction of the Inscribed Stock
Program in 2004. In addition, the Government is in the process of developing a medium term
debt strategy, which will:
(i) Assess the portfolio risk profile;
(ii) Establish benchmarks and determine the composition of Treasury Bills and Inscribed
Stock;
(iii) Determine the currency composition of external loans and debt ratios; and
(iv) Determine the composition of external and domestic debt ratios.

2.4 Improving Accounting and Computing System

As part of the Government’s medium to long term reform agenda, the Financial
Management Improvement Program (FMIP) was implemented to improve planning, budgeting
and accounting systems in government agencies, provinces and local level governments, and
delivering competency training so that there are skilled and adequately trained people available to
carry on the reforms when the program ends.

This program reviews current systems and where weaknesses are identified, corrective
measures are taken so that principles of proper training, budgeting and accounting are complied
with at all levels of management. The key improvements that the program intends to achieve are:

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 (i) Establishing an iterative relationship between the agencies and national budget in
preparation and monitoring;
(ii) Decentralization of budget monitoring and information to agencies, provinces and
local level governments;
(iii) Looking at the whole of government financial information and integrating trust
accounting systems; and
(iv) Strengthening cash and debt management.

2.5 Improving Expenditure Control

A number of initiatives have been undertaken by the Ministry of Finance and Treasury to
improve expenditure control. Initiatives range from conducting quarterly reviews, appointing
financial controllers to major spending agencies to amending the legislation to combat the build
up of arrears resulting from claims made outside of the government financial management system.

The Department of Treasury conducts quarterly reviews to ensure that there is no over-
spending or over-commitment by agencies, and administrative penalties (constraining warrants)
on entities that do not maintain expenditures within warrants and appropriation limits

Financial Controllers have also been appointed within 12 major spending agencies to ensure
that agencies adhere to the Public Finances (Management) Act and Financial Instructions when
committing expenditures

Claims resulting from outside the Government Accounting Systems build up to arrears, and
have a negative impact on the government’s ability to achieve the deficit and macroeconomic
targets laid down in the budget each year.

In order to combat this problem, the Claims By and Against the State and the Public
Finances (Management) Acts were amended to prevent the generation of claims outside of the
government’s procurement and accounting system.

Outcome/Benefits

The implementation of the policy initiatives has seen a considerable improvement in the economy
and in government’s budgetary position in 2004. In particular, the budget deficit in 2003 was less
than 1.5 per cent of GDP and this good outturn has continued in 2004. Inflation has fallen sharply
from as high as 20 per cent to as low as 2.9 per cent in the corresponding quarters (June 2003 –
June 2004).

The introduction of Inscribed Stock, which is done in a more timely and consistent manner, to
lengthen the maturity of domestic debt portfolio has resulted in decline in the issuance of Treasury
bills, resulting in a sharp fall on Treasury bill rates from 16 per cent in January 2004 to an average
of 7 per cent in June 2004. The government gained a windfall from the interest cost savings and
these savings are being used to retire debt and directed towards infrastructure development.

3. Improving Public Sector Performance

The reforms under this Objective seek to revitalize the public sector’s capacity to design
and implement sound policies as well as revive the erosion on its ability to manage its

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responsibility. The main initiatives in this area range from Functional Expenditure Reviews of
agencies, reducing public sector staffing levels, to improving public sector performance to
improve delivery of public service.

A total of 15 agencies have already had their functional expenditures reviewed, resulting in a
number of agencies amalgamated, separated and abolished.

The Public sector reform program based around performance oriented management will continue
but will undergo major revisions refocusing on addressing national strategic directions and
priorities.

The Public Services (Management) and Public Finances (Management) Acts has been reviewed
and amended to modernize and decentralize management, personnel and financial powers to
entity Heads but within a framework of significantly enhanced accountability/responsibility of
Managers and overall control of the speed of decentralization, according to the demonstrated
capacity of different organizations to manage.

Outcome/Benefits

Work is still on-going in this area which no greater benefits realized yet.

4. Removing Barriers to Economic Growth and Development

The reforms under this Objective focus on removing inefficient and anti-competitive trade and
investment restrictions and regulations, as well as making fundamental changes to improve
governance and to strengthen basic institutional arrangements needed for the private sector to
operate efficiently.

The cross-cutting theme of the microeconomic reforms is Deregulation, with the

government’s objectives of promoting closer adherence to:
• Simplicity – especially in terms of transparency and reducing the scope for arbitrary
interpretation;
• Neutrality among alternative economic activities; and
• Encouraging competition by reducing barriers to entry to economic activities and
reducing discrimination among alternative ways of supplying goods and services.

As part of this reform initiative, a National Working Group (NWG) on Removing Impediments to
Business and Investment was established to identify structural impediments to investment and
business and develop strategies to eliminate impediments. The NWG comprises of membership
from the private sector and the government.

4.1 Financial Sector Reform

One of the most important reforms undertaken by the government was to strengthen the
legislative framework pertinent to the domestic financial system as a means to allow effective
mobilization of capital to stimulate private sector investment in the economy.

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 The first course of action involved the enactment of the Central Bank Act in 2000 to
make the Central Bank of PNG fully independent from political interference in the
management of the monetary and exchange rate policies. This was an important legislative
reform in an economy where the government tends to borrow heavily from the reserve bank
to finance its fiscal operations, resulting in ‘crowding out’ of liquidity by the government.

The Central Bank was also given the responsibility of prudential supervision and
regulation of the financial system, including the prudential supervision of commercial banks,
superannuation (pension) funds, life insurance companies and credit unions (savings and
loans societies). The objective of prudential supervision and regulation is to protect public
interest and stability of the financial system to avoid financial crises.

The legislation governing each of the financial sector industries i.e. commercial banks
and non-bank financial institutions that take deposits [Banks and Financial Institutions Act],
superannuation [Superannuation (General Provisions) Act] and life insurance [Life Insurance
Act], were also reformed in 2000 to promote competition and strengthened in accord with
international “best practice” such as bringing minimum capital requirements. The provisions
of the legislation gave the Central Bank, the legal power to administer the legislation and
regulate these industries.

The existing regulations pertinent to foreign exchange control is being reviewed in 2004,
with the view to liberalize exchange controls on the inflow and outflow of foreign exchange,
which is in line with opening the domestic market for foreign investment. The review intends
to recommend substantial removal of foreign exchange control, except those necessary to
guard against balance of payment crises and money laundering.

The assessment of foreign exchange inflows and outflows, contractual agreements and
other legal documents will be transferred to commercial banks by the Central Bank. A well-
developed contingency plan will be put in place to counter risks of economic or political
shocks that may destabilize capital flows.

4.2 Competition and Regulatory Reforms

The competition and regulatory policy reforms commenced in 2000 to encourage

economic development, technological innovation and efficiencies of production. The
government adopted an approach that guarantees an equitable sharing of the benefits derived
from increased competition due to the fact that the relatively small market size of PNG
presents a real constraint on the ability to disaggregate existing monopolies and create
competition to the extent that might occur in other larger economies. In addition, PNG’s
unique political, cultural, economic and geographic characteristics limit the application of
some principles in developing efficient industry and regulatory structures for sectors of the
economy.

A regulatory approach has been adopted through the placement of a strong regulatory
framework in situations where it was not possible or practical to introduce or strengthen
competition, to ensure that the incentive for firms to abuse their market power are eliminated,
and thereby encouraging the firms to act in a more competitive manner.

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 The government also developed a structural control to encourage the development of a
market structure that mirrors competitive conditions in the case of the monopoly utility
sectors such as electricity, telecommunications, port services, postal services, water, aviation,
and third party motor vehicle insurance. This is in response to the weak economic and
technical regulation of these sectors over the recent years, which has led to higher prices,
lower quality of services and lack of innovative solutions to the difficulties faced in supplying
services throughout PNG.

An Independent Consumer and Competition Commission (ICCC), was also established

in 2002 with its own legislation, replacing the administrative function of the Consumer
Affairs Council and Price Control Unit of the Department of Treasury. The ICCC protects
the interests of the consumers by promoting competition and fair trading. The ICCC also
administers regulatory contracts with the major State Owned Enterprises, by determining how
prices are set and specifying minimum service standards.

The provisions of the ICCC Act governing anti-competitive behavior came into force in
2003. These provisions prohibit anti-competitive behaviors such as price-fixing, anti-
competitive covenants, mergers and acquisitions that will substantially lessen competition in
the market and primary boycotts (exclusionary provisions).

4.3 Facilitation of Business and Foreign Investment

The government recognizes immigration laws as a useful tool to facilitate economic

growth and development, especially through the support for growth in tourism and facilitation
of increased levels of inward investment. In this regard, the government commenced review
of migration laws in 2000, as part of the review of PNG’s foreign policy.

In recognition of the potential benefits of these laws, the government has given priority
to the review of Migration, Passport, and Citizenship Acts, as well the formulation of new
laws for people smuggling and refugee. A number of specific initiatives that the revised laws
will facilitate are; maintaining the visa on arrival facility, which includes introducing
Permanent Residency Visa to enable business owners to apply for an indefinite period of stay
in the country; participating in the APEC Business Travel Card to facilitate travel by business
people from the APEC member economies; introducing single entry business visa and
additional provisions to facilitate changes of status in the country to enable business to
continue operations and allowing movement of personnel under the same parent company.

The government has also reviewed and amended the Investment Promotion Act to shift
from case by case approval of foreign investments (certification) to a simpler system of
registration of businesses, with ex-post monitoring of investments.

4.4 Privatization of Selected State Owned Enterprises

There strong evidence that effective privatization attracts new investment and increases the
efficiency of all businesses concerned. The government has committed itself to pursue the sale of

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selected State Owned Enterprises, since it believes that this will lead to greater investment in
infrastructure and improved quality of public service provision.
A review of the privatization program in 2002 drew a distinction between core1 and non-
2
core assets. It was concluded that the privatization of non-core assets will proceed first, since
these assets continue to be a drain on the National Budget and act as a constraint on the private
sector. In the case of core-assets, a Public-Private Partnership approach was adopted, with the
issues of equity and efficiency as the priority.

4.5 Tariff Reduction Program

The Tariff Reduction Program is one of the key reform agenda, mainly because it was one of the
perquisites for the drawdown of the IMF Stand-By-Arrangement to support the deteriorating
balance of payment situation. The government approved a seven-year tariff reduction program in
1999, and which will end in 2006.

Outcome/Benefits

The amendment to the Central Bank Act prohibited the Central Bank from lending to the
government to finance its fiscal operations, thus forcing the government to undertake stringent
expenditure controls and prudent fiscal management. This relieved the pressure on inflation and
interest rates.
The Kina Facility Rate (KFR),3 which was introduced in 2001 by the Central Bank as an
official rate to indicate the monetary policy stance, has improved since its inception (falling from
15.5% in 2001 to 10.0% in May 2004). The fall in the KFR indicates that inflation and interest
rates have improved and the fall in the rates have stimulated private sector participation in the
market.
The enactment of the Superannuation and Life Insurance Acts has resulted in the
development of stringent ‘fit and proper’ requirements for appointment of Directors/Trustee
members, and the development of prudent investment strategies has resulted Superannuation
funds experiencing growth beyond expectations in 2003.

Reforms in competition and regulatory policies have resulted in each sector now having its
own competition policy and regulatory arrangements, which were previously non-existent. The
establishment of regulatory contracts with each of the State Owned Enterprises also defines a
period (up to 10 years) for the regulatory and pricing principles and formulae used to determine
the initial 10 year price paths, service standards, provisions for adjustments and trigger events to
allow either party to review contracts as part of the privatization process.
The establishment of ICCC has improved pricing principles and resolved confusion by the
private sector as to which goods have been declared priced-control items, which was a function
previously performed ineffectively by the Price Control Unit of the Department of Treasury. The
introduction of the provisions governing anti-competitive behaviors by firms is a positive step

1
‘Core assets’ include all enterprises owned by the State.
2
‘Non-core assets’ include buildings and properties owned by the State.
3
The Kina Facility Rate is a monthly rate which is based around 28-day Treasury bill weighted average rate. Any changes to
the rate should translate into market interest rate.

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towards improving market conduct, given the fact that there was no legislation governing
anti-competitive behaviors.
In the case of the Tariff Reduction Program, a review conducted in 2003 concluded that the
reduction of tariff had a positive impact on the PNG economy. In particular, the fall in effective
rates of protection have improved the agriculture and mining sectors, and service industry.
Industries whose tariffs have been reduced are making necessary adjustments to be more
competitive and these adjustments are taking place in all cost areas, including capacity, labor and
marketing. Industries are also stepping out and exploring other markets, both within and abroad.
TRP had a positive impact on the ordinary Papua New Guineans, particularly the lower
level income earners. Although prices of most goods purchased by these groups have increased in
recent years due to the declining Kina and other increased costs, the TRP has resulted in prices
increasing less than if the higher tariffs remain.

Conclusion – Challenges

The successful implementation of the reform program can be seen with the
improvement in the economic condition. Economic growth has picked up and employment is
growing. On the external front, the exchange rate has stabilized, the external position is
improving and foreign exchange reserves are at record levels.

The government of PNG, however, acknowledges that the reforms are the beginning, and
not the end, of a process of evolutionary development to put PNG back on economic recovery and
growth. The task is enormous and requires a collective and partnership approach with its
development partners, including the international financial institutions.

It is also important that the civil society and more importantly, the implementing
agencies participate effectively in the reform process. Otherwise, the development of a well-
defined system might useless and will eventually lead to a breakdown in the system, if no one
understands how the system operates.

Some of the reforms have been painful, with financial, social and employment
implications, but time will tell whether this will lead to greater prosperity for the economy
and the population at large.

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