Scope for Fiscal Policy

in Papua New Guinea

Presentation by:
Ebrima Faal, International Monetary Fund
Port Moresby, June 12, 2007

The views expressed in this presentation are those of the author and should not be attributed to the IMF, its
Executive Board, or its management.
Structure

„ This presentation complements the earlier one on “Fiscal

Management in Mineral-Producing Countries”, Theo
Thomas.
„ Organized as follows:
1. Recent developments.
2. Fiscal stance and fiscal impulse.
3. Analytical importance for PNG of the non-mineral
balance and other fiscal indicators.
4. Addressing long term exhaustibility–use of savings in
PNG.
5. Summary-Considerations.
 Part 1. Recent developments

Figures used are based on Government Finance Statistics presentation and reflects cash
accounting. They may be different from the outcomes reported by the Treasury of PNG
for this reason.
PNG: Until 2002, fiscal indiscipline led to fiscal
deficits. Notable improvements in the headline deficit
since then.
10 (in percent of GDP)
Improvement
5

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-5

-10
???
-15
Non-mineral balance 1/ Overall balance

1/ Deflated by non-mineral GDP

PNG: A positive external environment has led to
large increases in mineral revenue
30 (in percent of non-mineral GDP) (in percent of GDP) 14

25 12

Mineral revenue (right scale)

10
20
Non-mineral revenue
8
15
6
10
4

5 2

0 0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Important policy reforms also contributed to the
improvement in fiscal position

¾ The Medium-Term Development Strategy

¾ The Medium-Term Fiscal Strategy
¾ The Medium-Term Debt Strategy
¾ Transparent budget formulation process
PNG: Expenditure control also played an important
role…
35 (in percent of GDP)
30

25

20

15

10

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Total expenditure Non-interest expenditure

 Part 2. Assessing the fiscal stance and
impulse

What has been the impact of fiscal policy on

aggregate demand?
•Aggregate Demand=Total demand for goods and services in the
economy (Y) during a specific time period.
•Nonrecurring revenues are removed from analysis that follows.
 Preserving Macroeconomic Stability

„ Macroeconomic stability requires design of policies

that facilitate sustainable growth and low inflation
given absorptive capacity of non-mineral sector.

„ The non-mineral (primary) balance measure the

impact of fiscal stimulus on aggregate demand.
 Why the non-mineral (primary) balance?

„ Non-mineral balance is derived from the overall fiscal balance,

excluding mineral-related revenues and expenditures.
„ The non-mineral primary balance excludes mineral related
revenues and expenditures, and net interest payments.
„ Analytical importance of the non-mineral primary balance:
¾ Reasonable indicator of domestic government demand.
¾ Measure of injection of mineral revenue into the economy.
¾ Measure of fiscal effort and underlying fiscal policy stance.
¾ Key input into fiscal sustainability and intertemporal
analysis.
What is the optimal size of the non-mineral
(primary) deficit?
„ The non-mineral primary deficit should be consistent with
macroeconomic stability objectives.

„ In some petroleum exporters, large non-mineral primary

deficits are sustainable and do not pose vulnerability
concerns.

„ In others there may be a need to reduce the non-mineral

primary deficit due to vulnerability and sustainability
considerations.
Fiscal stance and fiscal impulse

„ The headline overall fiscal balance is not an accurate measure of the

impulse that fiscal policy imparts on the economy.
„ To disentangle cyclical from policy influences on the budget two
broad approaches:
I. Bottoms up approach: Account for budgetary effects of individual
policy initiatives and cyclical influences.
II. Top down approach: Estimates the policy effect as the residual after
purging the actual balance of business cycle influences (IMF,
OECD).
Limitations:
‰ Need to calculate potential output: Errors could arise.
‰ Unit elasticity assumption means that impact of automatic stabilizers
are included in the fiscal impulse.
 How to measure the fiscal impulse and the fiscal
stance?
„ First step: decompose the actual budget deficit into a cyclically
neutral component and a fiscal stance component.
„ The cyclically neutral component assumes that government
expenditures increase proportionately to potential output and
that revenues increase proportionately to actual output.
„ The fiscal stance is the residual between the cyclically
neutral and the actual budget deficits.
„ Second step: calculate the fiscal impulse as the annual change
in the fiscal stance measure.
9 Negative value: contractionary demand impulse.
9 Positive value: expansionary demand impulse.
PNG: A closer look at the fiscal stance…was fiscal
policy expansionary in PNG?
(in percent of GDP)
12

10 Non-mineral stance 1/ Overall stance

8

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
-2
1/ Percent of non-mineral GDP
PNG: The fiscal impulse: did fiscal policy
contribute to the increase in aggregate demand?
10 (in percent of GDP)
Fiscal stimulus?
8
6
4
2
0
-2 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-4
-6
-8
-10

Overall impulse Non-mineral impulse

Part 3. Analytical importance of the
non-mineral (primary) balance
PNG: Volatility of mineral revenues is higher than
non-mineral revenues…..

4 How to address short-term volatility?

Standard deviation

0
1996-2000 2001-2006
Mineral revenues Non-mineral revenues
…and therefore generates volatility in fiscal outcomes

5
Standard deviation

0
1996-2000 2001-2006

Overall balance Non-mineral overall balance

PNG: Correlation between mineral and non-mineral
revenues.

1.5 Correlation coefficient

Negative correlation implies financing of non-
mineral balance with mineral revenues.

0.5

1996-2000 2001-2006

-0.5 Mineral revenue Non-mineral revenue

Pro-cyclicality of spending means more difficult
adjustment on the downside.

30 (Percent of GDP) Costly adjustments.

25

20

15

10

0
2006 2007 2008 2009 2010 2011

Mineral revenue Non-mineral revenue Non-interest expenditure

Part 4. Address long-term exhaustibility–
use of savings?
 Save or spend mineral Wealth? Issues.

„ How to use mineral wealth resources?

„ Main objective is to make use of finite resources for the future
of the country. Do not want to waste resources.
9 Net financial saving. Financing consumption opportunities for
future generations.
9 Quality current spending. Address pressing social needs—
poverty reduction and MDGs.
9 Quality investment. Subject to capacity to implement and
monitor spending large infrastructure needs can enhance
economic growth and reduce poverty.

„ All of the options have implications for intergenerational

equity and macroeconomic situation.
However, expenditure prioritization has been
difficult
„ Little prioritization of spending from Trust accounts.

„ Expenditure control enforcement and oversight are weak

leading to leakage.

„ Capacity to implement development spending has been

limited.

„ Debt repayment, settlement of arrears, and other budget

liabilities such as pension fund liability may be optimal use
of funds.
 Summary—Policy considerations

1. Continue to develop multi-year rolling budgets

consistent with:
9 Macroeconomic stability
9 Smooth expenditure adjustments/fiscal stimulus
9 Develop costed spending priorities
2. For a less pro-cyclical and more credible long-term
fiscal policy use the non-mineral (primary) balance.
3. Consider developing long-term strategy to address
intergenerational issues and exhaustible resources.
4. Need for close monetary and fiscal policy coordination.
Thank you