Singapore, April 25, 2016 — Moody’s Investors Service has today downgraded the Government of Papua New Guinea’s (PNG) foreign currency and local currency issuer ratings to B2 from B1. The outlook on these ratings is stable. This concludes the review for downgrade initiated on 25 February 2016.
The key drivers of the downgrade are:
• Strains on foreign currency reserve adequacy due to heightened balance of payments pressures that will continue over the next two years; and
• The persistence of unfavorable domestic funding conditions for the government that have increased refinancing risks and eroded debt affordability.
The stable outlook is based on Moody’s view that PNG’s medium-term economic growth prospects remain robust, although lower commodity prices and the consequent fiscal and economic adjustment will weigh on growth outcomes in 2016 and 2017. In addition, a reduction in fiscal deficits has helped to slow the rise in government debt, which remains low among similarly-rated countries.
While the review was prompted in part by the impact of structurally weaker prices of oil and related commodities on PNG’s economy and fiscal accounts, we have determined that the continuation of the pressures on government and external liquidity first flagged when we assigned a negative outlook in 2015 were more relevant.
DOWNGRADE TO B2
First driver: Continued deterioration in foreign currency reserve adequacy
PNG’s gross foreign currency reserves have fallen sharply to $1.69 billion at end-2015, down from a peak of $4.26 billion at end-2011, reflecting the continuation of the balance of payments pressures that prompted our assignment of a negative outlook on PNG’s rating last year. Liquefied natural gas (LNG) production drove the large rise in exports and the restoration of the current account surplus since 2014. However, this has failed to stem the deterioration in PNG’s external payments position as cross-border debt servicing and other demands for foreign currency as represented by the large financial account outflows have overwhelmed the supply of hard currency available to the central bank, the Bank of Papua New Guinea (BankPNG).
BankPNG has intervened to stem a disorderly adjustment of the exchange rate, and placed the costs of this intervention at $828.5 million in 2015 alone. It also introduced exchange controls last year that effectively rationed foreign currency.
Although production at the country’s largest gold and copper mine resumed in March 2016, associated export receipts will only mitigate, not eliminate, the ongoing balance of payments pressures. Reserve adequacy has weakened accordingly, with our estimate of short-term external debt repayments rising to over 140% of the stock of foreign currency reserves as compared to 83.7% in 2014. Moreover, the challenging environment for external liquidity has fed back to the real economy through weaker sentiment, which is already suffering from the decline in global prices for PNG’s commodity exports.
Second driver: Pressures on the government’s liquidity position due to unfavorable funding conditions
Declining fiscal revenue and constrained domestic financing conditions have weakened the government’s liquidity position. Although commencement of LNG production supported economic activity in 2015, it has not benefited revenue to the same degree, because of lower LNG prices which track oil price trends with a lag of a few months. We estimate revenue as a share of GDP fell to 17.1% in 2015, the lowest level in at least a decade, and project a further decline in this ratio this year.
Wide deficits in recent years have led to higher interest rates for government securities, as domestic investors have lowered their exposure to sovereign risk by either shortening duration or limiting their holdings of government debt. Refinancing risks have thus risen as the proportion of domestic market debt comprised of short-term obligations has increased, and debt affordability has deteriorated rapidly on account of the higher interest rates demanded in primary auctions. Short-term debt now accounts for 48.1% of total domestic market debt as of end-2015, while interest payments as a share of revenue—our preferred measure of debt affordability—has nearly doubled to 9.8% in 2015 from 5.3% in 2013.
Central bank absorption has offset somewhat the decreased local appetite for government bonds—BankPNG held 21.0% of domestic market debt as of September 2015, up from 7.1% two years earlier. Nevertheless, poor funding conditions have led the government to curtail spending, further weighing on economic growth.
The stable outlook balances the weak near term growth outlook against more robust economic prospects over the longer-term. In particular, the successful implementation of the PNG LNG Project has demonstrated operational efficiencies, profitability, and a relatively low cost structure, which enhance PNG’s competitive advantage in extractive industries, and bolster the prospects of similarly large projects, even against the backdrop of structurally lower commodity prices. Such projects include a potential expansion of the preexisting PNG LNG Project, an entirely new development called the Papua LNG Project, and the Wafi-Golpu gold mine. While we do not expect material progress on the implementation of these projects until late 2017, the resulting upturn and stabilization in growth will, in our view, alleviate external and fiscal pressures from escalating. In the interim, however, Moody’s expects the government’s fiscal consolidation efforts to maintain low government debt levels compared to similarly rated peers, while funding conditions and external liquidity will remain tight. An upturn and stabilization in growth and exports will, in our view, keep external and fiscal pressures from escalating. In addition, Moody’s expects the government’s fiscal consolidation efforts to keep government debt levels low as compared to similarly rated peers.
WHAT COULD CHANGE THE RATING UP
Moody’s would consider upgrading the rating if increased non-debt creating external inflows lead to a material build-up in foreign currency reserves and improve reserve adequacy. A sustained improvement in the government’s fiscal and liquidity position accompanied by the restoration of the trend in debt consolidation would also be credit positive. Over the longer term, enhancements to potential growth and government revenue through the development of large projects, such as potentially significant additions to LNG and gold production, would also lead to upward pressure on the rating.
WHAT COULD CHANGE THE RATING DOWN
Triggers for a further negative rating action include: (1) a reemergence of wide fiscal deficits that lead to a rapid rise in government debt; (2) a worsening of growth prospects that could ultimately weigh on fiscal and debt sustainability; (3) a further decline in foreign currency reserves.
Moody’s has lowered Papua New Guinea’s long-term foreign currency (FC) bond ceiling to B1 from Ba3 as well as its long-term FC deposit ceiling to B3 from B2. PNG’s short-term FC bond and deposit ceilings remain unchanged at “Not Prime.” These ceilings act as a cap on the ratings that can be assigned to the FC obligations of other entities domiciled in the country.
- PNG’s local currency bond and deposit ceilings remain unchanged at Ba2.
- GDP per capita (PPP basis, US$): 2,470 (2014 Actual) (also known as Per Capita Income)
- Real GDP growth (% change): 9.9% (2015 Actual) (also known as GDP Growth)
- Inflation Rate (CPI, % change Dec/Dec): 6.4% (2015 Actual)
- Gen. Gov. Financial Balance/GDP: -3.9% (2015 Actual) (also known as Fiscal Balance)
- Current Account Balance/GDP: 20.9% (2015 Estimate) (also known as External Balance)
- External debt/GDP: 69.2% (2015 Estimate)
- Level of economic development: Low level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 20 April 2016, a rating committee was called to discuss the rating of the Papua New Guinea, Government of. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have not materially changed. The issuer’s fiscal or financial strength, including its debt profile, has not materially changed. The issuer has become increasingly susceptible to event risks. An analysis of this issuer, relative to its peers, indicates that a repositioning of its rating would be appropriate. Government and external liquidity risk have increased. Other views raised included: The issuer’s institutional strength/ framework, have not materially changed.
The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Ratings Methodologies page on http://www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
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Christian de Guzman
VP – Senior Credit Officer
Sovereign Risk Group
Moody’s Investors Service Singapore Pte. Ltd.
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