Moody’s downgrades Papua New Guinea’s rating to B2 with stable outlook

Global Credit Research – 25 Apr 2016

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.

 

RATINGS RATIONALE

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.

 

STABLE OUTLOOK

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.

 

COUNTRY CEILINGS

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.

 

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on http://www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see http://www.moodys.com for any updates on changes to the lead rating analyst and to the Moody’s legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on http://www.moodys.com for additional regulatory disclosures for each credit rating.

 

Christian de Guzman
VP – Senior Credit Officer
Sovereign Risk Group
Moody’s Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

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Demystifying the UBS Loan

by Government Insider

UBS Loan has been in the center of the discussion in Papua New Guinea politics and even everyday discussion since the O’Neil-Dion Government took it out in March 2014.

In my previous article on IPIC and the reason for USB Loan, I have given an account on why it as necessary for another loan to be taken in order for Papua New Guinea to safeguard its interest with Oil Search.

The USB Loan has been misunderstood by a lot of commentators and even social media has taken it into a level where it has been dissected incorrectly and is causing uncertainty to the readers. This article is to clear the muddy waters for all and hopefully once and for all.

The USB Loan is NOT just like another ordinary loan. It is a financial package put together to achieve the objectives of the Government of the day. The financial package of AUD1.235 Billon comprises two different facilities;

  1. AUD $ 900.4 million COLLAR LOAN at an interest of 4.95% per annum
  2. AUD $ 335 million BRIDGING LOAN facility at an interest of 5.50% per annum

The Collar Loan is collateralized by selling the 137 million (137, 012, 250) Oil Search shares at the maturity loan for $.7.40 per share even if the price falls below that rate. The maturity date for the Collar Loan is May 2016. This Collar Loan is issued to UBS and held in trust for PNG Government.

The Bridge Loan is to finance the State’s DIRECT shareholding of 12 million (12, 377,994) Oil Search shares, which is under the PNG Government’s own named. This is a straight forward loan facility which the PNG Government

The Collar Loan facility is the more complicated of the to facilities and I would like to spend some time to explain it.

According to Investopedia is “A collar is a protective options strategy that is implemented after a long position in a stock has experienced substantial gains. It is created by purchasing an out of the money put option while simultaneously writing an out of the money call option. ………

The purchase of out-of-the money put option is what protects the underlying shares from a large downward move and locks in the profit. The price paid to buy the puts is lowered by amount of premium that is collect by selling the out of the money call. The ultimate goal of this position is that the underlying stock continues to rise until the written strike is reached. 

Example:

Suppose an options trader is holding 100 shares of the stock XYZ currently trading at K48 in June. He decides to establish a collar by writing a JULSlide1 50 covered call for K2 while simultaneously purchases a JUL 45 put for K1.

Since he pays K4800 for the 100 shares of XYZ, another K100 for the put but receives K200 for selling the call option, his total investment is K4700.

On expiration date, the stock had rallied by 5 points to K53. Since the striking price of $50 for the call option is lower than the trading price of the stock, the call is assigned and the trader sells the shares for K5000, resulting in a K300 profit (K5000 minus K4700 original investment).

However, what happens should the stock price had gone down 5 points to K43 instead? Let’s take a look.

At K43, the call writer would have had incurred a paper loss of K500 for holding the 100 shares of XYZ but because of the JUL 45 protective put, he is able to sell his shares for K4500 instead of K4300. Thus, his net loss is limited to only K200 (K4500 minus K4700 original investment).

Had the stock price remain stable at K48 at expiration, he will still net a paper gain of K100 since he only paid a total of K4700 to acquire K4800 worth of stock.

In PNG Government Scenario:

UBS who is the Option Trader is holding 137 million shares of Oil Search for PNG Government. They have decided to write a COLLAR for MAY 2016 purchase at $8.20 per share. They purchased a PUT May 2016 at $7.40 per share.

During maturity in May 2016, the Oil Search share price was below $7.40, however, the PNG Government did not which to sell its shares and therefore, it made a “MARGINAL CALL.” Since the trading is a LONG collar, the maturity is every 2 years. Any gains from this Option trading is used to repay the “Bridge Loan Facility”

In a nutshell, the Collar Loan Facility is used as a money-generating stream to repay the Bridge Loan Facility. It all boils down to Oil Search share pricing and the purchase of a stake in Papua LNG paints a positive picture for Oil Search.