Overview

• Increasing debt levels and limited fiscal maneuverability leave PNG vulnerable to a volatile global environment.
• PNG recently restructured its sovereign-guaranteed debt, raising uncertainty over its willingness and ability to service debts that will come due in the next year or so.
• We are consequently placing our 'B-/B' long- and short-term ratings on PNG on CreditWatch with negative implications.
• We aim to resolve the CreditWatch within the next month after we obtain more information from the government.

Rating Action

On April 30, 2021, S&P Global Ratings placed its 'B-/B' long- and short-term foreign and local currency sovereign credit ratings on Papua New Guinea (PNG) on CreditWatch with negative implications.

CreditWatch

The CreditWatch negative placement reflects at least a one-in-two chance that we will lower our ratings on PNG. The change reflects growing uncertainty over the government's willingness and ability to service debts maturing in the next year or so. We learned recently that the government had restructured a debt originally owed by Eda Kopa (Solwara) Ltd. (EKS) that it had guaranteed. EKS is a subsidiary of state-owned Kumul Minerals Holdings. We have sought more information from the government to determine the credit effect.

We could lower our ratings to the 'CCC' category or lower if new information reveals a risk of sovereign default in the next year or so.

We could affirm our ratings at the current level if new information suggests the restructuring of the EKS debt does not signify a material deterioration of the government's credit fundamentals.

We expect to resolve the CreditWatch in the next month.

Rationale

The global pandemic continues to exacerbate structural fiscal challenges within PNG. Much weaker revenues, coupled with larger recurrent expenditure, are a feature of the fiscal landscape. Larger fiscal deficits and weak economic growth have propelled general government net debt, according to our calculations, to above 46.6% of GDP in 2021. We forecast it to reach around 47.5% in 2024 due to delays to the government's fiscal consolidation efforts because of fallout from COVID-19.

Reports online suggest that debt restructuring occurred over the past 12 months. The PNG government took responsibility for a state-owned enterprise's debt that it had guaranteed. However, there is significant ambiguity about the conditions and timeframe. We lack sufficient information to say whether the government's actions have materially increased the risk that its upcoming debt maturities or other guaranteed loans might not be fully repaid in time.

Our sovereign ratings on PNG reflect structural constraints inherent in a low-income economy dependent on the mining industry and served by weak institutions.

Flexibility and performance profile: Public debt burden is increasing while fiscal pressures grows

• We forecast fiscal deficits to be weaker.
• Debt continues to rise and is shifting toward external sources.
• Foreign-exchange shortages continue to suppress business activity.

We expect recent COVID-19 developments to put further strain on government finances. Weaker tax revenues and dividends from state-owned corporations have substantially lowered our revenue expectations since the start of the pandemic. On the expenditure side, significant overruns were incurred from a public sector wage bill because of increased wages and additional staff numbers. In response, the government has cut capital expenditure, partially offsetting the weaker revenues. But this does not address vulnerabilities linked to PNG's narrow tax base and it will continue to weigh on future growth.

The government commenced its International Monetary Fund staff-monitoring program at the start of 2020, outlining 20 structural benchmarks for the government. The incumbent government's focus is on fiscal consolidation and lowering debt. We expect this focus to provide an anchor to the government's economic and social reform agenda. Carrying out the agenda has been difficult because disruptions caused by the global pandemic have delayed targets.

We estimate the general government deficits to average 3.3% of GDP between 2021 and 2024. The 2020 fiscal deficit was higher than the government had projected. The economic slowdown and low commodity prices led to lower revenue collections. Government expenditure meanwhile increased due to pandemic-related fiscal support. To mitigate some of the revenue shortfall, the government applied for additional COVID-19 financing facilities established by multilateral development partners.

We expect multilateral and bilateral partner loans to finance fiscal deficits, with net debt increasing to about 46.6% of GDP in 2021. The government has included state-owned enterprise (SOE) debt in its debt measure that is higher than our standard definition of general government debt. A lack of disclosure means we are unable to separate the debt of SOEs from that of the general government.

The government continues to increase its reliance on external borrowing, with its debt strategy targeting a 50:50 split between domestic and external financing. Wider fiscal deficits in recent years have strained the ability of the domestic financial system to absorb large amounts of government debt, which is reflected in higher local interest rates.

PNG has diversified its funding base via drawdowns from a Credit Suisse, Asian Development Bank, and World Bank credit facilities budget support loan from Australia as well as its US$500 million sovereign bond issuance (see "Papua New Guinea's Proposed Unsecured Notes Assigned 'B' Long-Term Foreign Currency Rating," published Sept. 4, 2018). The government has used some of these proceeds to retire short-term expensive domestic debt, lowering its average cost of debt domestically. We anticipate interest payments to rise as debt stock increases to about 23% of general government revenues by 2024.

PNG's external position remains weak. The country's terms of trade volatility have subsided over the past few years. External debt ballooned between 2010 and 2013 during the construction phase of a liquid natural gas project. Large current account deficits--financed by a combination of external debt and foreign direct investment--averaged about 30% of GDP. The country's external imbalances have contracted during the past few years, with LNG production since 2014 resulting in repayment of external liabilities. Future LNG projects could exacerbate external imbalances again during the construction phase. We project a moderation in current account surpluses in 2023-2024, rather than the double-digit current account deficits of 2010-2013.

We forecast net external debt to be about 124% of current account receipts (CARs) in 2021. PNG's net external debt peaked at 370% of CARs in 2012. We consider PNG's strong current account surpluses to overstate its external position. Project development agreements allow developers of mining projects to keep export receipts in offshore foreign-currency accounts. These U.S. dollar revenues deflate our external ratios, presenting a stronger external picture than would otherwise be the case. We expect net external debt to peak at about 250% of CARs in 2024.

Foreign-exchange reserves have held steady over the past 12 months, sitting at about US$2.3 billion as of June 2020. PNG held about US$4.4 billion in international reserves in 2011, declining to US$1.7 billion in 2017. This has also resulted in an easing of the shortage in U.S. dollars in PNG, helping to lower the value and shorten the clearing time of outstanding foreign-exchange orders. However, we believe PNG maintains extensive foreign-exchange restrictions. This is symptomatic of a currency that persists above the market-clearing exchange rate. PNG's exchange-rate arrangements are "crawl-like," according to the International Monetary Fund. During the past few years, the PNG kina has depreciated against the U.S. dollar, falling around 15% since 2015. More broadly, the Bank of PNG's weak monetary policy flexibility is a rating constraint. This weakness mainly reflects the limited transmission of monetary policy settings to the interest rates faced by borrowers, largely because of the high level of liquidity in the banking system.

PNG's banking system is stable, with limited competition. It relies heavily on deposit funding, which is supported by high levels of liquidity. It also has a small net external asset position and limited linkages to global markets. That said, the country's low income levels and credit concentrations increase banking system risks. Legal infrastructure and judicial system delays also pose challenges to enforcing creditor rights.

Institutional and economic profile: Questionable debt payment culture; PNG's economic growth prospects dim on collapsing energy prices

• We believe there is increasing uncertainty over the government's willingness and ability to service its upcoming maturity.
• We expect economic growth to contract in 2021, before recovering when the Papua liquefied natural gas (LNG) project commences in 2022.
• Prospective projects delays are dragging on PNG's future growth prospects.

There is heightened pressure on our institutional assessment on the government. We believe there is increasing uncertainty over the government's willingness and ability to service debts maturing in the next year or so. According to reports online, PNG restructured a government-guaranteed debt originally owed by EKS. We have sought more information from the government about the circumstances surrounding this event determine the credit effect.

We could lower our already-weak institutional assessment if we see significant risk of a sovereign default in the next year or so.

In May 2019, PNG underwent a change in leadership after a vote of no confidence was made over promises related to resource-related deals. While the new leadership has mostly maintained existing policy, it has focused on revising negotiations on existing and upcoming resource projects, stalling progress. These issues are a feature of the country's political system and underpin our rating. The next elections are due in 2022.

Another key initiative of the government is to promote investment and address issues related to macroeconomic imbalances and economic diversification. Public-sector transparency remains an issue, as evidence by the lack of transparency around the recent restructure of SOE debt, but it is generally improving. The government has stated its intention to narrow the fiscal deficit and focus on PNG's longer-term strategy of economic diversification. The government's medium-term revenue and expenditure strategies provide a commitment to maintaining manageable debt levels.

As the COVID-19 pandemic continues against a backdrop of volatile markets and credit stress, we expect PNG's economic growth to remain volatile. PNG is heavily reliant on the commodity sector, which faced a slowdown in trade volumes and prices since the start of the pandemic. This will have an effect on PNG government revenues and economic growth forecasts. COVID-19 will continue to weigh on GDP by weakening private investment and domestic consumption in the country, leaving GDP growth to be suppressed while the pandemic rages globally. The closures of gold mines Progera and Ok Tedi in calendar 2020 led to a contraction in economic growth. Travel restrictions for fly-in fly-out workers from Australia led to lower production and productivity.

Protracted negotiations in upcoming resource-related projects are weighing on the country's economic growth outlook. While we expect the construction of several new LNG projects to lead to a sharp acceleration in economic growth, ongoing negotiation delays are pushing this benefit further out. A recent collapse in energy prices could result in investment decisions being delayed for several years, weighing on PNG's economy.

PNG's per capita growth levels are low compared with its similarly rated peers. This includes our expectation of several new resource projects, for which we expect construction to commence within the 2022-2024 period. PNG expects Papua LNG and the Wafi Golpu gold mine to drive economic growth.

These expectations are fraught with risks, especially in light of the current volatility in commodity prices and large oversupply. Lower prices and suppressed demand could limit the potential benefits of these touted projects. PNG is conducting feasibility studies on the gold-copper mines of Wafi Golpu and Frieda River and it expects both to be large-scale mining projects. Although these mines boost the economy through exports of natural resources, increased infrastructure investment offers additional benefits for rural areas, not only those that are project specific.

PNG continues to face pressing development needs. We estimate per capita GDP to be about US$2,700 in 2021. PNG's real per capita GDP growth remains low compared with its peers. Moreover, the prevalence of crime in major cities deters investment, while governmental institutions are weak, in our view. Economic data inconsistency is another credit weakness. Despite some recent improvements, there are gaps and lags in economic and external data.

Key Statistics

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Ratings Score Snapshot

Table 2

Related Criteria

• Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research

• Sovereign Ratings History, April 21, 2021
• Default, Transition, and Recovery: 2020 Annual Sovereign Default And Rating Transition Study, April 12, 2021
• Sovereign Risk Indicators, April 12, 2021. An interactive version is also available at http://www.spratings.com/sri
• Global Sovereign Rating Trends: First-Quarter 2021, April 9, 2021
• Sovereign Ratings Score Snapshot, April 7, 2021
• Sovereign Debt 2021: Asia-Pacific Central Governments To Borrow US$4.1 Trillion, March 2, 2021
• Sizing Sovereign Debt And The Great Fiscal Unwind, Feb. 2, 2021
• Asia-Pacific Sovereign Rating Trends 2021, Jan. 28, 2021

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria and Research').

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