Politicised central bank steering PNG down a slippery slope
22 June 2016
SIR MEKERE MORAUTA
THE O’NEILL government’s political interference in the Bank of Papua New Guinea is threatening the stability of the nation’s financial system and state finances.
It is also increasing risks for bank depositors and investors in financial institutions.
The central bank, the nation’s premier financial institution, is supposed to be the independent watchdog that supervises the system and ensures that risks are kept to a minimum.
One of the reforms my government (1999-2002) introduced was to strengthen the independence and the watchdog role of the Bank of Papua New Guinea, setting clear prudential guidelines and assigning it the additional role of supervising the superannuation industry as well as the financial intermediaries.
The transfer of the supervisory role of superannuation funds from the Minister for Treasury to the Central Bank was the result of the near-death experience of the National Provident Fund under the Skate regime.
But the current prime minister is increasingly using the Bank of Papua New Guinea as a tool to prop up his government’s shaky cash position and to defend his mismanagement of the economy and state finances.
As a result, the central bank is failing in its duty to oversee the financial system effectively and transparently.
The law gives the Bank of Papua New Guinea the authority to act independently, to protect the national economy and financial system. But it appears to have given in to political direction.
This lessening of the central bank’s independence, integrity and capacity is yet another sign that Papua New Guinea’s important institutions of state are being compromised and weakened.
It is yet another example of the destruction of systems and processes under the O’Neill government to protect its own interests and make way for its cronies to benefit.
There is hardly an institution left untouched by this government - compromised, rendered ineffective, pillaged and looted or otherwise incapacitated.
The Bank of Papua New Guinea had become a de facto money-printing machine for the government by buying unwanted treasury bills and inscribed stock and failing to monitor and control commercial bank lending to state-owned enterprises.
The Bank of PNG’s latest figures (to December last year) show that government domestic borrowings have hit K14.05 billion, more than double the K6.12 billion of 2012.
It is not as if the danger signs of such high levels of borrowing were not there. They were, and the central bank chose to ignore them.
Paul Flanagan, an economist specialising in PNG, wrote in October 2014 about the decision by the central bank to purchase from Treasury any T-bills or inscribed stock that were not bought by the private sector.
“In theory, this sounds great,” Flanagan wrote. “In reality, it is disastrous. There is now an imperceptibly fine line between what the bank is doing and the bank simply printing money to fund the growing budget deficit.
“So the central bank is now providing almost unlimited financing for any deficit. Once started, this near printing of money can be a very addictive habit for any government.
“This agreement by the central bank to purchase bills and stocks that the private sector doesn’t want, despite very significant increases in interest rates, is an extremely worrying step down what can be a very slippery slope.”
Now, the central bank has allowed the O’Neill government to proceed further down the slope. Government debt held by the central bank, mainly through T-bills and inscribed stock, has hit K2.34 billion, more than triple the K711 million held in 2012.
Banks and other deposit-taking institutions hold K7.67 billion in government debt, up from K3.60 billion. Super funds, insurance companies and the National Development Bank hold K2.69 billion, double the K1.27 billion of 2012.
Much of this is wasteful, unproductive lending.
For example, lending by domestic commercial financial institutions to state-owned enterprises – propping up the walking dead – has hit K2.3 billion. This is six times more than the K366 million in banking system loans to SOEs in 2012.
The level of loans to state-owned enterprises is especially disturbing, given that according to the Auditor-General they are notorious for waste and corruption and are mostly operating outside the various laws that govern them.
From its own published data, it would appear that the biggest lender to the sector is Bank South Pacific, which is likely to have loans to state-owned enterprises to the value of about K1.2 billion (based on its market share).
The prudential limit set by the central bank for lending by a commercial bank to one group is 40 percent of prudential capital. BSP’s prudential capital, according to the publicly available reports, is K1.9 billion, so the limit it should lend to any one group currently is around K760 million.
K1.2 billion represents 63%, well above the 40% limit set by the central bank (treating the government sector as one group, as BSP itself does in its official statements).
The damage being inflicted on the institutions of government and the financial sector by O’Neill is deep and will be long-lasting.
It will take a very strong and good prime minister to repair the damage and rebuild the institutions.
This is the real hidden cost of O’Neill’s survival actions that is not yet evident to the public eye.
One of the lessons of the Global Financial Crisis (GFC) is that any bank which makes itself hostage to one asset class or, worse still, one major debtor, is placing itself in a very dangerous position.
America's biggest banks grossly over invested in toxic Collateralised Debt Obligations (CDO) because these products were supposed to be AAA rated and "bullet proof" investments.
They weren't and the ensuing crisis brought the world's financial system to the very edge of complete collapse.
Unhappily, it seems that the main lesson learned from this crisis by the banks is that because they are "too big to fail", government (that is, the taxpayer) is compelled to rescue them in the event of failure.
This has created what economists call "moral hazard", whereby banks feel able to take increasingly big risks to make profits knowing that they will be rescued if their improvident lending puts them in jeopardy of collapse.
Put another way, they are like a teenagers with Mum and Dad's credit card, spending up big while all the while knowing that paying back the accumulated debt won't be their problem.
Sir Mekere Morauta has pointed out what should be blindingly obvious to those who are willing to see it: the O'Neill government's policies are placing PNG's banking institutions in mortal peril.
Some heroic assumptions appear to have been made about the underlying robustness and stability of not just PNG's economy but that of the wider world as well.
History shows that, within a capitalist system, betting that nothing can or will go wrong is an exceptionally stupid long term bet.
Right now, total private debt as a proportion of GDP is much higher than immediately before the GFC and is still climbing rapidly. The highest and fastest rises are occurring in Hong Kong and China.
Total government debt is also much higher than before the GFC because governments have had to recapitalise their private banking systems to prevent their collapse.
Governments have also borrowed heavily in an effort to stimulate economic growth, which remains anaemic at best across most of the world.
This is not a situation that ought to encourage a prudent banker to take major risks with bank funds yet this is exactly what is happening in PNG.
The history of banking failures is that the people running them never think there is a problem right until the moment that collapse is imminent. As was the case for powerful institutions like Lehman Brothers, this can happen, quite literally, over night.
PNG's situation, much like Australia's and many other countries as well, is far more perilous than their respective governments are willing to admit.
Not only do governments not know how to stop the rapid accumulation of unsustainable private debt but their great fear is that even acknowledging the growing problem might trigger the very crisis that they are desperate to avoid.
Like the proverbial rabbit in the headlights, they can see the oncoming truck but remain paralysed in its path.
My fervent wish is that someone, somehow, is going to be able to do something to prevent a repeat of the GFC but I fear it is too late to do so.
If I am right, then the PNG's banking system will very likely collapse. That is a high price to pay for the O'Neill government's financial recklessness and profligacy.
Posted by: Chris Overland | 22 June 2016 at 10:19 AM
Notwithstanding some recent, stand 'alone' comments in support of the current PNG leadership, the reality of running deficits, printing money to pay for promises and turning one's back on practical logic must lead to eventual disaster.
So if we listen to those who claim there is no problem and we are only grumpy old pessimists who can't understand what is really happening then those who say this please respond to the examples of history and say this isn't happening to PNG.
In post WW1 Germany the economy was ruined by political upheavals and sanctions by the victorious nations who wanted recompense for their war effort. The economy went into a tail spin and there is a classic example of printing money to pay for services where a postal clerk needed a wheelbarrow to take home his worthless pay in paper Deutschmarks. Zimbabwe is merely a recent example of this phenomena where those in charge can't or won't accept reality and keep choosing fantasy.
Can anyone deny that PNG's currency is under threat or that her foreign reserves are at rock bottom low or that the prices for consumer goods and essential food aren't reported to be rising dramatically and outstripping wages and salaries growth? Surely people who have an ounce of common sense can see the looming financial train wreck coming on down the track.
PNG's future generations will bare the burden of having to repay crippling overseas loans or submit to ignominious sanctions and potential takeover from those who now offer 'free' money.
There is no such thing as a free lunch.
That's reality Corey. Blaming any negativity on supposed vestiges of colonial contempt or similarly on the equally culpable US bankers and those who were duped by the offer of high returns for no effort and so caused the recent global financial crisis, is not only fantasy but bordering on intentionally malign misinformation.
This financial crisis in PNG is home grown and is being allowed to unfold by those responsible on those who are least able to withstand it's disastrous results.
Husat igiaman mipla nau yia?
Posted by: Paul Oates | 22 June 2016 at 08:52 AM