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Foreign exchange restrictions in PNG: costs & remedies


CANBERRA - Three years after their introduction in mid-2014, Papua New Guinea’s foreign exchange restrictions continue to be in place. Unofficial ballpark estimates of excess demand range between US$300 million to 1 billion.

In a 2017 Business Advantage survey of CEOs, 60% nominated access to foreign exchange as “the major obstacle… more than double any other challenge.”

Interviews with businesses reveal that they have to spend significantly more time on finding foreign exchange and managing the credit situation with their overseas suppliers. This increases their administrative costs, which are likely passed on to the consumers.

In addition, firms are piling up ‘dollarised’ debt when there is depreciating pressure on the kina.

The excess demand for foreign currency has led to a substantial delay in the processing time of foreign exchange orders, which is now reported to be between six and 16 weeks.

The processing duration is a function of fluctuating foreign exchange availability and the priority of an order, which the Bank of PNG (BPNG) sets at its own discretion.

The general pattern is that imports of basic food (especially rice) and fuel are favoured over other consumer goods, or raw materials for construction. Dividends and repatriation are near the bottom of BPNG’s priority list and the majority of such orders do not get processed at all.

To grasp the severity of the situation, and the extent of import-compression, consider the share of imports to GDP.

From 1980, the value of imports tends to hover around 50% of GDP, but over the past two years imports have collapsed to 15% of GDP, with the start of the sharp fall coinciding with the imposition of the FX-restrictions in 2014.

This decline in imports is far greater than the one experienced in 1994 when PNG underwent a currency crisis.

The argument could be made that the decrease in imports could be overstated due to the LNG project, which provided a substantial boost to GDP, with no commensurate increase in the demand for imports.

However, imports as a share of non-resource GDP (that is, GDP excluding the mining and oil/gas sectors) have also collapsed to 23%.

The foreign exchange restrictions are a strong indication that PNG’s real exchange rate is significantly overvalued.

The real exchange rate measures the domestic (kina) price of foreign goods relative to domestic goods, and takes into account not only the market exchange rate but also the difference between domestic and international inflation rates.

Imports as % of GDP & non-resource GDP
Imports as % of GDP & non-resource GDP

Since PNG is a resource-dependent country, theory suggests that there should be a strong co-movement between the kina and commodity prices. The graph here plots PNG’s real exchange rate together with the terms of trade, which primarily reflects the strength of commodity prices.

The real exchange rate and terms of trade indeed move closely together, but only during the boom up until 2012. Since the end of the boom, the two series have been diverging in the sense that the terms of trade decline while the real exchange rate continued to appreciate.

This suggests that, all else equal, the real exchange rate has begun to deviate from its equilibrium value, i.e. is overvalued.  Econometric results suggest a real exchange rate overvaluation of about 20%.

The quickest and easiest way to correct a real overvaluation is through a depreciation of the nominal exchange rate. BPNG now sets the USD-K exchange rate. Between 2015 and early 2016, the kina lost its value vis-à-vis the US dollar at a rate of about one percent a month. However, the rate has remained fixed at approximately US$0.31 per kina since March 2016.

Real exchange rate & terms of trade

While international experience shows that a depreciation would have huge benefits, it would also have short-run costs. What typically makes highly import-dependent countries such as PNG reluctant to devalue are concerns about rising inflation, especially in relation to staple foods like rice.

Moreover, a depreciation causes a fall in real income for predominantly the urban elite that is often politically influential.

Another reason for the hesitation to devalue is the prevalent “elasticity pessimism”, the belief that PNG exports are inelastic with respect to prices, due to capacity constraints.

However, there is ample empirical evidence that a real depreciation boosts the exports of even primary product-dependent low-income countries.

In PNG, depreciation would boost not only agricultural commodity producers (coffee, cocoa, etc) but also vegetable producers (since they would be more able to compete against vegetable importers).

Academic research shows that in PNG “smallholders are responsive to market opportunities” and sensitive to price changes, and that domestic food production expanded substantially due to the devaluation of the kina in the 1990s.

The longer a real exchange rate overvaluation persists the more difficult a correction typically becomes from a political perspective. But international experience also suggests that every real exchange rate overvaluation needs to be corrected eventually. PNG is no exception.

The government could allow the exchange rate to once again depreciate gradually (as it did over 2014 and 2015), but a larger devaluation would bring forward the benefits. It could do this either by floating the exchange rate once again, or by BPNG retaining control of the exchange rate, but devaluing it.

A good solution to this political economy problem could be the implementation of a transitional dual exchange rate system. This would operate as follows.

The current official rate could be maintained for important imports (e.g. food, essential pharmaceuticals, and fuel), whereas a significantly depreciated rate, perhaps even one freely determined by the market, could be applied to all other transactions.

To minimise the economic distortion costs associated with such a policy, a binding time limited of, say, 18 months could be imposed before the exchange rate is unified again.

Several developing countries in the past have used this device as a short-term strategy to help depreciate their overvalued exchange rates.


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