2003 Budget Speech DELIVERED BY THE HON. BART PHILEMON, MP MINISTER FOR FINANCE AND TREASURY

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2 2003 Budget Speech DELIVERED BY THE HON. BART PHILEMON, MP MINISTER FOR FINANCE AND TREASURY ON THE OCCASION OF THE SECOND READING OF THE 2003 APPROPRIATION BILL, PM, 28 TH November 2002

3 1. Introduction Mr Speaker, I move that the Bill now be read a second time. It is a great honor and also a great responsibility to present to the House the Somare-Marat's first full Budget. The importance of the occasion causes me to reflect on my upbringing in Butibam village and then Lae. I have drawn great support and inspiration from members of my electorate, Lae Open and also my family as we have worked on matters of great national importance in recent months in the preparation of the 2003 Budget. The results of our work are now before members and the nation in the form of a full and comprehensive set of budget documents. My task today is to provide a description and overview of what the documents set out and particularly to outline the economic policy framework that provides the foundation to our budget formulation. 2. A Difficult Inheritance Budgets look forward not backwards. That is the approach the Government wishes to take. We do not wish to live in the past. We seek to develop sound policies and plans for a future that will allow for improved hope and better living conditions for all in Papua New Guinea. However, in moving forward we need to have a very clear picture of where we have recently come from and where we currently are. For the first fifteen years or so after independence our country had a proud international record of sound and effective financial and economic management. 1

4 To be certain we received significant support and assistance from the international economy. Notwithstanding this support we were fiercely independent in the way we managed our financial affairs. A hallmark of the very first Somare Government was that we took full responsibility for our financial management and that our leaders were held accountable for delivering sound financial performance. The central plank of our policy in those days was that we would manage our affairs within our means and without the use of significant domestic or foreign borrowing. We maintained good relations with the International Monetary Fund and considered their advice. But we had an active policy of not borrowing from them or entering into programs with them. This was because we had confidence in our own abilities to manage our finances responsibly. Because we managed responsibly we did not have large holes in our finances to fill up. So there were no media reports in those days of Papua New Guineans wandering the world with begging bowls seeking further foreign loans to plug gaps in our budget created by irresponsible management. Unfortunately in the nineties our reputation as sound financial managers became increasingly tarnished. Some factors were beyond our control, particularly the very rapid withdrawal of Australian budget support and many difficult years for the prices of our commodities. Other factors proved very difficult to control particularly the closure of Bougainville copper, landowner demands and the breakdown of stable law and order in parts of the country. 2

5 However, at heart as a country we have persistently for a decade chosen to spend significantly more than we earn. This has resulted in a mountain of debt. This not only costs significant money to repay but also has adverse implications for macro economic conditions, and particularly creates conditions that make it difficult for the private sector to grow. To its credit the previous Morauta Government more or less correctly diagnosed the problems confronting the nation. It even developed some policies that might have helped in moving the nation forward. However, at the end of the day like several Governments before it, the Morauta Government failed us all miserably. It lacked the courage, determination and political skills to manage our finances responsibly. Worse than this in its final year the Government became completely corrupted, running up huge expenditures in an attempt to buy an election victory. 3. Managing 2002 We are now trying to live with and manage the aftershocks of the final twelve months of an expenditure avalanche by the previous Government. The shock waves are not merely restricted to management of the budget. They have also impacted adversely on our broader economic conditions. This creates a need for the development of appropriate broad economic policies to take us forward. Improving budget policy is important, but alone will not be enough. The difficult financial and economic climate in which the new Government finds itself has been well documented. Mr Speaker let me spell out some of the important dimensions of our situation. 3

6 Economic growth has been very poor recently with several years of negative growth in Total GDP and also Non Mining and Petroleum GDP. Fortunately we are now seeing some recovery coming through in non mining sectors of the economy which we are projecting to grow at around 2 to 3 per cent this year and next. It is pleasing that some growth is reemerging in the agricultural export industries which we are projecting will grow at 3 to 4 per cent this year and next. Unfortunately inflation remained high throughout the term of the previous Government. Inflation in annual average terms is estimated to average 13 per cent a year in the four years 1999 to Because of pressures built up in the system and due to delays in the effects of currency depreciation passing through to domestic prices, it is our assessment that it will take a year for inflation to completely wash out of the system. The Kina has undergone stress on several occasions during 2002, though fortunately has shown renewed strength in the weeks leading up to the Budget presentation. Kina weakness has at times related to short term seasonal trade patterns and periodical uncertainties and declines in confidence of the private sector. However, the fundamental cause of the long term decline of the Kina since 1996 has been persistently excessive spending by the Government, financed mainly from domestic borrowing. Because of the unprecedented nature of the expenditure binge in the final year of the Morauta Government we are still feeling the effects of fiscal injection through the money and currency markets over recent months. 4

7 Since my coming to the Treasury strong fiscal discipline and tight expenditure control has been reintroduced to managing the budget. We have now recorded several months of fiscal surplus in a row and intend to continue very tight management through November and December and the early months of The Treasury is very confident that continuation of a tight fiscal stance will assist to see the reemergence of a far more stable Kina by the first quarter of Reemergence of fiscal and currency stability is of fundamental importance to getting inflation much lower. This is no short term task. It will take a year before the inflation numbers improve. However, the Treasury is confident that we can return to inflation of around 5 per cent by Mr Speaker, without good access to credit at reasonable rates of interest we cannot expect our private sector to grow. Commercial bank lending rates to the private sector averaged 18 per cent throughout the Morauta years. Not surprisingly private sector credit failed to grow. To get interest rates down will require significantly reduced involvement of the Government in the domestic debt markets as well as the consistent implementation of policies to get inflation down. This will also take time and indeed in the short term interest rates have risen. However, as we persist with the return to fiscal responsibility and as the currency stabilizes we can expect to see interest rates falling in the second half of Managing the PNG economy must always take account of the external situation and the level of our international reserves. Recent reserves levels are relatively comfortable and manageable. Recent Gross Foreign Reserves have been equivalent to around eight months of non mining import cover. 5

8 Policy aims to retain reserves at manageable levels, mainly through a return to more responsible fiscal policies. This will be supplemented by small strategic external refinancings to address a large short term bunching of external debt commitments in coming years. Mr Speaker, before turning to more directly address the 2003 budget details let me conclude my outline of the current situation by indicating that although the situation we have inherited is difficult, it is not at all beyond hope. Our detailed assessment is that we can successfully manage 2003 and the medium term providing we successfully change the way we go about managing things. There remains good cause for optimism and hope. Mr Speaker, let me now turn to more directly outline to you the key objectives and strategies for the 2003 budget. 4. Key Approaches and Themes of the 2003 Budget The 2003 budget preparation process has been different in two important respects. Firstly, it is forward looking and secondly it is policy driven. Political reforms have meant that the Government has a real chance of remaining in office for a full five years. Accordingly, we have recast our fiscal framework within a five year time horizon. The budget has been prepared under a different ethos. Policy is now at the fulcrum of the decision making processes. Placing policy at the core is helping to develop ownership, consensus and cohesiveness at the political level, thereby legitimizing the budget process. 6

9 The linking of policy, planning and budgeting will in future drive the formulation of the budget, rather than the reverse as has been the case over many years. In forming the 2003 Budget the Government has aimed to generate consensus and commitment through a variety of consultative processes. Initially, I established a Ministerial Budget Committee to assist me in Budget formulation. Further, consultations were also held with a committee of "Economic Sector" Ministers. These 2 forums will be further strengthened next year when the trade-offs between different competing policies and priorities are confronted during the process of public expenditure rationalization. At the heart of our newly emerging public expenditure management strategy is the discipline of hard budget ceilings. The Medium Term Fiscal Strategy is being crafted with a view not just to fiscal sustainability but also to external sustainability as well. Mr. Speaker, the Government's high level policy objectives are: Good governance; Export driven economic growth; and Poverty alleviation and rural and human resource development. Fiscal policy sets the following goals for the medium term. Stabilizing debt dynamics with a gradual decline in the debt-to- GDP ratio; Increasing public savings, that is increasing Government investment in infrastructure and people; and 7

10 Reallocating scarce resources more efficiently. Given these goals the Government is now finalizing a Medium Term Development Strategy (MTDS) that will provide the blue-print for resource allocation. I will have more to say on this shortly. For the 2003 budget fiscal policy is importantly directed at the pursuit of improved macroeconomic performance. In particular, seven core objectives have been set for the 2003 Budget. These are: 1. To alleviate pressure on the Kina; 2. To reduce demands on domestic financing, so reducing pressures on inflation; 3. To facilitate an easing of monetary conditions and reductions in interest rates; 4. To stabilize foreign exchange reserves; 5. To commence a fundamental restructuring of the Budget to focus on more productive outlays; 6. To allow entities to operate with greater certainty and achieve better budgetary outcomes; and 7. To establish the platform for robust broad based sustainable growth. Mr. Speaker, I would like to emphasize that we have not forsaken growth for stability. I announced in the 2002 Supplementary Budget that a 1 per cent of GDP deficit target was planned for the 2003 Budget. 8

11 This target was eventually eased to allow additional quality investment spending within the Development Budget to take place. These additions will be fully financed from concessional external sources and will not impose additional pressures on domestic financing sources for Mr. Speaker, stabilization is necessary for renewed economic growth but is not a sufficient condition to provide it. The Government must take active but responsible interventions to strengthen the economy s growth prospects. We have chosen a role for Government where it undertakes judicious investments to support the role of the private sector as the engine of growth. In this regard a package of structural and reform measures designed to stimulate private sector activity and yield growth dividends for Papua New Guinea are being introduced as part of the budget. Full details are contained in Volume 1. One component of this package will be a review of the Tariff Reform Programme, which has been in effect for the last three years. It is now time to take stock of the programme, to assess its merits and to see if appropriate rates of protection are being provided to Papua New Guinea based industries. I emphasize that Papua New Guinea remains committed to free and fair trade and that we will not contravene the rules of our membership with the World Trade Organization and the Asia-Pacific Economic Cooperation. 9

12 5. Details of the 2003 Budget and Medium Term Fiscal Framework 5.1 Revenues Mr Speaker, total tax revenues for 2003 are estimated at K 2.5 billion or 20.6 per cent of GDP. This is a 7.0 per cent increase over expected tax collections for The 2003 Budget introduces a number of taxation measures raising an additional K120 million in revenues, around 1 per cent of GDP. In addition, measures to strengthen the operation and capacity of the Internal Revenue Commission are expected to raise an additional K50 million through improved tax compliance. Let me now outline the key tax measures contained in the 2003 Budget. The prescribed taxable value of housing and automobiles provided by employers to employees is increased by 25 per cent, raising K6 million. The company tax rate is increased to 30 per cent from the current 25 per cent, raising K60 million. A new debits tax will replace the existing stamp duty on cheques, with a rate of 0.01 per cent of the withdrawn amount with effect from 1 April To protect people on low incomes the debits tax will not be applied to passbook accounts and charities. Excise rates for alcohol and tobacco products will be indexed by 4 per cent every six months from 1 May The index rates will be reviewed after two years. In addition new arrangements will be introduced for the taxation of tobacco products. Mr Speaker, the log export tax, currently expressed in Kina terms, is to be converted to US dollar rates. This will provide certainty of tax rates to the logging industry following several years of increasing effective tax rates due to depreciation of the Kina. 10

13 Mr Speaker, I am pleased to announce a number of fiscal concessions aimed at stimulating the mining and petroleum resource sectors. In relation to the mining sector, the Government has decided: To abolish the Additional Profits Tax. To relax the ring-fence on mines to allow the accelerated deduction of pooled exploration expenditure. To provide a double deduction for mineral exploration expenses which results in a mining development. To introduce new depreciation arrangements for new projects, with a 25 per cent declining balance pool for all assets. To replace the twenty-year time limit on loss carry forward with an indefinite loss carry forward in order to simplify administration for companies and the IRC. To provide some balance to the package of incentives to the mining sector it has been decided to discontinue the phasing out of the mining levy with revenue savings of K32 million in The Departments of Treasury and Mining will by July 2003 complete a review of State equity provisions in relation to mining projects. The review will consider reform of current provisions. From 1 January 2003, new projects wishing to make use of the provisions of the Fiscal Stabilisation Act will be required to pay a premium of 2 per cent of company tax payable. In relation to the petroleum sector, the Government is introducing special fiscal terms for Petroleum Prospecting Licenses issued before 1 January 2008 which convert to Petroleum Development Licenses before 1 January These developments will be entitled to a reduced petroleum corporate tax rate of 30 per cent, compared with the usual petroleum corporate tax rate of 45 per cent. 11

14 This will make Papua New Guinea's tax rate on petroleum projects by far the lowest in the World. Finally in relation to petroleum the first tier of the Additional Profits Tax is abolished for new projects. Mr Speaker, the Government recognizes the importance of improving our tax administration performance as part of financial improvement. The IRC will carry out a strategic review with the assistance of the Australian Tax Office, to identifying problems and solutions to its institutional requirements. The IRC s budget in 2003 has been increased by K5 million to enable it to operate at full capacity, increasing its ability to collect outstanding tax debts, carry out an enhanced program of audits and improve taxpayer compliance. Mr Speaker, during 2003 the Government will consider recommendations of the National Economic and Fiscal Commission on among other things how to give effect to the new VAT sharing arrangements to take effect from 1 January An agreement reached in 2002 provided that 80 per cent of net inland revenue will flow to the provinces, with each province s grant reflecting actual collections. This distribution will have quite different implications for each provinces revenues some will win and some will lose. Compensating arrangements need to be developed. The Government has been requested by some better off provinces to implement the new distribution mechanism from 1 January We will not be doing so, as any decision would preempt the NEFC report and have significant implications for inter-governmental financial relations. Mr Speaker, total non-tax revenues for 2003 are estimated at K million. 12

15 Of this Departmental revenues for 2003 are estimated to be K95.0 million. This includes an additional K21.2 million in non-tax departmental revenue from increasing fees to take account of inflation, and new fees and charges. Foreign project support grants are estimated at K million for 2003 compared to an estimated K million in This is an increase of 20.1 per cent, mainly due to exchange rate fluctuations. Mr Speaker, the total revenues and grants for 2003 are estimated at K 3.5 billion or 29.2 per cent of GDP. This is some 7.9 per cent higher than the level of K 3.2 billion estimated for The new measures implemented in 2003 have important implications for bolstering our medium term revenue outlook to 2007 by which time mining and petroleum revenues will be starting to decline. Our revised estimates for total revenue and grants collections in 2007 are that these will now fall to 28.6 per cent of GDP a somewhat healthier picture than thought at the time of the Supplementary Budget. The revenue reforms being introduced have been important in improving our medium term outlook. No further major new taxes are anticipated during the life of the Government. Mr Speaker, let me now turn to the expenditure side of the budget. 5.2 Expenditures Recurrent Expenditure Total recurrent expenditure and net lending for 2003 has been appropriated at K 2.5 billion. This level reflects virtually no change over the projected outturn for As a proportion of GDP recurrent expenditures fall from 23.2 per cent of GDP in 2002 to 21.2 per cent of GDP in 2003, indicating an adjustment of K 250 million on the recurrent expenditure side of the budget. 13

16 The medium term estimates indicate a continuing tight approach to managing recurrent expenditure. By 2007 the Recurrrent Budget is estimated to grow to K 3.0 billion and to maintain its level of approximately 67 per cent of all budget expenditures while falling slightly as a proportion of GDP. Important elements of the expenditure adjustment are as follows: A freeze on recruitment and wages will save K 84 million; One off expenditures of K 80 million for the 2002 national elections will not be repeated in Reductions in education subsidies will save K 75 million. A large number of cuts to miscellaneous Departments and Agencies will save K 84 million. All of these recurrent savings will be offset by higher interest costs of K 73 million. Mr Speaker, while a major effort has been made to prune the running costs of Governments, detailed attention has been given to ensuring that realistic and achievable targets have been set for each budget entity. This assessment has included detailed review of wage and salary requirements and fixed cost needs in areas such as utilities and rentals. All entities will be forced to manage very tightly in But they have all been provided with sufficient funds to meet their basic needs and to provide services to the community. The pressure on entities to manage their running costs to tight targets in 2003 has been applied to all levels of Government approximately equally. 14

17 The National Departments, Statutory Authorities and Provinces are all being asked to raise their efficiency in a tight financial environment while still improving service delivery. In addition to the normal running costs of entities, some K 35.0 million has been provided for Structural Adjustment initiatives and a further K 60 million has been set aside to cover arrears. It is my intention to clear all arrears owed by Government within the next two years. Development Expenditure Mr Speaker, the Government has aimed to ensure that our limited financial resources are used to fund our most important economic and social programs. The Government has responsibility for implementing an expenditure program that will promote economic growth and rising living standards. To this end, K1.2 billion has been appropriated to the Development Budget. This represents an increase of K95 million on the expected level of development expenditure in The medium term estimates indicate continuing high priority to development expenditure. By 2007 the Development Budget is estimated to grow to K 1.4 billion and to maintain its level of approximately 33 per cent of all budget expenditures and 10 per cent of GDP. Our limited resources have been channeled to the priority areas of public expenditure that will help put in place the foundations necessary for export driven economic growth, rural development and poverty reduction. 15

18 The five priority areas are: (1) Improved market access, through transport infrastructure maintenance and rehabilitation. (2) Direct promotion of income-earning opportunities, especially in agriculture. (3) Securing peace and good order. (4) Improving the delivery of basic services; and (5) Strengthening administrative systems for good government. The Government is confident that if resources are concentrated on these priority areas, we will empower ordinary Papua New Guineans to drive the development process. Our philosophy is clear. Higher living standards are not achieved by ad-hoc and unplanned Government expenditure decisions. Rather, higher living standards are achieved through the efforts and hard work of ordinary Papua New Guineans. The role of Government is to put in place the environment that will allow our people to mobilize their own resources their land, labour and skills for export growth, increased incomes and ultimately, higher living standards. Mr Speaker, the policy direction of the 2003 Development Budget is consistent with the principles that underpin the Government s forthcoming Medium Term Development Strategy. The Minister for National Planning and Monitoring is currently formulating the new development strategy and it will be finalized early in

19 Honourable Members will understand that as this is the first full Budget of the Government, significant proportions of development resources are already committed to ongoing activities. Further resources are locked-away to meet constitutional obligations and other legally binding commitments. Resources available for new initiatives are always limited. Nonetheless, by sticking closely to our priorities for 2003 the Government has cancelled, scaled-down or re scoped a number of programs and projects. Funds released have been used to supplement the resources available for high impact activities. I am pleased to announce that activities that have received the highest priority in the Budget are road maintenance and agricultural support programs. Very importantly, a significant funding boost has been provided to the Highlands Highway, with an estimated 85 million Kina likely to be spent on maintenance and rehabilitation work in Furthermore it has been decided to fast-track the World Bank supported Highlands Highway Rehabilitation Project, so even higher levels of funding are planned 2004 and Mr Speaker, I pose the question to Honorable Members, in terms of improving market access, is there a higher priority than the Highlands Highway? In total, around K356 million of the 2003 Development Budget has been allocated to infrastructure projects throughout the country. In relation to agriculture, 28 million Kina has been appropriated for research, extension and smallholder support programs, while 12.5 million Kina has been appropriated for the nucleus agro-enterprises project. This initiative seeks to expand the model that has operated successfully here, particularly in relation to our oil palm industry. 17

20 The Budget has also appropriated K2.0 million for the Rural Development Bank as part of our strategy for export driven growth and rural development. We will also be exploring options for securing further assistance for the Bank, which will not only consider capital needs, but will also strengthen management and corporate governance systems. Finally, the Government is fully committed to the peace process in Bougainville and will provide for all agreed levels of funding under the Development Budget for the setting up of autonomous Government structures and other agreed purposes. Mr Speaker, our initial efforts in reformulating the development budget have been important and will be successively built on over the medium term. Total Expenditure and Net Lending Mr Speaker, Total Expenditure and Net Lending is targeted at K 3.9 billion for 2003 some 6.4 per cent higher than the expected 2002 outturn. Total Expenditure and Net Lending falls as a proportion of GDP from 33.3 per cent in 2002 to 31.2 per cent in Over the medium term Total Expenditure and Net Lending is projected to fall further in relative terms to reach 29.6 per cent of GDP in To reach such levels will require further cuts of around K 120 million or 1 per cent of GDP. It is intended to identify these cuts as part of the expenditure review and rationalization exercise which will be undertaken in

21 5.3 Financing Mr Speaker, let me turn to the very important financing side of the budget. A deficit of K million or 2 per cent of GDP has been targeted for This compares to much higher deficits of K million in 2001 and an estimated K million in Over the medium term it is planned to progressively phase our deficit levels down to one per cent of GDP, or K 152 million by Our medium term deficit reduction plan will see our total debt to GDP ratio fall from over 70 per cent of GDP in 2002 to around 60 per cent in Over the same period our primary budget balance will rise from around zero to approximately 3 per cent of GDP. For 2003 there is an important shift away from domestic market financing which will total K million next year compared to K million this year and K million in Importantly the Government has recommitted itself to a responsible asset sales program through the IPBC and plans to raise K 200 million in sales next year. The Prime Minister will announce the details of our privatization plans to Parliament in coming days. Our foreign financing side will be boosted by drawdowns of foreign concessional project financing of K million next year. This is much higher than levels of K 84 million in 2001 and K 93 million expected this year. Finally, with regard to financing the Government will refinance a number of bunched foreign commercial payments that fall due in The amount required here is around US $ 50 million or K 215 million Kina. 19

22 Ideally we would like to negotiate a refinancing of short term debt provided by Australia, but if they remain reluctant we will go to the markets. Mr Speaker, before concluding let me turn briefly to discuss relations with the international donor community. 6. International Relations Mr Speaker the Government values its relations with the international donor community and will work hard in the period ahead to improve those relations. Preparation of the Budget was assisted by a visit of the International Monetary Fund in October who provided advice on budget formulation. Following a decision of the National Executive Council the International Monetary Fund has been invited to return in late January for further consultations and to explore the merits from both sides of entering into formal or less formal programming arrangements in the future. As I have indicated to Honorable Members earlier the Government has moved rapidly to implement strict financial discipline. Furthermore, we have specifically designed the 2003 Budget such that it can be managed without recourse to any significant new levels of foreign borrowing. Solutions to our financial and economic problems lie largely at home and not through the seeking of large foreign loans. Our further discussions with the Fund will not be to seek large additional loans. Rather they are likely to focus on assistance to further restructure our budget as a result of recommendations likely to flow from the proposed public expenditure and rationalization exercise planned for early

23 We also look for support of the Fund and Australia to assist in a small refinancing of around US $ 50 million in 2003 to help smooth out a major bunching in our foreign debt servicing commitments. The Government has also appreciated the assistance of Australia in the preparation of the 2003 Budget, particularly it s agreement to allow reprioritization of project grants of approximately K 100 million to support domestic financing of priority items including pharmaceuticals, education supplies, law and order supplies and road maintenance. Australia and all other grant donors including New Zealand, Japan and the European Union are gratefully thanked for the funding of a very large project grant program of K 827 million in Conclusions Mr Speaker, I have been on my feet for a lengthy period now and will quickly draw to a close. I thank all Honorable Members for their attention and look forward to their support in the passing of the Bills. The Government has come a long way since taking Office and the passing of the Supplementary Budget. Mismanagement in the final eighteen months of the Morauta Government has been arrested and turned around. While we will all continue to do it hard on emergency rations for the remainder of this year the Government will nevertheless get through 2002 with a reasonable result quite close to that targeted in the Supplementary Budget. It could have been so much worse. Perhaps the thing that we have learned most in working through the Supplementary and now the 2003 Budget is that our situation is by no means hopeless. 21

24 To be sure we have challenges. But these are challenges that we can largely address at home through our own independent actions. Providing we continue with determination in our efforts to improve financial and economic management we will over the course of 2003 begin to see rapidly improved results. Improved financial management can be consistent with a related improvement in our basic service delivery performance through better efficiency. Our development budget will continue to grow and will be targeted at high priority and growth generating activities. These results of our reforms will be particularly targeted at and beneficial to our private sector. Without rapid growth in our private sector we cannot rapidly improve living standards This includes renewed growth in our mining and petroleum sectors, which have been provided considerable incentives in the Budget. As the private sector moves to higher growth our basic economic indicators will improve and so will our international reputation and investment performance with it. The 2003 Budget represents a move to significantly better economic management so improving prospects of better living standards for all our citizens. It is a Budget, which warrants the support of all Honorable Members of this House. I now commend the Bill to Parliament. 22