Moody's: Papua New Guinea's B2 rating reflects significant pressure on government financing and external liquidity

Moody's Investors Service says that Papua New Guinea's (PNG) B2 rating and stable outlook reflect significant pressure on government financing and external liquidity amid structurally low commodity prices and continued weak GDP growth.

Credit challenges also stem from weaknesses in governance and security, low incomes and poor infrastructure, while domestic political risk remains a constraint on the sovereign's credit profile.

Balancing these, PNG's credit strengths include strong growth potential supported by natural resources wealth and low, albeit rising, government debt.

Moody's conclusions are contained in its recently released annual credit analysis, "Government of Papua New Guinea -- B2 Stable." The report elaborates on PNG's credit profile in terms of Economic Strength, Low (-); Institutional Strength, Very Low (+); Fiscal Strength, Moderate (+); and Susceptibility to Event Risk, Moderate; the four main analytic factors in our Sovereign Bond Rating Methodology. It does not constitute a rating action.

We forecast real GDP growth of around 3% in the coming years as the economy adjusts to persistently lower commodity prices than in the first half of the decade.

Stronger mining and agricultural production and construction ahead of the 2018 Asia-Pacific Economic Cooperation summit will support output; however, continuing fiscal tightening, high inflation and a shortage of foreign currency weigh on consumption and investment.

Despite government efforts to curb expenditure, fiscal deficits remain wide and debt levels continue to climb. Government liquidity risks have risen due to an increasing reliance on short-term financing, while higher interest rates reduce debt affordability.

External liquidity pressures are prominent. A backlog of foreign-exchange payments highlights a greater degree of balance of payments stress than PNG's metrics capture. Clearing this backlog will continue to place high demands on the country's foreign reserves.

The rise in government debt since 2011, in contravention to fiscal rules, is an indication of limited fiscal policy effectiveness. Such debt breached the legislated limit of 30% of GDP in 2016.

The government's new Medium Term Fiscal Strategy (MTFS) 2018-2022, to be formulated later this year, will provide greater clarity on limits around fiscal deficits, debt and foreign currency borrowings. The MTFS, if successfully adhered to, could allow the government to build fiscal buffers that can help mitigate the impact of potential future negative shocks.

We expect the government's revenue performance to remain subdued because of persistent weak domestic demand and low commodity prices. The government is responding to fiscal pressure with broad-based cuts in expenditure, including operational expenses and capital investment.

The stable outlook balances the weak near-term growth outlook against more robust prospects over the longer term. The boost to potential growth from investment in large energy and mining projects in the coming years would help alleviate fiscal and external pressures, and could lead to upward pressure on the rating.

Downward rating pressure could develop as a result of (1) a re-emergence of wide fiscal deficits, leading to a rapid rise in government debt; (2) deteriorating growth prospects that ultimately weigh on fiscal and debt sustainability; and (3) a further decline in foreign currency reserves that increases external payment risks.