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Rating Action:

Moody's changes Papua New Guinea's rating outlook to stable from negative; affirms B2 rating

15 Feb 2019

Singapore, February 15, 2019 -- Moody's Investors Service ("Moody's") has today changed the outlook on the Government of Papua New Guinea's (PNG) issuer ratings to stable from negative and affirmed the B2 issuer and senior unsecured ratings.

The decision to change the outlook to stable reflects Moody's view that constraints on government liquidity will continue to ease. In particular, the continuation of the government's strategy to use proceeds from foreign-currency denominated commercial and concessional borrowings to repay short-term and high cost domestic debt will reduce refinancing risk.

This is balanced against Moody's view that the government's fiscal strategy faces risks from a higher reliance on external and foreign-currency borrowings that renders the debt burden and debt-servicing costs more vulnerable to a potential local-currency depreciation and sudden shifts in international investor confidence. A materialisation of such risks would damage the government's fiscal strength.

The decision to affirm the B2 ratings incorporates Moody's assessment that PNG's domestic government liquidity risk and external liquidity risk are balanced against credit strengths stemming from prospects for high GDP growth in the medium term as investment in PNG's natural resources wealth is realised, and a moderate level of government debt compared to peers. The rating is also underpinned by credit challenges related to moderate political risks and weaknesses in governance.

The local-currency bond and deposit ceilings are unchanged at Ba2. The foreign-currency bond ceiling is unchanged at B1 and the foreign-currency deposit ceiling is unchanged at B3. In addition, the short-term foreign-currency bond and deposit ceilings are "Not Prime.''

RATINGS RATIONALE

RATIONALE FOR THE STABLE OUTLOOK

GOVERNMENT LIQUIDITY CONSTRAINTS EASE, ALTHOUGH RISING EXTERNAL DEBT RAISES EXCHANGE RATE RISK

The government is lowering domestic refinancing risk through a strategy of shifting borrowing towards longer-dated and lower-cost sources of external debt (mixing commercial and concessional debt) and using the proceeds to repay short-term and high cost domestic debt.

The government has used a portion of the proceeds from its debut international sovereign bond issuance and budget support loans from the World Bank (IBRD, Aaa stable) and Asian Development Bank (Aaa stable) in late 2018 to retire some expensive short-term domestic debt. This is lowering local currency interest rates and the government's domestic debt servicing costs. Yields on 12-month Treasury bills have fallen to 6.84% as of 8 February, 2019, from an average of 8.05% in 2018. Similarly, yields on 10-year Treasury bonds are declining. Overall, Moody's expects interest payments to remain broadly stable at around 14% of government revenue in 2019-2020, the same as in 2018. At these levels, PNG's debt affordability ratio is in line with the median for B2-rated sovereigns.

Moody's expects a continued drawdown on these loans, and that new external borrowings in the next couple of years will be used to repay more domestic debt.

Moody's expects annual gross borrowing requirements -- incorporating projections of a narrowing in fiscal deficits and continued reduction in domestic debt -- to be 13.5%-14% of GDP in 2019-20, about two percentage points lower than previously forecast, and down from about 15% in 2018 and 20% on average in 2016-17. Moody's forecasts assume Treasury bills with maturities of less than 12 months will account for between 20%-25% of all outstanding government debt in 2019-20, lower than 32% in 2018 and as high as 39% in 2016 and 2017. The government's refinancing of short-term debt at longer maturities, will over time, lengthen the maturity schedule of the debt portfolio and further reduce refinancing risk, supporting a stable outlook on the B2 rating.

These credit-positive developments are partly offset by a gradually increasing proportion of foreign-currency debt in total government debt, which raises exchange rate risk. In the next few years, rising external debt will leave the debt burden and debt servicing costs more vulnerable to a potential local currency depreciation, particularly as repayments on external commercial loans come due in 2020 and 2021. This makes PNG's access to financing and financing costs vulnerable to a potential shift in foreign investors' confidence.

RATIONALE FOR THE RATING AFFIRMATION AT B2

EXTERNAL LIQUIDITY CONSTRAINTS EASE BUT BUFFERS REMAIN THIN

Stronger foreign exchange inflows from new external loans and higher commodity prices for PNG's key exports in 2018 and early 2019 have helped increase the stock of foreign exchange reserves and bolster reserve adequacy. Foreign exchange reserves rose to $2.3 billion in December 2018, markedly higher than $1.6 billion, on average, from 2015 through most of 2018.

Greater foreign exchange inflows have significantly helped authorities address the foreign exchange backlog that has constrained PNG's economic activity over the past few years. According to the Bank of Papua New Guinea, the central bank, the foreign exchange backlog has fallen to PGK400 million (about $120 million and 5% of foreign exchange reserves) as of January 2019, from PGK1.4 billion (about $415 million and 24% of foreign exchange reserves) in January 2018.

Moody's expects foreign exchange reserves to remain above $2 billion in 2019 and 2020. A combination of mining and agriculture export receipts, drawdowns on external concessional loans and commercial external loans, and increasing dollar revenue from mining and petroleum-related projects will support foreign exchange inflows. This is balanced by outflows from continued clearance of the backlog of import payments, repatriation of corporate dividends and repayments of external debt.

However, external liquidity pressures could heighten again, given downside risks to prices for PNG's key exports. In particular, PNG's reliance on commodity exports -- including liquefied natural gas, gold, copper and nickel among others -- renders it susceptible to commodity price shocks. Lower commodity prices would reduce export receipts and add to external vulnerability risks. Furthermore, while foreign direct investment (FDI) inflows should increase as anticipated resource projects commence construction in the next couple of years, at least some of these funds will likely be used for capital imports. In general, prospects for a stronger domestic economy will raise demand for imports and thereby foreign currency.

INVESTMENT IN LARGE RESOURCE PROJECTS COULD BOLSTER GROWTH POTENTIAL

PNG's longer-term growth is supported by potential investment aimed at tapping the country's natural resources wealth.

Key resource projects including Papua LNG, an expansion to the existing PNG LNG project, and Wafi Golpu gold, copper and silver mine, are progressing toward a final investment decision in the next 18 months. The recent signings of Memorandum of Understandings at the Asia-Pacific Economic Cooperation (APEC) meetings in November 2018 for Papua LNG and Wafi-Golpu underscores the commitment from investors and the government to develop these projects, which could boost investment, employment and incomes in the 2020s. Ongoing negotiations between the government and major energy and mining companies on the terms and conditions of the projects and the potential impacts on PNG's government revenue and foreign exchange inflows remain uncertain.

Other projects could bolster growth potential. The undersea cable project from Australia to PNG, to be completed in November 2019, will boost internet connectivity. Longer term, prospects for an electrification project, funded by the governments of Australia (Aaa stable), US (Aaa stable) and Japan (A1 stable), would provide access to electricity 70% of PNG's population by 2030 from the current 15%, enhancing power supply and raising economic development.

In the baseline, Moody's expects real GDP to grow at an average rate of around 4%-4.5% between 2019 and 2022, following a quake-affected 0.3% outturn in 2018, supported by early works and construction of the new mining and petroleum projects. Moody's expects stronger growth in the non-mining sector, as increased availability of foreign exchange supports domestic business confidence and investment.

MODERATE FISCAL STRENGTH SUPPORTS CREDIT PROFILE, BUT POLICY EFFECTIVENESS WILL REMAIN CHALLENGING

In early 2018, the government adopted a new fiscal framework aimed at consolidating public finances and reducing government debt as a share of GDP.

In line with its fiscal strategy, fiscal deficits narrowed to between 2%-2.5% of GDP in 2017-18 from between 4.5%-7% of GDP amid the oil price shock during 2013-16. The government estimates a fiscal deficit of 2.3% of GDP for 2018, despite the effects of the February 2018 earthquake, which hit GDP growth, lowered government revenue and raised expenses for rehabilitation and reconstruction.

Moody's forecasts fiscal deficits of around 2% of GDP in 2019 and 2020. This forecast faces downside risks to revenue projections from lower prices for gas and other commodity exports. Overall, Moody's projects government debt to remain broadly stable at around 31% of GDP in 2019 and 2020, from 31.2% in 2018 and 32.4% in 2017, in line with the debt ceiling range in the government's Medium-Term Debt Strategy. At these levels, PNG's government debt-to-GDP ratio is much lower than the 56% median for B-rated sovereigns.

Over the medium term, fiscal reforms and technical support from international financial institutions and development partners will enhance the conduct of fiscal policy. In particular, the Medium-Term Revenue and Expenditure strategies provide fiscal anchors that if successfully adhered to, could allow the government to rebuild fiscal buffers that help mitigate the impact of potential future shocks. But very low institutional strength and capacity imply policy implementation and effectiveness will continue to be challenging.

WHAT COULD CHANGE THE RATING UP

Moody's would consider upgrading the rating upon evidence of durably lower refinancing risks. This could result from a sharper fiscal consolidation and larger refinancing of short-term domestic debt at longer maturities than currently assumed, which would materially reduce gross borrowing requirements.

Moody's would also consider upgrading the rating if an increase in non-debt-creating external inflows leads to a more material and sustained build-up in foreign exchange reserves than the agency currently assumes. Such an outcome would bolster reserve adequacy and domestic economic output on a sustained basis.

Stronger growth potential than is currently assumed -- should that enhance the economy's shock absorption capacity and generate higher government revenue on a sustained basis -- would also likely lead Moody's to upgrade the rating.

These scenarios would potentially become more likely over the medium to longer term.

WHAT COULD CHANGE THE RATING DOWN

Moody's would consider downgrading the rating as a result of renewed increasing reliance on short-term domestic market funding at high local currency interest rates to fund fiscal deficits. This would substantially raise refinancing risks and result in higher government funding costs and debt than Moody's currently assumes.

Moody's would also consider downgrading the rating upon evidence of a renewed decline in the stock of foreign exchange reserves or worsening of foreign exchange shortages that heightens risks to external debt servicing.

In general, a deterioration in government and external liquidity -- perhaps stemming from lower commodity prices or a natural disaster -- that results in substantial and lasting worsening of GDP growth prospects and, in turn, government revenue, would ultimately weigh on the sustainability of public finances and the rating.

GDP per capita (PPP basis, US$): 3,658 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 4.7% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -2.4% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 26.4% (2017 Actual) (also known as External Balance)

External debt/GDP: 73.2% (2017 Actual)

Level of economic development: Low level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 12 February 2019, a rating committee was called to discuss the rating of the Papua New Guinea, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Matthew Circosta
Analyst
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

No Related Data.
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