Papua New Guinea issued its first sovereign dollar-denominated bond in September 2018, a major achievement for the island nation. Ongoing structural reform and market-focused policies played a key role in attracting foreign capital that year, and the $500m instrument has since led to a steady flow of dollars into the market. In addition to increasing foreign exchange reserves, the debut bond has been earmarked to refinance short-term domestic debt and help fund essential works and services of the government. Therefore, the bond has been hailed as a milestone in changing the country’s debt dynamics and should help PNG improve its economic resilience.
Foundations
Access to foreign currency has been a major issue since 2014, the year the Bank of PNG (BPNG), the central bank, imposed a currency trading band. The decision was designed to stabilise the value of the kina, but it quickly reduced the availability of foreign currency and weighed on business activity by pushing up inflation, increasing the cost of imports and slowing the pace at which payments could be made to overseas suppliers. Other forces that contributed to a dwindling stock included revenue from resource projects and tax receipts that fell short of expectations. Natural disasters also took their toll, with output from key extractive projects being halted at various times and affecting the inflows required to narrow the supply gap.
The country failed to garner investor interest for a sovereign bond in 2016, thus the successful issuance of the first sovereign dollar bond in 2018 gave PNG a chance to meet its immediate financing obligations while increasing foreign currency reserves. With total foreign debt of $2.5bn in the fourth quarter of 2018, the bond will play a leading role in settling outstanding accounts. However, given PNG’s dependence on extractive industries, there are concerns that the country could struggle to meet bond obligations if commodity prices decline below a certain point.
In addition to the inaugural sovereign bond, loans at attractive rates from Credit Suisse, the World Bank and the Asian Development Bank (ADB) helped finance the budget in 2018. A recovery in commodity prices led to higher export earnings and greater foreign capital inflows, while the government’s commitment to fiscal rationalisation also improved economic prospects. Furthermore, an uptick in extractive tax receipts and dividend payments in 2018 played a key role in supporting public finance objectives.
Backlog
The dollar bond was pivotal in reducing the outstanding backlog of foreign exchange demand. According to the March 2019 monetary policy statement from BPNG, the foreign currency backlog fell dramatically from PGK1.7bn ($515.6m) in December 2017 to PGK320.1m ($97.1m) in February 2019. According to locally reported figures from BPNG, this rose in subsequent months, with the foreign currency order book valued at around PGK1bn ($303.3m) at the end of July 2019, a figure half of the backlog amount two years prior.
BPNG is also taking policy measures to address the shortage, including assuming full control of the approval of onshore foreign currency accounts to prevent the accumulation of foreign assets in individual or corporate accounts; putting an end to the prioritisation of foreign currency for strategic sectors; and making direct interventions in the spot market.
Sovereign Bond
The bond raised $500m for PNG and carries a yield of 8.375% over 10 years. According to a report by Reuters, some $3.3bn in orders were received for the bond, mainly from the US. The book orders of almost seven-fold indicate the willingness of investors to loan to the Pacific Island – a reflection of PNG’s economic potential.
In the lead up to the bond sale, the government embarked on an investment roadshow in Singapore, Hong Kong, London, New York, Boston and Los Angeles to drum up interest. By most accounts, investor appetite was beyond expectations, leading some market observers to believe that PNG could issue another such bond in the coming years, provided the political and economic situation remains stable.
While the average time taken to service foreign exchange orders decreased from about five months at the end of 2017 to less than three months at the beginning of 2019, the imbalance between supply and demand continued in the first quarter. According to the quarterly Business Liaison Survey by BPNG, foreign currency orders were still delayed, with foreign exchange dealers rationing the flow of funds. The survey indicated that dealers were assisting customers with import orders but not transferring any surplus dollars to the inter-bank market.
Ratings
The bond received an investment grade of “B” from credit rating agency Standard & Poor’s and “B2” from Moody’s. PNG joins eight other countries that hold a “B2” rating, including Argentina, Tunisia, Egypt, Cambodia and Sri Lanka. The likelihood that the government will pay its debt obligation is considered slightly lower than in nearby Fiji, which has a sovereign bond rating of “Ba3” from Moody’s.
Global Forces
Uncertainty in the global trade environment has been cited as a reason for investors to diversify into emerging and frontier market bonds. An extended period of low international property yields is another factor that worked in favour of PNG’s first issuance. With rental returns falling across the globe, many investors have turned to sovereign bonds as one vehicle to secure a greater return on their capital, as leasing charges lag behind capital costs. According to a survey by London real estate consultancy Savills on 25 cities, Hong Kong – one of the most expensive cities to live and work in – had property yields of 2.43% in 2018. Frankfurt, Berlin and Tokyo performed only slightly better, with property yields of 2.9% – considerably lower than the 8.375% offered through PNG’s 10-year dollar bond.
Support Loans
In addition to the bond issuance the government secured three years of budget support funding from the ADB in 2018, as well as two years of support from the World Bank for 2019 and 2020. According to a debt sustainability analysis by the IMF in 2017, PNG faced a moderate risk of debt distress based on an assessment of publicly guaranteed external debt. Given this level of risk and an inadequate supply of foreign currency, the state has worked to strengthen its fiscal position by obtaining more cost-effective, longer-term financing.
In a major win for PNG’s public finances, the government achieved its ambitious financing agenda in 2018. The country’s total external borrowings amounted to $940m that year, which included the last $190m tranche of a $500m loan from Credit Suisse; the $500m sovereign bond; a $100m loan from the ADB as part of a $195m health loan; and a $150m loan from the World Bank that included $50m to cover earthquake expenditures.
Prior to the change in government in June 2019, PNG was in discussions with the Export-Import Bank of India for a line of credit for PGK300m ($91m). Set to be used for the construction of the Baiyer-Madang road and the Hoskins-Kimbe road – both of which have been deemed “economically enhancing” infrastructure – the loan came through in July 2019 at a value of $100m, with $60m and $40m to be used for the respective connections.
Domestic Currency
Supporting the local currency is also important. In the first quarter of 2018 the Trade Weighted Index (TWI) – a measure of the value of the kina against a basket of currencies of PNG’s major trading partners – began to reverse after a downward trend that began in the second half of 2013. While the kina has depreciated against the US dollar in nominal terms, on a trade-weighted basis it has appreciated against the Australian dollar, which makes up more than half of the TWI basket.
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