Papua New Guinea - Structural Adjustment Loan

Docunent of The World Bank FOR OFFICIAL USE ONLY Report No. P-5307-PNG REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUSTMENT LOAN TO THE INDEPENDENT STATE OF PAPUA NEW GUINEA MAY 10, 1990 Tbis document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank autborization.  CURRENCY EQUIVALEN-S Annual Averages 1981 K 1.00 = US$ 1.49 1982 K 1.00 - USS 1.36 1983 K 1.00 - US$ 1.20 1984 K 1.00 = US$ 1.12 1985 K 1.00 = USS 1.00 1986 K 1.00 = USS 1.03 1987 K 1.00 = US$ 1.10 1988 K 1.00 = USS 1.15 1989 K 1.00 = US$ 1.16 March 31, 1990 K 1.00 = USS 1.02 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ADB - Asian Development Bank Adcol - Administrative College BCL - Bougainville Copper Limited BPNG - Bank of Papua New Guinea CPI - Cousumer Price Index CCFF - Compensatory and Contingency Financing Facility DFP - Department of Finance and Planning EEC - European Economic Community HEP - Higher Education Plan IDA - International Development Association IFC - International Finance Corporation IMF - International Monetary Fund MIGA - Multilateral Investment Guarantee Agency MLT - Medium- to Long-term MRDC - Mineral Resources Development Corporation NIDA - National Investment Development Authority NTP - National Training Policy O&M - Operations and Maintenance PEA - Public Employees Association PIP - Public Investment Program PNG - Papua New Guinea RMC Resource Management Committee SAL - Structural Adjustment Loan SNAPEM - Strengthening National and Provincial Economic Management SOE - Statement of Expenditure TFAP - Tropical Forestry Action Plan UNDP - United Nations Development Program  FOR OMCUAL USE ONLY PAPUA imr 6U0A STRUCTURAL ADJUSIII LOAN Loan and Program Summry Borrower : The Independent State of Papua New Guinea Amount : US$50 million equivalent Terms s 20 years, including 5 yerrs of grace, at the standard variable interest rate Description : The objective of the proposed loan is to support the stabilization and structu:al adjustment program the Government has embarked on in response to adverse shocks, including the closure of the Bougainville mine. The program focuses on: macroeconomic policy adjustments to maintain financial stability; improvements in public resource management, through atrengthening revenue mobilization, improving expenditure management and enhancing institutional capacities; and promotion of the nonmining private sector, through adjustments in exchange rate and wage policies, investment deregulation, privatization, and trade policy reform. Benefits and Risks : Effective implementation of the program to be suppported by the proposed loan will: allow domestic and external financial stability to be maintained in the face of a large shortfall in export income; minimize the short-term costs of adjustment and facilitate an early economic recovery; and ley the basis for follow-up structural reform and development to help achieve stronger and broad-based growth in the economy over the medium term. The implementation of the program and the economic outlook are subject to three main risks: policy slippage due to political opposition to some of the envisaged adjustments; the uncertain outlook for the Bougainville mine; and delays in the development of the new mineral projects and/or shortfalls in their financial contribution to the economy. The political risk is mitigated by the strong commitment to adjustment already demonstrated by This document has a restricted distribution and may be used by recipients only in the rarformnance of thieir official duties. Its contents may not otherwise be disclosed without Worl' 4:' authorization.  - ii - the Government, and a special program of interventions aimed specifically et alleviating the social costs of adjustment that the Government will be undertaking with donor assistance. A prolonged closure of the Bougainville mine and delays in new mineral projects will require a continuation of stabilization policies beyond the period of the present program (1990-91) and will constrain growth in the medium-term. The various uncertainties relating to mineral sector developments reinforce the case for a strong, multiyear program of structural reform to develop the nonmining economy. Estimated Disbursements s The loan will be disbursed in two equal tr%nches of US$25 million, the first upon loan effectiveness and the second upon completion of a satisfactory review of overall impleme.tation of the program and the implementation of specific second tranche release actions. The review of program implementation for the release of the second tranche wv..ll be held within six months of the release of the first tranche. Disbursement of the entire loan is expected to be completed within 18 months of loar effectiveness. Economic Rate of Return a Not applicable Appraisal Report s None  PAPUJA REV CUIRKA STUCTURAL ADm si? LOAN Table of Contents Page No. LOAN AND PROGRAM SUMMARY i I. THE ECONOMY . 1.... .. . ....... A. Improvement in Economic Performance, 1985-88 .1 B. Recent Shocks and Need for Adjustment .. 3 II. THE ADJUSTMENT PROGRAM (1990-91) ........6.... 6 A. Program Objectives ...................................... 6 B. Main Elements of Adjustment Program 7 (a) Macroeconomic Framework for Stabilization 7 (b) Improvement of Public Resource Management 8 (c) Promotion of Nonmining Private Sector 11 C. Economic and Financial Outlook 13 D. Social Impact of Adjustment 15 E. Financing of Adjustment ................................. 16 F. Program Risks and Uncertainties in Outlook ........ 17 III. THE PROPOSED LOAN ... ............... ... . .... ......... . .... ........... . 19 A. Loan History ***********..................*..*.....**......... 19 B. Loan Administration ... .......................... ........ 19 C. Tranche Release Conditions ............... ... ............. 21 D. Program Implementation and Monitoring ................... 23 IV. BANK GROUP STRATEGY IN PNG .................................. 23 V. COLLABORATION WITH 14 .............. . ....................... 26 V'1. RECOMMENDATION o .......o .*..o...**....o.. 26  Page No. ANNES I. Key Economic Indicator Tables ................ ....... 27 II. Status of Bank Group Operations in PNG ...................... 31 III. Supplementary Data Sheet .. ... ...... . ........... ...... 32 IV. Letter of Development Policy ......... ............ 33 V. Policy Hatrix ................*****............... 46 TEXT TABLES Table 1 Recent Economic Developments, 1980-89. 2 Table 2 Impact of Adverse Economic Shocks, 1989-91 4 Table 3 Macroeconomic Adjustment Response 1989-91 5 Table 4 Economic Outlook During Program Period and Medium Term, 1990-99 .............. .13 Table 5 External Financing Requirements and Sources During Program Period, 1990-91. 17  REPORT AND RECOMTKNDAION OF THE PURSIDENT OF THE IITENUMTIONAL IA[ FOV RECOXSTRUCTION AIMD DEVELMOMET TO THE EXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUS!TENT LOAN TO THE INDEPENDENT STATE OF PAPUA VEW GUINEA 1. I submit the following report and recommendation on a proposed structural adjustment loan to the Independent State of Papua New Guinea (PNG) for the equivalent of US$50 million. The proposed loan will have a term of 20 years, including 5 years of grace, and will carry the Bank's standard variable interest rate. 2. An economic report, entitled 'Papua New Guinea: Strategy for Adjustment and Growth' (No. 8518-PNG, dated April 30, 1990) was distributed vo the Executive Directors on May 4, 1990. Annex I gives the main economic indicators of the country. PART I - THE ECONOMY A. Improvement in Economic Performance. 1985-88 3. Papua New Guinea's economic performance was on an improving trend in the second half of the 1980s. Overall economic growth revived sufficiently during 1985-88 to allow some recovery in per capita income following several years of decline (Table 1). It also permitted a pick-up in employment growth. The almost continuous fall in public investment occurring in the first half of the decade was halted and some ground regained. The improvement in performance was the most noticeable in macroeconomic management. Both the fiscal and balance of payments deficits were substantially reduced, inflation was curbed to below 51 p.a., and discipline was restored over external borrowing which was reflected in an improved debt service position. Improved fiscal performance enabled PNG to reduce its reliance on Australian budgetary support. 4. Most of the acceleration of economic growth occurring during this period, however, was on account of increased activity in the mining sector, which has weak linkages with the rest of the economy and a limited capacity to generate employment. Growth in the nonmining economy, the source of income and employment to the bulk of the population, also rose, but modestly. Thus, despite the stronger overall growth, the increase in employment was insufficient to keep unemployment, already high, from rising. An important factor underlying this outcome was the limited progress made in improving the environment for private sector investment. Private nonmineral investment continued to decline in real terms for most of this period. In the absence of broad-based growth, regional income disparities appear to have increased, with areas lacking mineral resources or established treecrop cultivation lagging behind others.  -2- Tabl I: R