SOME 18 months ago, in an article for the Development Policy Centre, I congratulated the Bank of Papua New Guinea (PNG’s central bank) for its constructive stance in stopping the effective printing of money to fund the government's budget deficit.
I noted how this reflected positively on the independence of the bank, an independence built into its charter by former prime minister Sir Mekere Morauta and then central bank governor Sir Wilson Kamit in response to PNG’s last major economic crisis in the late 1990s.
Unfortunately, from the start of 2016, this independent role appears to have been reversed.
Based on the bank’s latest Quarterly Economic Bulletin, PNG appears to have returned to the slippery slope of effectively printing money by back-stopping auctions in government securities.
The bank started buying surplus government securities (that no one in the private market was willing to buy) in September 2014. This continued until March 2015, the end of first phase of effectively printing money.
Over the remainder of 2015, despite increasing cash shortages facing the government, the bank persevered with this policy which helped ensure the government finally started to address its budget problems and reduced the risk of accelerating inflation.
In an extremely worrying trend, the central bank again started purchasing large amounts of government debt from February 2016.
Over the next five months it acquired K1,167.7 million in extra government securities. This is over half (55.3%) of the government's expected budget deficit for the full 12 months of 2016.
Indeed, for the single month of June 2016, the increase was slightly over K704.8 million - the largest monthly increase in the bank’s history.
The data stops in June 2016. Has the situation improved since then or become much worse? I recently asked the bank for updates on the figures but there was no response; the usual government reaction to any of my requests for checking or clarification.
So why is this purchase of government debt a problem? Economic history indicates that a central bank buying surplus government bonds is a slippery path towards overheating the economy and hyper-inflation with all the disastrous impacts for growth and well-being.
This is what happened in Zimbabwe and the Germany Weimar Republic before World War II.
"Hyperinflations are usually caused by large persistent government deficits financed primarily by money creation (rather than taxation or borrowing),” states Wikipedia. “As such, hyperinflation is often associated with wars, their aftermath, socio-political upheavals, or other crises that make it difficult for the government to tax the population.
“A sharp decrease in real tax revenue coupled with a strong need to maintain the status quo, together with an inability or unwillingness to borrow, can lead a country into hyperinflation."
Once started, this near printing of money can be a very addictive habit for any government.
So how is this different from quantitative easing in developed countries such as we have seen in Japan and the United States.
First, there are few inflationary risks in these countries – in fact there have been fears in Japan and the US of deflation prior to introducing the policies. PNG's inflation rate has already started creeping up even though its managed depreciation has now stopped.
Second, the quantitative easing policies in the US were directed at restoring private sector economic growth by increasing the level of credit in the banking system – not simply financing a government budget deficit.
Government spending may also be important for growth, but that depends on the quality of the spending. For PNG, recent budgets have seen massive cutbacks in key sectors such as infrastructure and longer-term social investment spending in health and education programs.
The biggest areas of government expenditure growth have been in interest costs, government administration and political constituency funds – none of which could be seen as pro-growth spending.
Third, developed countries have used quantitative easing as a transparent measure designed to build economic confidence. In the case of PNG, this appears to be a policy done by stealth. I can find no comment on the public record about this change of approach since February 2016.
Fourth, there is no known exit strategy. The return to a government surplus keeps getting pushed back. The lack of transparency inevitably raises fears.
Finally, PNG does not have the offsetting policies that can help minimise the damage to macro-economic stability from this quantitative easing. Specifically, it no longer has a market-related flexible exchange rate and there is no clear wages policy.
The central bank appears to have moved PNG's economy back onto a slippery slope of effectively printing money.
Providing a blank cheque to the government also squeezes out the private sector in such important areas as getting access to foreign exchange.
Alternative financing options for the government's deficit over recent years have not gone well - and the full costs of the Credit Suisse loan are unknown.
Even minor attempts to increase tax in the 2017 budget appear at risk due to political pressures. Expenditure cuts have been too severe and in the wrong areas.
If there is a change of government in mid-2017, much work will be required to restore PNG's economic credibility.