PAPUA NEW GUINEA’s much-discussed K6 billion loan from China raises a number of concerns.
The first is about the terms of the loan: that is, the interest rate, the repayment time and the political terms - what sort of international support does China expect from PNG?
Remember, there is no free lunch, ever! With or without concessions there will be a quid pro quo.
Secondly, the loan is very large for PNG, being 25% of current GDP.
So in one fell swoop it adds 25% to PNG's debt-GDP ratio.
This is not necessarily of concern as PNG's debt-GDP ratio is low and forecast growth is high, meaning that debt dynamics are likely to be stable. This can be seen from the recent upgrade in PNG’s debt rating.
Thirdly, what does the government plan to do with the money: why K6 billion?
As an alternative the government could sell government bonds to raise funds from domestic and international savers. If they were to raise capital this way how much would they borrow?
Although the terms would not be as good as the Chinese are offering, it gives perspective to the purpose of government borrowing.
Fourth, PNG lacks the administrative capacity to administer the loan, and also lacks the skilled labour for the projects that the funds might be directed towards.
The leads to waste (apart from the corrupt diversion of funds) as salaries for current skilled workers are pushed up without any necessary increase in output unless skilled overseas workers are hired.
Contrary to the general negative views about overseas skilled labour, it is a necessary part of development.
Fifth, the Dutch Disease - yes, even a large loan can cause it. The Chinese will disburse the loan in yuan, which will be converted to kina. This will cause the kina to appreciate at a rate dependent on how quickly the loan is brought onshore.
If the Bank of PNG prevents the kina from appreciating, then the money supply will increase which will eventually lead to inflation (unless they sterilise this effect by selling bonds).
Either way, it makes all export sectors less competitive because the real exchange rate rises.
This particular point is also relevant to the LNG project - how is BPNG going to respond to the inflow of foreign exchange from LNG? As yet I have heard nothing of their proposed strategy.
Sixth, the rate of return on infrastructure investment in developing countries is very high. This is also true for education. If directed to the right places and adequate international skill is hired, the loan could achieve returns that are significantly higher than the interest rate on the loan. Chances of this happening are probably pretty low.
Finally, if it all ends up badly in 20 years, and PNG can't repay, we can always default. This is actually an acceptable option for developing countries (and even developed ones).
Default means that the Chinese government loses (not domestic savers) and international capital markets usually forgive eventually (allow for a couple of political cycles, or the entry of a very credible government).
Although one does not want to go into the agreement with this intention, if necessary it is a valid escape route.
PNG Attitude generally does not publish anonymous articles and rarely publishes where it does not know the author’s identity. In this case, because of the quality of the discussion, we have made an exception