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The costs and benefits of borrowing from China

PNG Reflection

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

Comments

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Tony Flynn

I saw a great phrase on my web surfing: "Knowingly entering voluntary servitude".

It was to do with becoming indebted in a big way. Would this apply to the K6 billion loan from China?

I believe that all agree that we do not have the capacity to get the cash and do the job. We suffer from lack of capacity at all levels; the situation we are in is a failure of successive governments.

All of them have neglected maintenance of the fabric of our country preferring to embrace any project that has lots of kudos.

Humdrum maintenance of roads, bridges, schools, hospitals, housing etc. have little to interest our politicians.

This Chinese money will go to Chinese contractors, Chinese machinery and Chinese skilled labour. We will again be suppliers of cheap labour and at the end we will be very little better off in terms of work capacity than we are today.

We have to accept this loan and make the best of it; do not forget that this unenviable position is the bequest of our previous governments.

Bernard Yegiora

A good economic analysis of the loan.

China is an alternative that all nations will use in the years to come.

It is a trend that we cannot stop.

Alex Harris

But what would be the consequences of default?

It is not your mum and dad loaning the money here; not Australia, nor the IMF - all with a history far more benevolent than China.

What would be the actions of a disgruntled China should PNG default?

What pledges of security has the PNG government made in the event of default?

The Chinese government does not like to lose.

Given the extraordinary tussle currently between China and Japan over a few barren islands that has the very real possibility of leading ridiculously to war, I can't help but think 'an island of gold in a sea of oil' will be in for a great deal more than the suggested debt forgiveness.

If China was not so obdurate in matters of territory, I might feel differently.

In addition, the Chinese ExIm Bank has a history of funding foreign projects on the proviso that Chinese labour is employed - much of it unskilled. This would be disastrous for PNG.

It is important PNG and China learn from the mistakes of MCC in Madang Province (I'm sure MCC has). Other Chinese companies would be served well to study the history of the Ramu project.

Any PNG government that allows masses of foreign labour into the country will be setting the country up for bikpela mess.

I agree, foreign skilled labour is essential, but so is training. Sending a half-dozen bright students to university in Beijing doesn't cut it.

All of the planned infrastructure projects need to establish sound training schemes to train and employ thousands and thousands of PNG people, or they will end up being nothing more than monuments to foreign capital for the benefit of foreign companies only, and not for the benefit of the nation as a whole.

To suggest otherwise is to ignore history and relegate the people of PNG to poverty in perpetuity.

Mrs Barbara Short

I feel that the lack of an "administrative capacity to administer the loan" is a key factor, and also there may be a problem with the skilled labour.

Hopefully, someone is right now doing something about improving this "administrative capacity" and introducing courses to supply the skilled labour required in the capital investment.

I would imagine that there is a lot of preparation taking place in PNG for the handling and application of this loan even before the loan is a certainty.

Jeff Febi

Nicely explained in simple terms and makes reading this article such a wonderful read.

I hope all money borrowed would be used wisely.

I agree PNG needs to bring in foreign labour and may be foreign contractors to work in order to ensure real work is done and we see tangible results in the end.

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