PNG Economy –

Impact on Forex,

Business & Investments

CPA PNG Conference - Lae

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Zanie Theron, KPMG Managing Partner 24 August 2017

Contents

Setting the context

What are we seeing? 4

Trade Balance Snapshot (2016 + ) 6

Key Highlights of the Papua New Guinea Kina (PGK) 8

Controls placed on Foreign exchange 9

Forex – Burdening the PNG Financial & Investment Environment 10

Forex Impact on PNG Business – The Good and The Bad 11

Impact on Investments 16

Questions and Conclusion 22

Setting the Context

Global GDP Growth

Source: World Bank, June 2016

Global GDP between 2013 and 2016 (Forecast) has been relatively flat around the 2.5% growth mark and is forecast to reach the 3% growth mark in

2018. Advanced Economies GDP Growth experienced a low-high-low-high between 2013 and 2016 before it is forecast to flatten at circa 1.8% in 2017.

Growth for Emerging Markets and Developing Economies is estimated to dip in 2015 before recovering and returning to above 4.5% in 2018.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

2013 2014 2015E 2016F 2017F 2018F

World Bank - Global GDP Growth (Real)

World Advanced Economies Emerging Markets and Developing Economies

PNG GDP by Economic Activity

Source: PNG Treasury

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0 1,000 2,000 3,000 4,000 5,000

Agriculture, forestry & fishing

Oil & gas extraction

Mining & quarrying

Manufacturing

Electricity, gas & water

Construction

Wholesale & retail trade

Transport, storage & communication

Finance, real estate & business services

Community, social & personal services

GDP by Economic Activity at Current and Constant Prices (PGK Millions)

2015E 2016P 2017P

CAGR

2015 - 2017

3.57%

1.43%

9.43%

4.00%

4.49%

3.25%

4.00%

4.00%

3.00%

3.50%

Source: PNG Treasury and Bank of PNG

PNG GDP and GDP Growth

According to BPNG real GDP growth is expected to be 2.3% for 2017 driven by activity in the

non-minerals sector and infrastructure development.

0%

2%

4%

6%

8%

10%

12%

14%

0

5

10

15

20

25

2011 2012 2013 2014 2015 2016 2017 2018 2019

Gro

wth

in G

DP

(%) G

DP

(P

GK

Mill

ion)

PGK Millions Year-on-Year Growth (%)

Source: Bank of PNG

Consumer Price Indices - Inflation

Headline inflation outcomes have been at manageable levels, averaging 6.0% percent for 2015 despite

the declining Kina. Headline inflation is predicted to be 7.5 percent in 2017

-4%

-2%

0%

2%

4%

6%

8%

10%

2011 2012 2013 2014 2015 2016P 2017P 2018P

CP

I (a

nnual %

change)

Headline inflation (CPI) Trimmed-mean Exclusion-based

Kina Exchange Rate

Source: Oanda – June 2016

The Kina continued to depreciate against the US$ due to the continued imbalance in the foreign

exchange market. The increase against the AUD is more of AUD/USD weakness and this has now

retreated.

0.25

0.30

0.35

0.40

0.45

0.50

0.55

Jul-1

1

Se

p-1

1

Nov-1

1

Jan

-12

Ma

r-12

Ma

y-1

2

Jul-1

2

Se

p-1

2

Nov-1

2

Jan

-13

Ma

r-13

Ma

y-1

3

Jul-1

3

Se

p-1

3

Nov-1

3

Jan

-14

Ma

r-14

Ma

y-1

4

Jul-1

4

Se

p-1

4

Nov-1

4

Jan

-15

Ma

r-15

Ma

y-1

5

Jul-1

5

Se

p-1

5

Nov-1

5

Jan

-16

Ma

r-16

Ma

y-1

6

FX Movements PGK:USD and PGK:AUD for last 5 years

PGK/USD PGK/AUD

Global Commodity Prices

Source: EIU forecasting service (August 2012)

Prices of main PNG export commodities

2011A 2012A 2013A 2014A 2015A 2016P 2017P 2018P

(Kina per tonne fob, unless otherwise specified)

Agriculture

Copra 1,619 1,044 835 975 1,088 1,128 1,128 1,128

Cocoa 6,895 4,759 5,321 7,344 8,320 8,791 8,632 8,321

Coffee 12,622 8,622 6,940 10,970 9,314 9,068 9,412 9,773

Palm Oil 2,590 2,091 1,854 1,972 1,657 1,641 1,675 1,556

Rubber 9,720 6,633 5,704 4,390 4,402 4,963 4,353 3,967

Tea 3,478 3,161 3,585 3,529 5,907 6,897 6,897 6,897

Copra Oil 3,847 2,604 1,814 2,119 2,362 2,450 2,450 2,450

Logs (K/m³) 233 188 211 214 207 221 221 221

Minerals

Gold (US$/oz) 1,517.9 1,658.4 1,368.3 1,133.0 1,147.6 1,044.6 1,247.2 1,238.5

Copper (US$/pound) 408.2 360.1 332.8 296.4 262.4 224.9 260.0 300.0

Oil (Kutubu Crude: US$/Barrel) 117.5 114.8 109.5 98.6 51.6 33.0 35.3 39.1

LNG (US$/000 mmbtu) 14.0 9.7 8.3 8.4 8.5

Condensate (US$/Barrel) 86.8 51.0 32.0 35.0 38.0

Nickel (US$/tonne) 17,542.0 11,998.8 18,885.3 11,568.9 8,572.6 8,701.2 8,805.6

Cobalt (US$/tonne) 28,761.0 30,000.0 23,855.9 28,178.0 22,288.8 22,288.8 22,288.8

Source: PNG Dept of Treasury (National Budget) and Bank of PNG (MPS)

Impact

“ The Papua New Guinea Economy is gradually stabilising as it adjusts to the impact of the PNG LNG Project…. But there are financial stresses “

– David James, Business Advantage

KPMG Papua New Guinea is associated with KPMG Australia, a member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“ KPMG International” ), a Swiss entity.

• History of boom and bust

• Relatively small economy with some giant levers that impact it

• Where are we now in the cycle

• What are the levers? • Resources sector: upcoming and existing projects

• Tax breaks

• Foreign debt in place

• Budget deficit

• CPI vs GDP growth

• High unemployment rate

• Banking covenants under pressure

• Working harder for less revenue

• Decreases in profitability

• Staff rationalisation

• Reluctance to offer permanent roles – flexible workforce

• The past does not determine the future – business is changing

• “Traditional” PNG business model is not sustainable

• A new model: younger, dynamic, technology-driven, smarter – raising the bar

• MNCs building up cash – this changes their strategies

• Budget deficit continues. Update: there is USD300m about to be lent by ADB as budget support (specifically in health) although how this will be utilized and how this impacts on the FX situation is not completely clear at this stage

What are we seeing?

Key Highlights of the PNG Economy 2016 & 2017

2.5% Budget Deficit w.r.t. Nominal

GDP*

K5,25bn 2016 - Gross Foreign Exchange

Reserve*

2.8% Real Economic Growth*

*Source: Bank of PNG & Business Advantage for 2017

The capital and financial account is projected to be in a deficit of K11,7bn in 2017

The Bank of PNG adds that if ‘any of the major projects in the mining and LNG sectors advance to development stage over the coming two years, the capital and financial account will turn into surplus.’

It is projected that the level of foreign exchange reserves will be US$2,106.6 (K6.6bn) at the end of 2017

The Bank continues to use its reserves to intervene heavily in the level of the currency using K1.35bn in 2016 for this purpose

In 2016, the currency fell slightly against the greenback, from US$0.3325 to US$0.3150. It has only slightly weakened since then

To ease budgetary pressures, the authorities floated plans in June to raise $1bn on the international bond market; however, due to a lack of investor interest this did not go ahead.

It was hoped that the debt issuance would help bridge the 2016 deficit and inject liquidity into the economy.

6.4% 2016 Inflation*

The PNG Economy is gradually stabilising as it adjusts to the impact of the PNG LNG project

PNG’s exports have risen, causing a current account surplus, BUT money continues to flow out, causing a financial account deficit

Trade Balance Snapshot (2016 + )

Negative: Due to outflows from ongoing debt servicing by the PNG LNG Project Capital and Financial Account is projected to be in a deficit of K11,7bn in 2017.*

Positive: Bank of PNG reports that the current account is in surplus, largely because of LNG exports.*

Expectation: This trend is expected to continue in 2018 and 2019.

Source: Bank of PNG & Business Advantage

Balance of Payments in K ’Million *

Impact

Forex and the PGK Currency

Forex – Burdening the PNG Financial & Investment Environment?

• The current state of the economy affects the investment and financial activities in Papua New Guinea in many ways.

• One major factor that impedes the progress of further development and strengthening of the corporate environment in PNG is the rationing and displacement of Foreign Exchange (Forex)

• Since most MNCs present are unable to dynamically trade their Forex, it causes an environment distracting from potential Foreign Investment and to Global trade in general

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Key Highlights of the Papua New Guinea Kina (PGK) over the years

After appreciating roughly 90% against the US dollar between 2002 and 2012, the Kina

depreciated 18% against the USD over 2013 and a further 6% since then. Over the

same 10 year period, the Kina appreciated roughly 16% against the AUD.

The general strengthening of the Kina over the last decade can be attributed to the

significant inflows from financing PNG LNG construction, and strong demand for

commodities.

Between 2010 and 2012, FX supply was abundant due to inflows associated with the

PNG LNG project and strong commodity prices, leading to the rapid appreciation of

the Kina.

This upswing reversed in 2013, as FDI inflows declined and commodity prices fell and

the Kina started to depreciate.

The BPNG sought to slow the Kina depreciation through its FX sales in the interbank

market.

However, FX supply continued to tighten since 2013 as major disruptions to mining

operations and cash crop exports reduced FX earnings.

Controls placed on Foreign exchange

*Source: ANZ PNG, Kina Funds Management Research & Business Advantage

We see the below key factors that have led to the current state of PNG’s Foreign Exchange

About K3.3 bn in foreign currency orders with PNG-based commercial banks was awaiting processing. As follows as at yesterday: BSP – K1.5bn, ANZ K1.3bn, Westpac K500m. All due to limited FX coming in from Ok Tedi, Exxon and Oilsearch (all are sitting on large Kina balances now apparently). Further the coffee crop this season was incredibly poor.

Banks are coping with this situation by maintaining a dialogue with customers to ensure that critical payments are prioritised where possible.

The currency has moved from 0.42 in May 2017 against the AUD to 0.39 today. It has remained reasonable stable against the USD at 0.3 this year, with a short-lived high of 0.31 in March 2017.

Without returning to a more competitive position, there will be continuing pressures on PNG’s balance of payments and foreign exchange reserves.

Bankers and analysts say if the trading band were to be totally removed, there would be ‘a significant fall’ in the currency .

PNG Kina will move to a downward momentum in relation to the US$ and will fluctuate in relation to other foreign currencies over the next six months, - Kina Funds Management Research

Back Orders and ‘rationing’

Kina Movements

Downward Trend

Forex Impact on PNG Business – The Good and The Bad

The Good

“ Excess kina liquidity may open up opportunities for local companies in Papua New Guinea ”

-Business Advantage, May 2017

The difficulty in getting foreign exchange is making goods made in Papua New Guinea more attractive

The Kina Investment Outlook for May says ‘a large amount of funds are held “captive” within PNG, resulting in a very liquid financial system.’

‘Extra liquidity in the market ‘is sufficient to drive domestic investments, and agriculture seems to be a strong contender for this.’

‘Long term interest rates are likely to gradually increase and short term rates will stabilise over the next six to 12 months as a consequence of continued foreign exchange supply issues,’ the report says.

*Source: Business Advantage

KPMG Papua New Guinea is associated with KPMG Australia, a member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“ KPMG International” ), a Swiss entity.

“ We have clients who don’t want to go through the hassle of getting the foreign exchange.. ‘They know when they come to our company they can pay for their product in PNG kina. ”

- Frank McQuoid, Chairman of steel fabricator, Steel Industries.

The Good – “ Business Talk ”

“ My competition from Fiji you hardly see on the shelves now. ” - Ernestine Maxtone-Graham, founder of MaxtoneHaus

“ People are making saveloys in PNG. We have five new indigenous manufacturers located throughout the Highlands. That is someth ing we have never really had before: people taking value-added and manufacturing industries of a significant scale into the heartland where people are. It is really positive. ”

-Chey Scovell, Chief Executive of the Manufacturers Council of PNG

*Source: Business Advantage, EMTv

KPMG Papua New Guinea is associated with KPMG Australia, a member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“ KPMG International” ), a Swiss entity.

Impact

‘The supply and availability of hard currency still remains the major issue in our market.’ -David Kelso, MoniPlus MD

The Bad

“ Banks continue to see a build-up of FX orders with very little levels of activity and continued shortages of FX supply which in turn affect importers. ”

-Kina Funds Management Research

PNG’s foreign currency situation is affecting the ability of businesses to purchase goods and services from Australia, compelling some companies to extend credit to their subsidiaries or delay purchases.

Long and increasing delays in accessing foreign exchange by importers are causing costly disruptions to business activities, which highlights the need to improve the foreign exchange allocation mechanism to ‘rectify’ the foreign exchange market imbalance.

When small PNG businesses can no longer open foreign exchange accounts (due to the Vostro account review which is now being audited but has not yet been completed), this ultimately also hurts sustainable growth.’

*Source: World Bank, Business Advantage

Companies that do have foreign exchange exposure certainly have reason to be wary. The Kina Securities report anticipates ‘ongoing depreciation’ of the kina against the US dollar.

Company earnings are also expected to be depressed because of the subdued economic activity.

‘Earnings results from companies in discretionary consumption industries have been particularly impacted by the foreign exchange

shortage issues,’

KPMG Papua New Guinea is associated with KPMG Australia, a member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“ KPMG International” ), a Swiss entity.

Impact on Investments

Investment observations

• Foreign investors can’t repatriate funds

• Tax incentives

• Due to the investment hurdles IRR needs to be higher

• For all business valuations a country risk of 30% is applied

• Land acquisition

• FX needs for construction

• Local ownership requirement – uncertainty

• A lot of liquidity in the market – banks are not necessarily taking deposits

• Opportunity for local investors?

Looking at SMEs

• March 2016 SME policy with ambitious goals for 2030 • Increase SME contribution to GDP from 6% to 50% by 2030 • Grow the number of SMEs from 49,500 to 500,000 • Reduce unemployment from 84% to 49% • Increase per capita income from US$2,000 to $US9,600

• Significant opportunity • Expanded commercialization of agriculture • Providing products and services to the resources sector • Servicing the governments development agenda

• Growing beyond a small enterprise

• Access to finance

• A defined strategy

• Robust forecasting, budgeting and reporting

Current PNG incentives for investing

1. 10 year exemption from income tax for new businesses in designated rural development areas

There are 41 rural development areas for example Bogia in Madang Province and Wabag in Enga Province.

The venture must not be dependant on natural resources for its development (areas covered by Petroleum Development Licenses or Special Mining Leases are excluded)

Prescribed industries include agriculture, construction, hotels, restaurants and manufacturing.

2. Export Incentives – 7 year tax exemption period

Export profits for the first 4 years are exempt

Profits of any increase in export sales over the average for the first three years are also exempt

Exports must be new manufactured products, including canned foods, confectionery, dairy products, glass products, paper products, wooden furniture components and doors, and must be exported by the manufacturer.

3. Accelerated Depreciation 100% deduction available for the capital cost of:

Industrial plants not previously used in PNG, with an effective life exceeding 5 years and used in a manufacturing process (includes buildings and structural improvements for the housing of manufacturing plant, component parts and the finished product).

Plant or articles used directly for the purposes of agricultural production (includes vehicles)

Plant or articles used by residents solely of commercial fishing purposes

Boats or ships (including ancillary equipment) used by accredited scuba diving or snorkeling tour operators

Impact on Investments

FDI inflows in Papua New Guinea have experienced a slight slowdown since 2012 due to the conclusion of a major liquefied natural gas project (LNG - construction of a 400 km pipeline), which was finished in September 2014.

Divestments outpaced investments in 2016, resulting in a negative FDI flow of USD 39.6 million (UNCTAD). The current FDI stock reached USD 4.2 billion. The mining, oil and gas sectors attract most of the FDI.

FDI remain weak compared to the country’s potential due to lack of equipment, the State's monopolies, political instability and insecurity.

The law does not permit direct foreign ownership of land, and investment in several sectors is restricted.

The judicial framework is inadequately resourced and underdeveloped.

Pervasive corruption and nepotism are the biggest hindrances to development.

Papua New Guinea ranks 119th out of 190 countries in the classification ’Doing Business 2017’ issued by the World Bank, moving up fourteen positions in one year.

*Source: World Bank, Business Advantage

Impact on Investments contd.

French energy giant Total told in April 2016 it intended to proceed with the establishment of a major gas extraction, processing and export project.

The plant – dubbed Papua Liquefied Natural Gas – has an expected production capacity of 7m tonnes per annum, with investment estimated at around USD 10 billion.

ExxonMobil is also planning to expand the output and export capacity at its joint venture PNG LNG facility. The operator is considering a proposal to add a third processing train, a project valued at USD 9 billion.

As mentioned one consequence of the high levels of liquidity may be a greater availability of capital for local companies to invest.

CFOs of major MNCs in PNG are holding the funds back in the event that if the value of the kina drops the firm will end up expending more.

High levels of kina liquidity are unlikely to affect the level of the stock market, according to analysts.

The Standard & Poor’s report says PNG’s equity markets ‘remain underdeveloped and lack the degree of participation by both households and corporates typically observed in developed markets.’

*Source: World Bank, Business Advantage

With vast reserves of natural resources, Papua New Guinea is well positioned to benefit from its proximity to rapidly growing Asian markets. Its young, diverse and growing population presents significant opportunity, but where is growth in the country

expected to come from, and is it sustainable?

- Credit Suisse, March 2017

What is the answer?

• Curbing the flow of unknown fund repatriation

• Tax reform – broadening tax base

• Investment in social infrastructure, law – quality of life

• Connectivity

• Different types of businesses

• Broad-based SME – local business owners

• What is my response as a CPA? Also what is our firm doing?

Questions?

The contacts at KPMG in connection with this

Presentation is:

Zanie Theron, Advisory, Partner

Tel: +675 321 2022 ztheron@kpmg.com.au