Can gold ease Papua New Guinea's foreign exchange pressures as Covid-19 pandemic disrupts inflows?
Papua New Guinea’s foreign currency reserves are being put under renewed pressure by the coronavirus pandemic, but there is hope that gold exports could partially offset falling prices and lower demand in other commodities markets.
The Pacific Island nation initially entered a two-week state of emergency on March 24, shortly after its first Covid-19 case was detected. During this time, international flights were suspended, movement between provinces was prohibited, schools were closed and all non-essential workers were ordered to stay at home.
Although the state of emergency was later extended until the end of May, certain measures have been relaxed: schools and tertiary education institutions have been cleared to resume classes and domestic flights permitted to begin operations again. Public transport is expected to resume in the coming days under Covid-19 health protocols.
Prime Minister James Marape’s decision to prolong the state of emergency was informed by concerns that the country’s health care infrastructure would struggle to cope with large numbers of Covid-19 patients.
As of April 23, PNG has officially recorded eight local Covid-19 cases and no deaths; by comparison, its smaller neighbours Fiji and New Caledonia have each registered 18 cases.
With a population of approximately 8.9m, PNG currently has capacity to conduct around 900 Covid-19 tests a day. Testing and contact tracing efforts have been mainly focused on the provinces with confirmed cases: East New Britain, National Capital District and Western Provinces.
Disruption to the global economy is impacting on PNG’s extractive exports and foreign exchange (FX) reserves.
In 2019 the extractive industries contributed approximately 28% of PNG’s GDP and were responsible for 94% of exports, mostly as a result of liquefied natural gas (LNG) and gold shipments. This means general FX flows are primarily linked to commodity markets, all of which are currently in negative territory - with the exception of gold.
Difficulties in sourcing FX have been an issue in the country since long before Covid-19.
Respondents to OBG’s CEO surveys in the country have consistently cited foreign currency shortages as the biggest impediment to doing business in PNG, indicating that they add to business administration costs and cause delays in paying foreign suppliers, while also undermining productivity and long-term corporate planning.
The issue dates back to 2014, when the central bank imposed a trading band for the kina. This was an effort to prevent further slides in value caused by the completion of the construction phase of the $19bn PNG LNG project, alongside a slump in commodity prices.
However, the situation seemed to be improving before the Covid-19 outbreak, thanks to the combination of a maiden $500bn sovereign bond issuance in 2018; concessional loans from development banks and bilateral partners; improved performance in extractive exports; and targeted interventions by the central bank.
Speaking to local media on April 21, central bank governor Loi Bakani said the country had FX reserves of around PGK6.9bn ($2bn), equivalent to 9.3 months of non-mining import cover and 5.4 months of total import cover.
He added that the central bank would intervene in the FX market to ensure health care institutions and related businesses on the Covid-19 frontline could meet their import needs.
“Careful management of our reserves will see FX supplies into the market continue on a regular basis, but care will need to be taken to ensure demand needs are met whilst not running down reserves, especially give the increased demand for Covid-19-specific responses, a priority that was not envisaged just weeks ago,” Deepak Gupta, executive general manager, business partners and wealth, Kina Bank, told OBG.
“Through various state-owned entities, PNG has built up large FX balances that are held overseas. Although they are not necessarily needed at this point in time, it would be worthwhile looking at bringing them back onshore as part of the FX toolkit, to be used should conditions worsen or extend for a longer period,” he added.
To help fund immediate Covid-19 response measures, PNG is looking to tap donor countries and multilateral institutions, for example by sourcing PGK1bn ($291m) from the IMF under a rapid credit facility.
Some argue that a long-term solution for the FX shortage is to devalue the kina. The IMF recently indicated that the currency could be overvalued by 11-18%.
Devaluation should make PNG's exports more attractive while simultaneously incentivising local industry to fill the gaps created by the higher cost of imports - both of which would boost foreign exchange reserves.
Jonathan Seeto, Managing Partner at PwC Papua New Guinea, felt that while there was merit in an ongoing discussion around devaluation, the current climate of uncertainty was not suited to a sudden devaluation as exports and local production were unlikely to increase quickly enough to offset the adverse effects on the costs of business.
"Without intervention by the central bank, there is the risk that any commodity shocks - and now the shocks arising from the global pandemic - could introduce even greater volatility, uncertainty and instability into an already fragile environment," Seeto told OBG.
Gold is seen as a safe option for investors looking to hedge against uncertainty in equity and currency markets, and there is thus some hope that PNG’s plentiful gold mining reserves could partly offset declines in other commodity exports.
PNG is the world’s 14th-largest gold producer, and the precious metal accounted for almost 77% of the mining sector’s export revenues in the first half of 2019. Major active mines include Lihir (gold), OK Tedi (gold, copper and silver) and Porgera (gold and silver).
Although prices of copper, PNG’s second-most-valuable mining export product, have fallen significantly since December 2019, gold prices have steadily risen to above $1700 per ounce.
Bank of America has projected that the price could go as high as $3000 per ounce within 18 months, while Swiss investment bank UBS has forecast prices of around $1800 per ounce in the short term.
Mining companies have maintained operations in PNG, accompanied by the implementation of new hygiene and social distancing measures and the preparation of medical response facilities. They have also made roster adjustments to reduce fatigue and cover for the usual fly-in, fly-out portion of the workforce.
Emphasising that the situation changes daily, Peter Graham, managing director and CEO of OK Tedi Mining, remained hopeful that increases in gold revenues could offset declines in copper.
“Assuming Covid-19 does not cause production to be shut down, I expect that FX inflows from mining should not change significantly in 2020, given the balance of gold and copper production,” Graham told OBG.
Looking ahead, the government's development strategy is focused on maximising returns from the country's mining and energy reserves to boost foreign exchange earnings, promote inclusive growth, and diversify the economy away from dependence on extractive revenues.
To this end, there are high hopes for the joint venture between Harmony Gold and Newcrest Mining, which seeks to develop the estimated reserves of 13m ounces of gold and 4.4m tonnes of copper at the Wafi-Golpu mine. Capital expenditure over the life cycle of the mine is projected to be $5.4bn.
Although discussions on permits and benefit sharing have yet to be finalised, the project should provide another reliable source of FX if it is cleared to enter the development phase.