Overview of Foreign Exchange issues in Papua New Guinea by Mr. Rowan Rupa & Mr. Wilson Onea BANK OF PAPUA NEW GUINEA.

Overview of Foreign Overview of Foreign Exchange issues in Exchange issues in Papua New Guinea Papua New Guinea

byby Mr. Rowan Rupa & Mr. Wilson Onea

BANK OF PAPUA NEW GUINEA

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HISTORY OF KINAHISTORY OF KINA►1975 - - INDEPENDENCE - “HARD KINA POLICY”

►1976 - PEGGED TO AUSTRALIAN DOLLARSEVERAL REVALUATIONS

►1978 TO 1988 - PEGGED AGAINST IMPORTED WEIGHTED BASKET OF CURRENCIESTO AUD DOLLAR

►1988 TO 1994 - PEGGED AGAINST A TRADE WEIGHTEDBASKET OF CURRENCIES.

►1994 TO 2010 - KINA FLOATED(10th October 1994,Kina floated following devaluation of kina by 12.0% on the 12th September 1994)

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TRANSITION TO TRANSITION TO FLOATING REGIMEFLOATING REGIME

♦ REASONS FOR TRANSITION

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► IMPRUDENT FISCAL MANAGEMENT

► RECOURSE TO DOMESTIC FINANCING

► OIL PRICE SHOCK

► ACCOMMODATIVE MONETARY POLICY

► LOW RESERVES LEVELS

► BOUGAINVILLE CRISIS

► THE TRANSITION FROM FIXED ER REGIME TO FLOATING ER REGIME IS A SENSITIVE ISSUE AND BPNG HAS TO MAINTAIN UTMOST CARE, DISCRETION AND MAINTAINENCE OF PUBLIC CONFIDENCE

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THE FLOATING THE FLOATING EXCHANGE RATES EXCHANGE RATES REGIMEREGIME

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► VALUE OF KINA DETERMINED BY DEMAND AND SUPPLY CONDITIONS OF THE MARKET

► EXCESS SUPPLY - TENDENCY FOR KINA APPRECIATION

(EXPORTERS)

► EXCESS DEMAND - TENDENCY TO DEPRECIATE

► EQUILIBRUM RATE IS WHEN DEMAND AND SUPPLY CONDITIONS MEET

► KINA IS AUTOMATICALLY ADJUSTED

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MARKET MARKET INFRASTRUCTURE & INFRASTRUCTURE & TRADINGTRADING

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► OPEN CRY AUCTION WAS ABOLISHED IN AUGUST 1995

► SCREEN BASED SYSTEM INTRODUCED. BID AND OFFERS ARE PLACED ON REUTERS SCREEN

► BPNG TAKES THE ROLE AS A BROKER

► DEDICATED LINES STRAIGHT TO DEALING ROOMS

► RECENTLY INTRODUCTION OF A STRAIGHT THROUGH PROCESS UNDER THE NEW RESERVES MANAGEMENT

SYSTEM ( DEALING TO SETTLEMENTS)

► CURRENCY QUOTED IS PGK/USD.

► BANKS CAN MATCH OTHER CURRENCIES DEMAND AND SUPPLY IN THEIR OWN BOOKS. THIS IS REFERRED TO AS INHOUSE TRADES.

► WHEN BANKS CANNOT MATCH ORDERS INHOUSE, THEY PLACE THEIR ORDERS IN THE MARKET. THIS IS REFERRED TO AS THE INTERBANK TRADING .

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BANK OF PNG ROLE IN THE BANK OF PNG ROLE IN THE FOREIGN EXCHANGE FOREIGN EXCHANGE MARKETMARKET

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► BROKER

► OPEN MARKET OPERATION THROUGH ITS INTERVENTIONS

‘BANK OF PNG INTERVENES TO MAINTAIN PRICE STABILITY (ER…INFLATION)…MAINTAINS A SMOOTH TRANSITION OF THE “TREND EXCHANGE RATE’

► REGULATOR AND SUPERVISOR

► “LENDER OF LAST RESORT” … SUPPLIER OF DOLLARS / KINA

► THE GOVERNOR IS SOLELY RESPONSIBLE FOR INTERVENTIONS IN THE FOREIGN EXCHANGEMARKET

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TOOLS THAT GUIDE BPNG’S TOOLS THAT GUIDE BPNG’S INTERVENTIONINTERVENTION

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► OPEN POSITION OF BANKS DAILY (SYSTEM LIQUIDITY)

► KINA TRADE WEIGHTED INDEX ( DIRECTION)

► EXCHANGE RATES PRESSURE INDEX (OUT LOOK)

► EXCHANGE SETTLEMENT ACCOUNTS (SETTLEMENTS)

► RESERVE LEVELS (FUNDING)

► OTHER DEVELOPMENTS REPORTED BY BANKS (FLOWS)

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REGULATION OF FOREIGN REGULATION OF FOREIGN EXCHANGE MARKETEXCHANGE MARKET

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► BANKS AND FINANCIAL INSTITUTION ACT (2000)

► LISCENSING CONDITIONS

-Corresponding banks, dealing rooms, Fit and proper Test

► PRUDENTIAL LIMITS

-10% OF CAPITAL BASE ON SINGLE CURRENCY

-15% OF CAPITAL BASE ON OVERALL CURRENCY POSITION

► PENALTIES

► INFORMATION DISCLOSURE

►

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CHALLENGES OF MANAGING A CHALLENGES OF MANAGING A FLOATING EXCHANGE RATESFLOATING EXCHANGE RATES

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► SEASONALITY AND CYLICAL FLOWS

-Market imbalance between exporter and importer flows leads to uncertainty in short term policy direction

-Mineral taxes receipt are received quarterly (April,July,October)

-Demand for foreign currency driven by Consumption for goods and material inputs (esp Petroleum)

-Needs close scrutiny and open dialogue with real sector.

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CHALLENGES OF MANAGING A CHALLENGES OF MANAGING A FLOATING EXCHANGE RATESFLOATING EXCHANGE RATES

► MARKET STRUCTURE & LEGISLATION

-Bank are Deposit taking institution and under the Central Banking Act can clear their FX transaction with each other using the Exchange Settlement Account with BPNG.

-Other Non Banks participating in the FX market cannot clear or settle funds using the Exchange Settlement

-A special clearing account is made available for them with special rule.

-Needs a new automated clearing system to supplement high value transaction in the foreign exchange market

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CHALLENGES OF MANAGING A CHALLENGES OF MANAGING A FLOATING EXCHANGE RATESFLOATING EXCHANGE RATES

► MONETARY POLICY & FISCAL POLICY

-The most important ingredient in managing FX in a floating regime is synchronizing fiscal policy with monetary policy

-Political pressure to spend leads to fiscal slippages and increased liquidity in the banking system….inflation

-Compels Central Bank to intervene and issue new bills and ease pressure on the kina and sterilizes liquidity

Alternatively,

Fiscal surplus leads to loan repayment & Debt restructure….liquidity shrinks… BPNG intervenes

Needs close liaison and dialogue with Department of Treasury

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CHALLENGES OF MANAGING A CHALLENGES OF MANAGING A FLOATING EXCHANGE RATESFLOATING EXCHANGE RATES

MARKET SIZE AND PARTICIPANTS

>The are only five licensed foreign exchange dealers

>All have internal limits less than the prudential limits. This create liquidity problem in the market.

>The size of the market is small. Banks therefore use information to price aggressively or to price to the disadvantage of the competitor.

> Challenge is to tighten market rules and broaden market.

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CHALLENGES OF MANAGING A CHALLENGES OF MANAGING A FLOATING EXCHANGE RATESFLOATING EXCHANGE RATES

EXCHANGE RATES & BPNG’S BALANCE SHEET

>Appreciation of the kina leads to realized losses on the balance sheet

>Depreciation of the kina leads to realized gains on the balance sheet

>Mitigating effects on the movement of kina influences foreign currency liquidity and therefore price and subsequently monetary policy action.

>Trying to find the optimal exchange rates that will minimize effect balance sheet losses/gains and kina stability remains a big challenge.

Insufficient Research

Need quality research followed by good implementation

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THE LIQUEFIED NATURAL GASTHE LIQUEFIED NATURAL GAS

>THE LNG PROJECTS LIFE IS AROUND 50 YEARS

>THE LNG PROJECT WILL INCREASE GOVERNMENT EXPENDITURE AND LEAD TO GROWTH AND INCREASE IN WELFARE.

>ACCORDING TO A JOINT STUDY BY BPNG, CENTRE OF POLICY STUDIES

THE GOVERNMENT HAS THREE SPENDING OPTIONS OVER THIS PERIOD

A)CONSERVATIVE APPROACH – SAVE REVENUE BONANZA AND ONLY BUDGET WITHOUT PROJECT………………..KINA EFFECT STERILISED

B)PASSIVE EXPENDITURE PATH – USING REVENUE EARNED TO SPEND TODAY…………………….KINA EFFECT STABILIZED

C)ACTIVE EXPANDSORY POLICY- BORROW NOW AND USE FUTURE INCOME TO REPAY LOANS…………………KINA DEPRECIATION

In all during the construction phase, the kina will appreciate during the construction phase due to demand for labor and raw material inputs

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THE LIQUEFIED NATURAL GASTHE LIQUEFIED NATURAL GAS

>Sector effects: construction, manufacturing, transport, service sector will increase during the construction phase. This most affected will be the Agriculture sector (Kina appreciation) – “Dutch Desease”

>Conduct of Monetary Policy will be much easier if the Government takes a conservative path.

>Creation of Sovereign Wealth Fund. ( Joint Committee between DOT and BPNG)

>Seek Australian Government assistance in setting up a Sovereign Wealth fund.

> In summary, there is still no clear fiscal path and the SWF is still on the tables

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END

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