Determinants Of Private Sector Credit In Papua New Guinea
Determinants of private sector creditin Papua New GuineaSolomon Kasingu Bank of Papua New GuineaGail Sabok Bank of Papua New GuineaDiana Tuam Bank of Papua New GuineaJeconiah Hamua Bank of Papua New GuineaJen-Je Su Griffith UniversityParmendra Sharma Griffith UniversityGRIFFITH UNIVERSITY–SOUTH PACIFIC CENTRAL BANKSJOINT POLICY RESEARCH WORKING PAPER SERIESGriffith Asia InstituteGriffith University–Bank of Papua New Guinea JPRWP#11
Griffith Asia InstituteGriffith University–South Pacific Central BanksJoint Policy Research Working Paper SeriesDeterminants of private sector credit inPapua New GuineaSolomon Kasingua, Gail Saboka, Diana Tuama,Jeconiah Hamuaa, Jen-Je Sub,c and Parmendra Sharmab,cabBank of Papua New GuineaDepartment of Accounting, Finance and Economics, Griffith UniversitycGriffith Asia Institute, Griffith University
About the Griffith Asia InstituteThe Griffith Asia Institute (GAI) is an internationally recognised research centre in the GriffithBusiness School. GAI aims to be the informed voice leading Australia's strategic engagementin the Asia Pacific by cultivating knowledge, capabilities and connections that will inform andenrich Australia's Asia-Pacific future.GAI's focus is on conducting and supporting excellent and relevant research on the politics,security, economies and development of the Asia-Pacific region; facilitating effectivepartnerships and policy outcomes for positive impact in the region; leading and informingpublic debate on Australia's place in the Asia Pacific; and shaping the next generation of AsiaPacific leaders.The Institute reflects Griffith University's longstanding commitment to the study of andengagement with nations of Asia and the near Pacific.About this publicationThe Joint Policy Research Working Paper Series endeavours to disseminate the findings ofwork in progress to academics, governments and the public at large to encourage theexchange of ideas relating to the development of the South Pacific financial sector andthereby national economic growth and development. The papers carry the names of theauthors and should be cited accordingly. The findings, interpretations, and conclusionsexpressed in this paper are entirely those of the authors and do not necessarily represent theviews of the partner Bank or Government.Disseminating findings quickly, even if work is still in draft form, is expected to encourageearly and wider debate.This joint Bank of Papua New Guinea—Griffith University working paper is part of an ongoingextensive research capacity building program led by Griffith University for the South Pacificcentral banks.The texts of published papers and the titles of upcoming publications can be found on SouthPacific Centre for Central Banking page on the Griffith Asia Institute minants of private sector credit in Papua New Guinea’, Griffith University–South PacificCentral Banks Joint Policy Research Working Paper No. 11, 2020.
About the AuthorsSolomon KasinguMr Solomon Kasingu is a Senior Research Analyst in the Research Project Unit of the ResearchDepartment, Bank of Papua New Guinea (BPNG). He served the Bank for more than 11 yearsin the Economics and Research Departments. His interest in research lies particularly in thearea of taxation and its implication on macroeconomic policies. Solomon is available atskasingu@bankpng.gov.pgGail SabokMs Gail Sabok is a Research Analyst with the Bank of Papua New Guinea. Previously sheworked as a technical staff member in the Monetary and Economic Policy Division at theBPNG and has co-authored an empirical research paper titled 'Estimating an AggregateImport Demand Function for Papua New Guinea’ which was published as a BPNG workingpaper.Diana TuamMs Diana Tuam is a Senior Research Analyst in the Monetary Policy Unit of the EconomicsDepartment, Bank of Papua New Guinea. Prior to joining the Bank in January 2017, she servedat the Department of Treasury for 12 years, where she undertook her Master of Public Policyspecialising in Development Policy from the Australian National University (2013 and 2014).Her interest in research lies particularly in the area of fiscal policy implications/impact onmonetary policy and on macroeconomic policies. Diana is available at dtuam@bankpng.gov.pg.Jeconiah HamuaMr Jeconiah Hamua is a Research Analyst with the Monetary Policy Unit of the EconomicsDepartment, Bank of Papua New Guinea. Prior to joining the Bank in April 2017, he workedwith the National Research Institute and Department of Treasury. Jeconiah is available atjhamua@bankpng.gov.pg.Jen-Je SuDr Jen-Je Su is a Senior Lecturer in the Department of Accounting, Finance and Economics atGriffith University. He has training in economics and econometrics and significant experiencein econometric modelling. Before joining Griffith, he had worked in several academicinstitutions across Taiwan, USA, and New Zealand. Dr Su has published intensively in the areasof time-series econometrics, international finance, economic development and tourism inacademic journals.Parmendra SharmaDr Parmendra Sharma is a senior lecturer and the program convenor of the South PacificCentre for Central Banking at Griffith University. His publications are beginning to fill the hugevacuum in the literature relating to South Pacific’s financial sector, including on issues such asdeterminants of bank interest margins, profitability and efficiency. His recent publicationsinclude Factors influencing the intention to use of mobile value-added services by womenowned micro enterprises in Fiji), Microfinance and microenterprise performance in Indonesia(International Journal of Social Economics), A first look at the trilemma vis-à-vis quadrilemmamonetary policy stance in a Pacific Island country context, (Review of Pacific Basin FinancialMarkets Policy), Mobile value added services in Fiji: Institutional drivers, industry challengesand adoption by women micro entrepreneurs (Journal of Global Information Management)and Bank reforms and Efficiency in Vietnamese Banks: Evidence based on SFA and DEA(Applied Economics).
ContentsAbstract .11. Introduction .22. Context of the study .42.1 Macroeconomy .42.2 Private sector credit .53. Data and methodology .93.1 Data .93.2 Unit root and breakpoint unit root tests.103.3 Methodology .114. Empirical results .135. Conclusion and policy implications .15Notes and references .16
Determinants of private sector credit in Papua New GuineaAbstractThis is among the first of studies to investigate the determinants of private sector credit inthe case of Pacific Island Countries. Using PNG as a case, various demand and supply-sidefactors and an autoregressive distributed lag model, the study finds that deposits at thecommercial banks, real gross domestic product, real effective exchange rate, and net foreignassets have significant positive influence on credit to the private sector in both the short andthe long-run. Interestingly, lending rates have no significant influence on credit to the privatesector. Policy implications are discussed.Keywords: private sector credit, PNG, autoregressive distributed lagJoint Policy Research Working Paper #11 1
Determinants of private sector credit in Papua New Guinea1. IntroductionIt is widely accepted that finance is sine qua non for start-up, establishment and expansionof a private sector enterprise; capital is indeed critical for operational as well as nonoperational activities. Generally, the capital structure encompasses a mix of internal andexternal sources, with the latter financed primarily and commonly by financial institutions likecommercial banks (White and Cestone, 2003; Galor and Zeira, 1993). Growth and expansionof the private sector then becomes almost invariably dependent on credit available andaccessible from the financial institutions, begging the question—what might thedeterminants of such credit to the private sector be? This question is important because awell-functioning private sector is in turn sine qua non for economic growth and developmentand thereby alleviate poverty and income inequality, enhanced employment and well-beingof a country and its citizens. Hence the purpose of this study—what indeed are thedeterminants of private sector credit in the case of Papua New Guinea (PNG), a Pacific islandCountry (PIC).PNG is a small, open and natural rich developing economy with a strong tradeable sectorexporting chiefly primary commodities (such as palm oil, coffee, cocoa, fish, gold, copper,crude oil and liquefied natural gas(LNG)); and is highly import dependent on manufactureditems (such as fuel, rice, vehicle, machinery and equipment and other consumables). Amongthe PICs, PNG is relatively larger, in terms of population and economy. The latter is dominatedby two broad sectors—agriculture, forestry and fisheries —the biggest sectoral employer;and the mineral sector which accounts for majority of export earnings and gross domesticproduct (GDP). The mineral sector is comprised mainly of foreign-owned mining andquarrying and petroleum companies funded predominantly by parent companies overseas.The other sectors and depend on the domestic financial institutions for investment andexpansion. PNG has experienced a period of sustained economic growth attributed to thehigh international commodity prices from 2003 to 2008 and the construction phase of themulti-billion-kina PNG LNG project which commenced in 2009 and was completed in 2013.PNG’s financial sector remains shallow and underdeveloped like other PICs and somedeveloping countries. The sector comprises of commercial banks, finance companies,merchant banks, savings and loans societies, superannuation funds, life insurance companies,and other licensed financial institutions. Commercial banks—Bank South Pacific (BSP) Limited;Australia and New Zealand Banking Group (ANZ) PNG Limited; Westpac Bank (PNG) Limited;and Kina Bank Limited make up more than 50 percent of the financial sector and is the largestlending group. As of 2017, BSP, the largest of these four banks, have over 40 branches acrossthe country and subsidiaries in some PICs, whilst ANZ, Westpac and Kina Bank have 16, 14and 1 branch, respectively.Via-a-vis other PICs, PNG’s domestic credit to the private sector as a percentage of GDPremains low. According to the World Bank’s Development Indicator database, domestic creditto the private sector as percentage of GDP in PNG has been hovering between 13 percentand 20 percent since 1994. This ratio reached 20 percent in 2013 but dropped to 15percent in 2017, far lower than the ratios elsewhere in the PICs. For instance, the ratio forFiji was 40 percent in 1994 and had reached 60 percent in 2006 and since then has beenmaintained around that level. Vanuatu’s ratio has also improved from 35 percent in 1994 to2 Joint Policy Research Working Paper #11
Determinants of private sector credit in Papua New Guinea68 percent in 2017. Thus, the greater relevance of the study’s question—what might thedeterminants of private sector credit be in the case of PNG?This research employed quarterly data for the period 2000 to 2017. The study adopted themethodology used by Baoko, Acheampong & Ibrahim (2017), which included both supply anddemand variables. The dependent variable is private sector credit expressed as percentageof real GDP. The independent variables from the supply side are ratio of deposit to real GDPand the weighted average lending rate, whilst real GDP, real effective exchange rate and ratioof net foreign assets to GDP are from the demand side. From the results obtained fromAutoregressive Distributed Lag (ARDL) model, all variables have positive and significantimpact on private sector credit in the long run except lending rate. The results show thatprivate sector credit in PNG is mainly influenced by demand factors.The rest of the paper is organised as follows. Section 2 provides a context of the study.Section 3 briefly reviews the literature. Section 4 outlines the data and methods. Section 5discussed the results. And section 6 concludes with some policy implications.Joint Policy Research Working Paper #11 3
Determinants of private sector credit in Papua New Guinea2. Context of the study2.1 MacroeconomyPNG’s small open economy, depends heavily on trade which makes the external sector crucialin the development and growth of the country’s economy. As is common in countries thatexport of primary commodities, developments such as high international commodity pricesor establishment of new resource projects are favourable to PNG in terms of boostingeconomic activities and growth. Foreign direct investment (FDI), especially in the extractivesector, has also contributed significantly in the development and growth of the domesticeconomy. On the other hand, the country depends heavily on manufactured imports given itshuman and technological capacity constrains (Aipi and Sabok, 2016). Commodity exportearnings and capital inflows from FDI are the main sources of foreign exchange which isneeded for importing whilst the inflows play an essential role in supporting the nationalcurrency (Kina) in the floating exchange rate regime. In light of these structural underpinnings,economic activity in PNG is strongly influenced by factors such as FDIs, foreign exchangeavailability, exchange rate movements and developments in global economy and internationalcommodity prices.PNG experienced a period of rapid economic growth reflected by significant increase in GDPfrom early 2000’s to 2014 (Figure 1). The period of growth between 2003 and 2008 wasattributed to high international commodity prices which eventually ended as a result of theGlobal Financial Crisis (GFC). Domestic economic activity, however, remained resilient duringthe GFC, supported by expansionary fiscal policy. Whilst external conditions slowly recoveredin the years following the GFC, the commencement of the construction phase of the PNGLNG project propped up domestic demand as economic growth gained momentum andpeaked in 2010. There was increased FDI inflows related to the project, which led toincreased supply of foreign currency in the economy with the country’s foreign exchangereserve at Central Bank recording historic highs in that period. The construction phase of theproject was completed in 2013.In 2014, GDP growth reached an unprecedented high level attributed to the commencementof production and export of natural gas from the PNG LNG project. However, export earningswere lower than anticipated, which reflected the provisions given to PNG LNG projectdevelopers under the PDA to keep most of the export proceeds offshore to service theirexternal liabilities, apart from meeting its operational costs, royalty payments and others.Furthermore, the international commodity prices dropped in the second quarter of 2014precipitated by the significant plunge in international oil prices, resulting in further decline inexport receipts. Foreign currency inflows were adversely affected, which led to build-up ofbacklog of foreign exchange orders for imports and other payments, and decline in thecountry’s foreign exchange reserve as the Central Bank intervenes in supplying foreignexchange to the market. The shortage of supply of foreign currency against a persistent highdemand in the market exerted downward pressure on the kina exchange rate. Consequently,import activities were hampered; affecting overall business activities and sentiments and ledto subdued economic growth since 2014.4 Joint Policy Research Working Paper #11
Determinants of private sector credit in Papua New GuineaFigure 1: Real GDP growth in PNG, 22013201420152016201720180.0Real GDPreal GDP growth rate2.2 Private sector creditThe growth in private sector credit between 2003 and 2014 was not in par with the strongeconomic growth in that period. However, this period of economic growth was characterisedby significant increase in deposits at the commercial banks from both the private andgovernment sectors (Figure 2). The high primary commodity export revenues earned inforeign currency by the private sector channelled via the commercial banks and wereconverted to kina. This led to a build-up of private sector deposits at the commercial banks.Meanwhile, the government deposits and converts most of its revenue earned, especiallyfrom trade and income tax, at the commercial banks and then draws them when needed forexpenditure purposes. This resulted in increase in deposits with the commercial banks(Figures 2 and 3), which contributed to the high level of deposits at the commercial banks.However, this supply of credit did not translate to increase in private sector credit as therewere other demand factors that could have affected the demand for credit.Figure 2: Deposit composition at commercial vernment depositsJoint Policy Research Working Paper #11 5Other 082007200620052004200320020.0
Determinants of private sector credit in Papua New GuineaPrivate Sector 0820072006200520042003181614121086420% government deposits949290888684828078762002% private sector depositsFigure 3: Deposit compositionGovernment DepositsThe government and private sector had accumulated sufficient funds and were using theirown cash stock to fund their investment and operations during the period of economic boomand as a result did not see the need to seek financial assistance form financial institutions. Thegovernment maintained expansionary budgets over the economic boom period and much ofthe spending was on development projects from which the private sector benefited throughbeing subcontractors to the government for the various projects (Figure 4). The government,in that manner, injected more liquidity into the domestic economy. In addition, during the LNGPNG project’s construction phase, the extractive company brought in its own funds andmachinery and did not rely on the domestic financial sector to fund its operations andinvestment. The non-mineral private sector also benefited from subcontracts from the PNGLNG project. The private sector largely benefited from the favourable
Determinants of private sector credit in Papua New Guinea . Using PNG as a case, various demand and supply -side . coffee, cocoa, fish, gold, copper, crude oil and liquefied natural gas(LNG)); and is highly import dependent on manufactured items (such as fuel, rice, vehicl
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