BSP Financial : Pacific Economic & Market Insight - December Quarter 2022

PACIFIC ECONOMIC AND MARKET INSIGHTS

December 2022 Quarter

DECEMBER QUARTER 2022

Key trends at a glance

GLOBAL ECONOMY SLOWS DOWN

• Global inflation was 8.8% in 2022 and is expected to slow to 6.5% in 2023. In 2023, advanced and developing economies' inflation rates are projected at 4.4% and 8.1% respectively.
• Global GDP growth is expected to slow significantly from 2.9% in 2022, to 1.7% in 2023. Monetary policy action is a key factor in determining global output.
• Factors stemming from the Russia-Ukraine conflict are expected to stifle growth in 2023, as central banks look to balance fighting inflation without tipping their economies into recession.

COMMODITIES PRICE TRENDS

• Energy prices fell sharply in Q4-22 as global inflationary pressures subside and growth falters.
• Precious metals inched higher as a response to a lower USD as the US Fed slowed the pace of interest rate hikes in Dec-22.
• Coffee and palm oil prices were lower in Q4-22, driven by an expected record coffee yield in Brazil and high palm oil inventories.
• Nickel prices are still extremely volatile, following the historic surge in March, with small shifts in supply and demand sparking large price movements as seen in late 2022.

PNG BOOSTED BY RESOURCE PRICES

• PNG's 2022 GDP growth increased to 4.6%

from 0.1% in 2021, due to higher oil and gas production, as developers sought to capitalise on higher prices. Production is expected to normalise in 2023, leading to lower growth of 4.0%.

• Non-resourceGDP growth is estimated at 4.5% in 2022, and 4.6% projected for 2023. Resource sector GDP growth in 2023 is projected at 1.2%.
• There is some upside with project negotiations expected to reach successful conclusions in 2023 and 2024. Reports indicate groundwork is being initiated by developers in anticipation.
• Headline inflation was estimated at 6.3% for the 2022 September quarter and is expected to reach 6.6% for the year.
• Inflation throughout the year was driven largely by imported inflation for crude oil and consumables. Given PNG's reliance on imports, the country was prone to the effects of heightened global inflation.
• BPNG is expected to maintain its contractionary stance on monetary policy through 2023, as inflation persists.
• The Kina Facility Rate was increased from 3.25% in July 2022 to 3.5% in January 2023. The Cash Reserve Requirement has also been increased steadily and is currently at 10%.

ECONOMIC GROWTH FOR THE SOUTH PACIFIC

• South Pacific countries' 2022 economic growth was estimated to be 5.3%, mainly driven by growth in PNG's mineral sector and Fiji's tourism sector.
• Samoa and Solomon Islands were impacted by lingering COVID-19 effects, resulting in negative growth in 2022.
• In 2023, all Pacific economies are expected to post positive GDP growth, with regional growth of 4.8% as the recovery in some countries stabilises.

REAL GDP GROWTH

2021 2022 2023

-4.1% +14.5% +5.6%

-0.5%-4.2%+3.0%

-7.1%-6.0%+2.0%

-2.7%-2.2%+2.5%

+1.0% +2.0% +4.0%

-29.1% +10.5% +11.2%

Source: ADB December 2022 Economic Forecasts.

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DECEMBER QUARTER 2022

BSP's economic and market views

Ronesh Dayal

Acting Group Chief Executive Officer

What were the key operational highlights for the Group in 2022?

• Through the course of the year, and with the reopening of borders across the Pacific, we have seen marked improvement in economic activity across the Group compared to the COVID-19 period. ADB projects economic growth at 5.3% for the Pacific in 2022, which will serve as a platform for further growth in 2023.
• BSP saw high demand for cash during the PNG election period, as campaign- related spending progressed in the lead up and during the elections. Our staff were able to meet this surge in demand and deliver to customers across the country throughout this period.

How will the increase in Bank Income Tax rates to 45% affect the banking sector?

• We appreciate the fiscal mandate to raise revenue in order to progress the development of the country. As a Group, BSP is committed to supporting the economic growth and success of all the markets in which we operate.
• Differentiated industry corporate income tax rates can be particularly damaging for emerging economies such as PNG. Such tax policies are detrimental to the proper functioning of market forces and conflicts with modern economic theory.
• Further, the tax rate increase on commercial banks comes at a time when locally- grown financial institutions are looking to obtain commercial banking licenses. The timing is unfortunate, and will nullify any momentum towards the expansion of the financial sector and investment (new branches and digital offerings) in PNG.

What were the key economic highlights of 2022, and what can we expect in 2023?

• In the medium-to-long term, the government stated commitment to supporting agriculture outputs and attracting foreign direct investment (FDI) bodes well for PNG's economic prospects in 2023. However, in early 2023 we need to see tangible FDI commitments particularly from the extractives sector before we see PNG's economic recovery commence.
• In short, the progression of the key extractive projects, as well as the re- opening of Porgera, are needed to boost business sentiment and expenditure that will underpin economic growth in 2023 and into 2024.
• The Bank of Papua New Guinea (BPNG) has adopted a contractionary stance to monetary policy, in response to high inflation. BPNG has increased the Kina Facility Rate (KFR) from 3.25% in July 2022 to 3.50% in January 2023. The Cash Reserve Requirement (CRR) has been increased through a series of hikes as well, from 7% in June 2022 to 10% by year end. We expect that BPNG will maintain the contractionary stance throughout 2023.
• The increases in the KFR and CRR have the intended effect of restricting lending to reduce spending in the economy, thereby addressing inflation. Increasing these rates also has the effect of cooling the PNG economy and subdues growth.

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DECEMBER QUARTER 2022

BSP's economic and market views

Peter Beswick

Group General Manager - Corporate Bank

Do you have any concerns regarding inflation?

• Inflation remains the primary concern for the Bank of PNG (BPNG), businesses and consumers. BPNG increased the Cash Reserve Requirement (CRR) to reduce market liquidity on 12 December 2022, as a further measure to counter imported inflation BPNG signaled a further increase in interest rates with its third lift in the Kina Facility Rate by 25 basis points on 3 January 2023. This is likely to dampen investment and consumer spending.
• Strong demand and ongoing supply issues, continue to boost goods price inflation. Key inflation drivers remain unchanged with elevated price levels ascribed to supply-chain disruptions, logistics costs and fuel prices.
• Foreign currency reserves have hit multi-year highs at USD3.6 billion, delivering strong coverage for government foreign currency loan repayment obligations and BPNG intervention for importers throughout 2023.

What recent trends have you seen in business confidence?

• Business and consumer confidence continues to lift through Q4, with anecdotal evidence across a broad section of our retailers who experienced record pre and post Christmas sales activity.
• Increased business and leisure travel has seen hotel occupancies reach pre-COVID levels, with many facilities at near full occupancy and our customers are projecting this demand momentum to continue throughout 2023.
• Papua LNG is "go" with FID expected in late 2023 and this will deliver significant opportunities through Local Content for Landowner and PNG companies … either directly or through JVs, with global engineering procurement and construction contractors. At end 2022, five large tender packages were released to the market in the lead-up to FID. Papua LNG, Government infrastructure projects (ports and roads) plus our delayed resource opportunities (Porgera, Wafi-Golpu, P'nyang, Twinza) are leading multiple customers to build people and resource capacity.
• Globally, there is a shortage of skilled and unskilled labour and our customers are focusing on looking after their best people, with retention strategies now critical.

Rohan George

Group General Manager - Treasury

How was foreign exchange liquidity and the Kina in the Final Quarter of 2022?

• FX market turnover in the December quarter rose 2% from the September quarter 2022. FX turnover for 2022 increased by 17.3%, compared to the prior year. This was supported by strong commodity prices, in particular Oil, Copper, Palm Oil, and Coffee. Firmer commodity prices assisted to offset the lost FX inflows from the closure of the Porgera gold mine.
• Outstanding FX orders with BSP fell by 70% in the past quarter, with large end of year FX inflows and Central Bank interventions more than offsetting large crude oil imports and pre-Christmas stocking.
• BPNG FX intervention in the December quarter 2022 rose 51% compared to September quarter.
• The Kina mid-rate was stable against the U.S. dollar at 0.2840. Recessionary fears amid a tightening of monetary policy in Australia and widening unfavorable interest rate differentials, weakened the Australian dollar early in the quarter, but it rebounded at years end, and remained broadly unchanged over the quarter.
• BPNG raised the CRR of commercial banks to 10% of total deposits, a tightening monetary policy to combat inflation, with the intent of reduced system liquidity, higher interest rates and reduced demand.

What's the outlook for FX inflows for the upcoming quarter and how should Corporate and Retail customers manage volatility in foreign currency inflows?

• After strong FX inflows in the December quarter, we expect post-Christmas import orders to increase in January and February, with FX inflows gaining momentum into the end of March.
• To manage volatility in foreign currency flows, businesses should place FX orders (with correct documentation), as soon as possible, ensure orders are cash backed whilst awaiting execution, tax clearance certificates are current and reflect the expected FX order execution time.

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DECEMBER QUARTER 2022

Global growth outlook

Fighting inflation will be the main concern for monetary authorities around the globe, and it is expected that global inflation will ease in 2023. However, cooling inflation also has the added effect of stifling economic growth, leading to lower projected global output in 2023.

GLOBAL INFLATION (%)

GLOBAL GDP GROWTH (%)

PACIFIC GDP GROWTH (%)

	9.9		6.7
			5.9
	8.8	8.1	5.3
5.9				3.4	3.4
7.2	6.5		2.9 2.5
4.7					1.7
	4.4			0.5
3.1
2021	2022	2023	2021	2022	2023
Global Inflation		Global
Advanced Economies		Advanced Economies
Emerging Market & Developing Economies	Emerging Market & Developing Economies

Samoa

Solomon Islands

Tonga

Vanuatu

Cook Islands

Fiji

-6.0

-4.2

-2.2

2.0

3.0

2.5

2.0

4.0

10.5

11.2

14.5

5.6

• Global inflation is estimated to be 8.8% in 2022, with the developing world being affected most due to being largely net importers. In 2023, advanced and developing economies' inflation rates are projected at 4.4% and 8.1% respectively.
• Real Global GDP growth is expected to slow significantly from 2.9% in 2022 to 1.7% in 2023. It is expected that inflation-fighting measures will continue in major economies, which will see global economic activity slow down in 2023.
• Advanced economies are expect to slow down more than developing economies in 2023, with 0.5% and 3.4% growth projected respectively.

2022		2023

• Natural disaster incidents and lingering COVID-19 effects in early 2022, posed some downside risk. However, through the course of the year, and with the reopening of borders, there has been a marked improvement in economic activity across the Pacific.
• The Asian Development Bank projects economic growth at 5.3% for the Pacific in 2022, which will serve as a platform for further growth in 2023. All Pacific economies are expected to post positive GDP growth in 2023.

Source: World Bank July GDP forecasts, Euromontor Economic Outlook Q3-2022

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