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

PACIFIC ECONOMIC AND MARKET INSIGHTS

September Quarter 2022

SEPTEMBER QUARTER 2022

Key trends at a glance

GLOBAL ECONOMY SLOWS DOWN

● The World Bank estimates that global growth will slow from the 6.1% recovery in 2021 to 3.2% in 2022, then 2.9% in 2023. This is largely due to supply chain issues and inflation.

• Ongoing tensions in Europe pose headwinds globally, as Russia moves to formalise its annexation of four (4) Ukrainian territories.
• Increased money supply from COVID-era stimulus, coupled with current shortages of oil on the global market, sees inflation increasing globally.

COMMODITIES WEAKENED

• Tighter monetary conditions as well as reduced consumption and high inflation, are skewing risks towards a recession and causing oil prices to fall even though a global shortage persists. OPEC+ has agreed to a historic production cut of 2 million barrels per day to maintain higher prices.
• Gold prices lost momentum in Q3-22, due to the surging US dollar (which makes gold more expensive) and higher bond yields (which is a substitute investment).
• Coffee prices gained momentum in Q3-22 due to supply shocks, but prices were still lower compared to Q2-22. The threat of a global recession adds downward pressure on prices for the remainder of 2022.

PNG BOOSTED BY RESOURCE PRICES

• PNG's outlook has improved according to

the ADB, with higher growth expected at 3.5% in 2022 and 4.9% in 2023. High import price and the Russia-Ukraine conflict are key headwinds to consider.

• Higher commodity prices and future prospects in mining and petroleum

underpin the improved outlook. Other segments of the PNG economy are expected to make forward strides in 2023.

• The resources sector contributes 39% to
  PNG's domestic production, according to the Chamber of Mines and Petroleum. The sector beat revenue projections in 2022 due to high energy prices which enabled a spending increase by the Government in the Supplementary Budget.
• BPNG has tightened monetary policy in
  Q3-22, by raising the KFR to 3.25% and the CRR to 9.0%. This has the intended effect of limiting the financial system's ability to create credit, with the aim of dampening consumption to counter recent inflationary pressure.
• Agriculture was among the key contributors to the economic recovery. Strong results were particularly driven by higher export volumes of palm oil. This led to solid growth in agricultural export receipts (+50% YoY) ‒ in particular receipts from the export of palm oil doubled.

ECONOMIC GROWTH FOR THE SOUTH PACIFIC

• Economic growth in the sub-region is expected to grow by 4.7% in 2022 and 5.5% in 2023, driven by rising visitor arrivals expected to support tourism- dependent Pacific economies.
• Given the high reliance on imported goods, the Pacific Island nations are particularly prone to high global inflation. Progression of national vaccination programs in most countries has also allowed for the reopening of the tourism industry whilst minimising health risks.

REAL GDP GROWTH

2021 2022 2023

-4.1% +11.7% +8.5%

-0.5%-4.2%+3.0%

-7.1%-5.3%+2.0%

-2.7%-2.0%+3.7%

+1.0% +2.0% +4.0%

-29.1% +10.5% +11.2%

Source: ADB September 202 Economic Forecasts.

2

SEPTEMBER QUARTER 2022

BSP's economic and market views

Robin Fleming

Group Chief Executive Officer

What are your views on inflation, and what impact will this have on the PNG economy?

• The National Statistics Office (NSO) estimates inflation at 5.5% at the end of June 2022. The Bank of Papua New Guinea further estimates that inflation for the year will end up at 6% in 2022.
• This is driven by higher prices for imports of fuel and household goods. Given
  PNG's reliance on imports and the lack of domestically produced substitutes, PNG remains highly exposed to global inflation.

How has BSP responded to the increase of the Kina Facility Rate (KFR) by the Bank of Papua New Guinea?

• To help control inflation, BPNG has increased the KFR from 3.00% to 3.25% in July. The KFR increase had the intended effect of increasing the cost of borrowing in order to cool down spending and reduce inflation.
• BSP adjusted its Indicator Lending Rate (ILR) with a 0.25% increase, in line with the KFR increase, enabling the transmission of policy rates into market rates. In addition, interest rates paid on customer deposits were increased to pass on the full benefit of the KFR increase to our customers.

The 2022 Supplementary Budget was passed in September, what are your key takeaways from the Budget.

• The Supplementary Budget increased government spending by K1.2 billion to K23.4 billion.
• PNG's oil, gas, and resource sector performed well, due to the supply shortages and the Russia-Ukraine conflict. The resources sector exceeded budgeted tax revenue by +300%, and dividends by 75% as a result.
• The new budget envelope means that Government spending will be equal to 21.2% of GDP. Spending of this magnitude by the government provides economic stimulus in the short term, but adds to inflationary pressures.
• The Fiscal Policy expansion seems at odds with BPNG's contractionary Monetary
  Policy stance. Greater coordination is needed between the two arms of government economic policy to maintain the soundness of the economy and the effectiveness of Monetary and Fiscal policy in the long-run.

3

SEPTEMBER QUARTER 2022

BSP's economic and market views

Peter Beswick

Group General Manager - Corporate Bank

Do you have any concerns regarding inflation?

• BPNG's Monetary Policy Statement (MPS) issued on 30 September reconfirmed its stance to tighten Monetary Policy and counter the high domestic inflation. Headline CPI for June quarter 2022 tapered to 5.5%, against 6.9% in the prior quarter. This is a positive sign, however inflation remains a key concern impacting business costs and consumer purchasing power nationally.
• The key inflation drivers remain unchanged with elevated price levels ascribed to supply-chain disruptions, logistics costs, and fuel prices.

What recent trends have you seen in business confidence?

• The Prime Minister's 11th Parliament opening address "Restructuring Governance & Real Development Outcomes" was well received by the market, with its key focus on support of foreign direct investment and agricultural outputs that have high potential to be competitive across global markets.
• With the conclusion of the national election, we are seeing an uplift in consumer and business enquiries for investing and spending across all sectors. This is expected to build momentum … leading into a strong 2023/24, initially driven by Barrick's reopening of the Porgera Gold Mine and then Papua LNG financial investment decision (FID).
• The continued increase in BPNG's foreign currency reserves to PGK12.7 billion, or
  USD3.6 billion, as at 31 August (reported in the MPS) is another positive indicator. Higher FX reserves should allow for increased business imports and will deliver strong economic and business activity.

Rohan George

Group General Manager - Treasury

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

• FX market turnover in the September quarter fell by 6.4% from the June quarter 2022. However, year-to-date turnover increased by 15% compared to the prior year. This was supported by strong commodity prices, in particular Oil, Copper, Palm Oil, Coffee.
  Firmer commodity prices assisted to offset the lost FX inflows from the closure of the Porgera gold mine.
• Outstanding FX orders with BSP have doubled in the past quarter, affected by lower August and September FX inflows, large crude oil imports and pre Christmas stocking.
• BPNG FX intervention in the September quarter 2022 fell 25% compared to June 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 and saw Kina rise 10.4% against the Australia dollar, cushioning imported inflation on Australian goods.
• BPNG raised the Cash Reserve Requirement (CRR) of commercial banks to 9% of total deposits, a tightening monetary policy to combat inflation. With the intent of seeing reduced 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 light FX inflows in the September quarter, we expect pre-Christmas import orders to increase in early in October and November, before end of year FX inflows satisfy the market's foreign currency appetite.
• BPNG enhanced exchange control compliance measures in the June quarter.
• 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.

4

SEPTEMBER QUARTER 2022

Global growth outlook

Global economic performance was resilient in the first half 2022, but has weakened significantly since the start of Q3-22 due to the impact of inflation, supply chain bottlenecks, and tighter monetary policy. The global economic outlook remains challenging with private consumption weakened, amid inflationary pressures, and the threat of a recession looming large over investment decisions.

GLOBAL GDP GROWTH			WORLD BANK ECONOMIC OUTLOOK -
								REAL GDP GROWTH
6.1	6.8					World Bank	World Bank
					Current	World Bank-
5.2						Prior Forecast
					Forecast
					3.9		Market			change
				3.6
			3.2
			2.9			[April - 22]	[July- 22]
			2.5
					1.4			2021f	2022f	2021f	2022f	2021f	2022f
							USA	-1.40%-1.00%	2.30%	1.00%	3.7%	2.0%
2021	2022		2023
	China	-1.10%-0.50%	3.30%	4.60%	4.4%	5.1%
		Global					East Asia
						7.20%	4.40%	2.60%	5.30%	-4.6%	0.9%
		Advanced Economies
					Pacific
		Emerging Market and Developing Economies	Euro	-0.20%-1.10%	2.60%	1.20%	2.8%	2.3%

RUSSIAN-UKRAINE WAR ECONOMIC IMPACT

• Russia has unilaterally declared its annexation of four (4) Ukrainian regions. The possibility of a retaliation by Ukraine and its Western allies has damped market sentiment across the globe. PNG is highly exposed to these effects through its reliance on imports.

INFLATION

		Jan. 2022 (World Bank proj.)
8.6	9.0	Jul. 2022 (World Bank proj. & act.)
8.3
7.0		6.9

					5.3	4.5	4.1
5.4	5.1	4.7	4.0
		3.6
			3.3	3.2	3.2
Q 1 - 2 2	Q 2 - 2 2	Q 3 - 2 2	Q 4 - 2 2	Q 1 - 2 3	Q 2 - 2 3	Q 3 - 2 3	Q 4 - 2 3

• Global real GDP growth is expected to slow significantly from a strong recovery of 6.1% in 2021 to 3.2% in 2022 and 2.9% in 2023, according to World Bank forecasts.
• The advanced economies' real GDP growth is expected to grow by 2.5% in 2022, a sharp decline from the 5.2% pace of 2021.
• The US and Eurozone economies are facing high stagflation risks but developing and emerging markets could be hit hard if the global economy enters a stagflation era.
• China's economy is expected to slow down to 3.3% in 2022 due to lower consumption and disrupted activities as the country retains its zero-COVID policy.
  China's economy is expected to grow to 4.6% in 2023.

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

• Rising inflation has spurred the withdrawal of monetary stimulus, and the risk of an inflationary spiral may prompt even more aggressive tightening.
• Inflation is projected to surge further in many key economies as a result of ongoing increases in food and energy prices, curbing real incomes and consumer spending and further dampening the global growth outlook. The risk of global stagflation remains significant.

MONETARY STANCE

• More aggressive tightening by the US Federal Reserve and other central banks, is denting global demand and rattling financial markets, according to the ADB.

5