Some Background

Trust funds have played a significant role in the management of fiscal resources in PNG since independence, especially in relation to absorbing the volatile revenue streams generated by mineral and resource extraction. With the commencement of the Panguna Copper Mine in Bougainville the Government created the Mineral Resource Stabilization Fund (MRSF) with legislation coming into force in 1974. The MRSF was designed to receive all of the Government’s revenue derived from mining taxes rather than having them flow directly onto the Budget. The Fund was then used to distribute these revenues to ensure a smoother allocation of resources over time and so that they could be used more effectively.

Despite a promising start the MRSF was however notoriously mismanaged. Even prior to the closure of Bougainville Copper in 1989, moves were made to relax the provisions of the Act in 1986 to give Government greater discretion in making withdrawals from the Fund. By 1998, the draw down from the MRSF to the public account totalled K330.1 million comprising 18 per cent of the government’s domestic revenue. Then in 1999 a decision was made to draw down the entire remaining balance of the fund (a total of almost K1 billion) to cope with a looming public debt crisis.

In addition to withdrawing excessive amounts from the Fund, successive governments paid little attention to providing processes and policy settings to ensure revenue was spent on building infrastructure or other productivity and capacity enhancing projects. Following the emptying of the Fund a decision was made to repeal the MRSF legislation, which became effective in December 2000.

Current Trust Account Usage

This situation is now having consequences for the current fiscal management of resource revenues. Government held trust accounts are held by agencies across the PNG public sector and were initially established to hold counterpart funding between PNG and donor agencies but their roles have varied over the years. The Department of Finance holds upwards of 29 accounts, the most important of which are the Supplementary Budget accounts where funds are transferred when revenue receipts are above those estimated in the Budget – which has been the case since 2002.

By the end of 2007 windfall revenues in Trust which had been designated for future investment reached about 17 per cent of GDP. As of 31st May for example the 2006, 2007 and 2008 Supplementary Budgets had appropriated K476.9 million to the health sector. Of this just 28.6 million (6 per cent) had been spent with the remaining K354.3 million paid into trust. Similar figures exist in the education and law and justice sectors. In total, if total unspent funds were treated as savings for the 2007 Budget this would have raised the estimated budget surplus to 11.4 per cent of GDP.

Is this sensible economic policy?

Why are Trust Accounts becoming so important to PNG Fiscal Management?

The major advantage of using these trust accounts is that they allow the Government to smooth their expenditures over time. This limits the impact of the current revenue boom on the already stimulated levels of aggregate demand, helping to curtail inflationary pressures which have recently reached double digits.

A slower release of mineral funds also improves the ability of the bureaucracy with its limited implementation capacity to focus on the quality of expenditures as well as limit the amount of economic rent seeking occurring within the economy. Another advantage of these trust funds over a consolidated fund such as the MRSF is that they allow additional unspent revenues to be allocated to a specific purpose whereas expenditures financed from the MRSF tended to fund general government consumption.

Domestic politics places a high priority on allocating available funds to particular activities. A number of political difficulties would arise if the Government was seen to be ‘holding on’ to these revenues without any plans for their expenditure. Specific purpose trust funds are also much less visible than a consolidated fund which history has shown tends to attract a large amount of pressure for higher expenditures making it more difficult for inter-temporal expenditure smoothing. In essence, these trust funds are allowing the Government to allocate funds without actually spending them which is appealing in both an economic and a political sense.

What Issues has this created for Fiscal Management?

The first and most obvious disadvantage of this approach is that holding such a large amount of revenues in trust for extended periods is clearly a second best policy to simply repaying the declining, but still high, levels of Government debt. New borrowing into the future would then allow inter-temporal expenditure smoothing and forego current debt repayment obligations.

The political reality of PNG fiscal management however suggests that this would be a difficult approach. The Government is already allocating a large portion of its resources to debt repayment in line with the Medium Term Debt Strategy, and it must be seen to be making new large scale productive investments in the physical and human capital of the country. Trust funds allow the Government to do this whereas debt repayments do not.

Another issue to be considered is that the opportunity cost of keeping this money in trust accounts is high. The numerous accounts which these funds are being held in also means that they have limited potential to generate higher rates of return from a more diversified portfolio base. Ex-Treasurer and now Opposition leader, Bart Philemon picked up on this issue in his reply to the Somare Government’s 2008 Budget. In it he highlighted that a total of K4.67 billion in public money was sitting in various trust accounts ‘doing nothing’. This included K515 million in the Bank of Papua New Guinea, K400.9 million in the Bank South Pacific, K197.1 million in ANZ (PNG) Ltd and K186.6 million Westpac (PNG) Ltd.

Perhaps the most important issue to be raised by the dramatic increase in the usage of these trust funds is the unclear management responsibilities and governance arrangements which surround their usage. In the 1990s and early 2000s trust accounts were the source of widespread misuse and extortion of government funds. During this period there were an estimated 3,000 separate accounts which combined with poor financial controls meant that it was difficult to trace or prevent illegal activities. Following a review in 2004, Treasurer Philemon declared a large portion of these to be redundant and the number was brought down to an estimated 300. Whilst the reduced number of accounts and improved financial controls will help prevent further misuse, confusion over their number, size and management still exists and may reduce their effectiveness and create further bottlenecks in financial control.

Some progress has been made in terms of transparency with the publishing of trust account details in the 2007 Mid Year Economic and Fiscal Outlook (MYEFO) but this is not a legal requirement and in the event that politicians wished to start hiding activities could be easily stopped. The Government’s Medium Term Fiscal Strategy (2008-2012) also places a limit on spending from trusts with total expenditures not too exceed 4 per cent of GDP. This may help to limit a potential raiding of these accounts but the threshold has not been reached yet and therefore whether it is binding has not been tested.

Finally, the Government has not articulated a strategic policy to address the implementation bottleneck in the system of government. Whilst holding onto revenues to limit their inflationary impact is important, much of the current lack of disbursement almost certainly reflects limited public sector capacity. For this to change a more competitive system of public sector employment conditions needs to be implemented so that the bureaucracy is more capable of managing productive investments which expand the supply of physical and human capital in the economy.

Concluding Remarks

Government held Trust accounts are playing an increasingly important role in the fiscal management of PNG. This approach of smoothing expenditure allocations from the current revenue boom offers a number of advantages but is probably the second best option in lieu of simply repaying government debt and borrowing into the future. The development of this approach has also been relatively ad-hoc at best and the management responsibilities are still unclear and need considerable improvements. If trusts are going to hold such a significant portion of government revenue then they need to improve their transparency and much of the confusion around their governance and accountability structures needs to be clarified, both to Parliament and bureaucrats.