THE International Monetary Fund (IMF) says Papua New Guinea still faces a number of budgetary challenges on the back of the downturn in commodity prices and a lack of foreign exhange.

Concluding its most recent consultation on PNG, the IM F reported that the countryis facing headwinds stemming from low commodity prices and is recovering from a major drought, which have weighed on economic growth, weakened the external position, and created fiscal challenges.

The IMF said foreign exchange (FX) remains in short supply but inflows have recently picked up somewhat, and the gross foreign reserve position is expected to remain broadly stable.

Revenues fell short of the budget in response to recent commodity price declines, prompting the Parliament to pass a supplementary budget 2016 that entails expenditure cuts. Inflation has increased somewhat, partly reflecting the exchange rate depreciation.

After strong economic growth driven by the new LNG project coming on stream in 2014-15, the underlying growth is expected to slow down reflecting base effects following the commencement of LNG production, as well as modest growth in the non-resource sector. The large LNG exports and import compression caused by the shortage of FX led to a strong current account surplus, largely offset by financial account outflows consistent with project development agreements. Inflation is expected to continue edging upwards in the near term due to the gradual exchange rate depreciation and prices of seasonal agricultural items.

Near-term risks to the outlook are tilted to the downside, as fiscal retrenchment may have a greater impact on the economy than currently expected and the limited availability of FX continues to constrain imports and economic activity.

A further drop in commodity prices would weaken the external and fiscal positions. In addition, natural disasters, climate change and weather-related shocks pose continual downside risks.

Over the medium term, risks are more balanced due to the upside potential of new resource sector projects.

The IMF’s executive board says that while progress has been made, additional fiscal adjustment is needed to ensure debt sustainability over the medium term. While the authorities should be commended for promptly passing a supplementary 2016 budget, further adjustment may be needed in view of financing constraints.

Passage of a prudent 2017 budget should be commended, which will facilitate continued fiscal consolidation over the medium term, anchored by the existing 30% public debt-to-GDP fiscal anchor. The pace of adjustment should continue to balance the need to maintain debt sustainability against the costs of excessive fiscal adjustment in terms of growth and poverty reduction.

Greater revenue mobilisation would create fiscal space for expenditures that would help address PNG’s huge development and social needs. Measures drawn from the National Tax Review should be adopted going forward. In the near term, efforts should be undertaken to improve tax compliance. There is considerable scope for improving the fiscal regime for extractive industries.

Government expenditure quality should be improved through public financial management (PFM) reform. There is much scope for better deploying existing public sector resources towards effective public service delivery, including on core areas of health and education.

Further PFM reforms should build upon the recently published public expenditure and financial accountability (PEFA) document and successes in rolling out the new information management system to encompass cash management issues.

The sovereign wealth fund should be put into operation as soon as possible to help improve transparency and ensure that resource revenue is used in a manner that is consistent with macroeconomic stabilisation and saving for future generations.

Greater exchange rate flexibility and a more efficient and transparent FX allocation mechanism are urgently needed. Lack of exchange rate flexibility has impeded PNG’s adjustment to sharply lower world commodity prices, weakened the external and fiscal positions, and reduced the growth contribution from net exports.

The pass-through of more rapid exchange rate depreciation into inflation would need to be countered through monetary policy tightening but transmission channels are impeded by excessive banking system liquidity, implying the need for measures to absorb excess liquidity.

Staff does not recommend Fund approval of the retention of the exchange restriction arising from FX prioritization and rationing of FX, of the tax clearance certificate requirement, and of the multiple currency practices (MCPs), because they are not temporary and in the absence of a timetable for their elimination.

An acceleration of structural reform is key for private sector development, in support of  PNG’s inclusive growth strategy. The business environment, particularly for agriculture and SMEs, needs to be strengthened through providing better infrastructure, access to financing, and law and order.

While welcoming the recent progress, the IMF team suggested more decisive action is needed to improve macroeconomic statistics.

Priorities for further reform include balance of payments, international investment position, and debt data.