Foreign Aid and Fiscal Behaviour Of The Government in Papua New Guinea Presentation by Peter Johnson Author Aaron Batten

1. Foreign Aid and Fiscal Behaviour Of The Government in Papua New GuineaPresentation by Peter JohnsonAuthor Aaron Batten

2. Overview • The paper seeks to determine what impact foreign grants have had on the fiscal behaviour of the PNG Government; • The core questions which are addressed include: • whether grant aid has tended to lower the PNG Governments domestic revenue raising efforts, • whether grant aid has encouraged the PNG Government to be less fiscally responsible and accumulate higher levels of foreign debt, • whether grant aid has encouraged a deterioration in the composition of government expenditures away from key service delivery sectors; and • whether budget support vis-à-vis project and program aid have had differential effects on any of the above.

3. The Data

4. Expenditure, Grant Aid and Domestic Revenue

5. Public Debt – Foreign v Domestic

6. Budgetary Support and Project and Program Grants

7. The Models • The paper presents three models • Each model has a long-run; short-run and total impact component • Model I (DB, DR, Grant, Expenditures) • Model II (DB, DR, Grant, Expenditures (General and Development)); • Model III (DB, DR, Grant (Budget and Program), Expenditures (General and Development)); • Each model estimate the long-run and short-run adjustments to domestic borrowing and total impact of a one standard deviation shock to grant flows.

8. Model I Model 1 – Fiscal Aggregates and Expenditure (DB, GR, DR, EX) • Long-run • Grant revenue has a highly significant positive coefficient estimate, suggesting that over the long term it has tended to act as a substitute for government borrowing; • Similarly, higher levels of domestic revenue collection are also associated with reduced levels of public debt; and • Lastly, the expenditure variable is negative and also highly significant. • As expected this indicates that higher long run levels of government expenditure have been associated with higher levels of public debt. • Short-run • Expenditure levels and following this debt levels are the key variables which adjusts in the short term to correct imbalances in the budget according to Equation (6). • This suggests that in the short term at least grant revenues have tended to replace rather than augment domestic expenditure levels.

9. Impulse Response Function A one standard deviation increase in grants reduces expenditure, borrowings and domestic revenue collection; The results imply that revenue collection fall by approximately half sized fall in taxation receipts after 5 years; The negative impact of grants on expenditure is short lived, with the effect eventually stabilising after approximately 5 years at a near zero value; Once all of the knock on effects within the fiscal system have stabilised the shock to grants acts primarily to replace domestic revenue collection and lower public debt levels, rather than augment levels of government expenditure.

10. Model II Model 2 – Fiscal Aggregates and Expenditure Composition (DB, GR, DR, EX_D, EX_G) • Long-run • The results support those obtained for the cointegrating relationships in Model I. Both grant and domestic revenues have a highly significant negative association with long run levels of public debt. • In addition, both of the expenditure variables have a highly significant positive relationship with long run levels of public debt. • Short-run • As in the previous model, the adjustment parameter in the public debt equation is significant and positively signed. This suggests that the PNG Government has tended to favour varying levels of public debt, rather than reducing expenditure or increasing domestic revenue, in order to adjust to short term fiscal imbalances.

11. Impact Response Function A one standard deviation shock to grant aid leads to a decline both in levels of domestic borrowing and in domestic revenue mobilisation; This suggests that while a portion of aid is treated as a substitute for further government borrowing that it has also encouraged the PNG Government to place a lower tax burden on its domestic constituents; Both the general and development expenditure variables also follow a similar time path to that shown for total expenditures in Model I with an initial small decline followed by an eventual stabilisation at approximately zero.

12. Model III Model 3 – Fiscal Aggregates, Expenditure Composition and Aid Modalities (DB, GR, DR, EX_D, EX_G, G_BS, G_PR) • Long-run • In this case, disaggregating the grant aid variable suggests the budget support component has been the major contributor to reduced levels of domestic borrowing, with the project aid being an insignificant long run influence. • Both expenditure categories also again have negative coefficient estimates, supporting the results of the previous two models that higher levels of spending have a positive relationship with domestic borrowing. • Also in line with the previous two models, higher levels of domestic revenue have a negative relationship with debt levels. • This indicates that increases in domestic resources are not entirely allocated to higher levels of expenditures, but rather to also lower domestic borrowing.

13. Short-run • coefficients once more reveal that expenditures have been a key adjustment mechanism in the short-run. It also appears that the majority of this adjustment has occurred through the development expenditure variable, recording a highly significant positive coefficient estimate whilst the general expenditure variable is insignificant. • In addition, with the disaggregation of aid flows the estimation results show that both project aid and budget support have responded to short term imbalances in PNG’s fiscal position. • The results indicate the Budget support increases in response to fiscal imbalances while Program support declines.

14. Impulse Response Function (shock to G_BS) As in the previous two models, the shock to foreign grants (in this case in the form of budget support) has an unambiguous negative relationship with levels of domestic borrowing; In this case however, rather than eroding tax collection budget support is shown to have an almost benign impact on levels of domestic revenue; and The IRF also shows that an injection of budget support has a significant impact on improving the composition of government spending by increasing the amount of funds going to key development sectors whilst reducing the amount of spending in the general expenditure category;

15. Impulse Response Function (shock to G_PR) In contrast to budget support, the project aid impulse leads to higher levels of general expenditure but not development expenditure. In fact, the project aid impulse leads to a small decline in the amount of government funds allocated to key development activities. Also in contrast to budget support, the project aid impulse raises levels of public debt.

16. Conclusion • What are the key shock absorbers for PNG’s fiscal system? • The PNG Government appears to have been most willing to adjust levels of expenditure in a number of key development sectors in response to fiscal imbalances; • Aid has had an unambiguous negative effect on the accumulation of additional domestic debt; • Aid grants net effect on aggregate expenditure levels has been close to zero; • The claim that grants have supported higher overall levels of unproductive government expenditure are however, not supported by the data.