Papua New Guinea governor to tackle high liquidity

The governor of the Bank of Papua New Guinea, Loi Bakani, has told CentralBanking.com that he is moving to tackle a build-up of liquidity in the economy due to the success of a major gas project.

The central bank projects GDP to grow in line with the government's forecast of 9.9% during 2012 and Bakani attributes the high growth rate to a liquefied natural gas (LNG) construction project, which is currently reaching its peak in terms of output.

Bakani said the success of the project is causing problems for the central bank as the country is experiencing high levels of liquidity following a rise in foreign exchange flows as well as a build-up in foreign reserves derived from mineral tax receipts. This has led Bakani to dub managing excess liquidity the central bank's "main issue".

The central bank expects the country's broad money supply to increase by 13.3% in 2012, while the monetary base and private sector credit are projected to grow by 32.6% and 10.1%, respectively.

Bakani said high liquidity can be a problem if it generates unsustainable growth in credit. This can lead to an increase in demand for imports and in turn the demand for foreign currency, which may reduce the amount of foreign exchange reserves and the value of the kina; pushing up inflation.

Bakani said credit growth is still moderate, and the central bank is employing a variety of measures to manage liquidity. For example, it has increased the cash reserve requirement for commercial banks from 7% to 8%. "It has worked as well as expected in stabilising conditions in the domestic market, vis-a-vis the liquidity level and interest rates," he said.

Another tool at the central bank's disposal is the weekly issuance of ‘central bank bills' – government securities – that remove liquidity from the market. Later this month, the central bank will issue some of these bills through a new ‘tap facility', designed to involve small investors in the securities market.

"This can affect liquidity when the public buys the bills by withdrawing their deposits from commercial banks and giving it to the Bank of Papua New Guinea," Bakani said.

In its Monetary Policy Review, published in October, the central bank eased its monetary policy stance in reaction to low inflation rates, which registered at 1.4% over the year to June 2012, leading the central bank cut its benchmark interest rate from 7.75% to 6.75% in September.

The low inflation occurred principally as a result of the appreciation of Papua New Guinea's currency, the kina, though the governor noted economic activity was not impacted by the higher value currency.