Trade finance: A catalyst for foreign currency, growth in PNG

ADB
Edward Faber

Cityscape of Port Moresby, PNG.

At a recent local business forum on trade finance in Papua New Guinea (PNG)'s capital, Port Moresby, there was notable anxiety among many local businesses.

"Where can I get US dollars from, can you help?" said one local businessman, involved in the transport business. "I need to buy goods from abroad; it's really hurting my business if I can't get them" said another, from the construction industry.

Such concern is replicated across the business community in PNG, where businesses have to queue for several weeks before they can source from banks the hard currency they need to purchase goods from overseas. Banks, meanwhile, juggle clients’ orders, and go cap in hand to the central bank asking for release of additional foreign currency into the system, if it is available.

PNG has been suffering from a notable shortage in foreign currency reserves ever since commodity prices took a down turn.

Natural gas is the country’s main export, contributing close to 30% of total export revenues. But gas prices have fallen by around 40% over the last five years. Some of PNG's other key exports—coffee, cocoa, gold, lumber, fish and palm oil—have seen similar trends.

Decline in commodity prices has sparked foreign currency shortage in PNG

The declining value of exports has subsequently depressed export revenues, and sharply reduced the amount of foreign currency coming into the system.

Consequently, when importers can't source the foreign currency they need to purchase goods from abroad, construction projects get halted or delayed, as businesses cannot import steel and construction materials. Shelves in supermarkets and in shops become empty, as key imported goods simply don't make it into the country.

Export businesses are also severely affected: tuna factories can't buy cans, and coffee producers are unable to get their hands on new processing machinery. All this helps to put a drag on PNG’s economy.

More access to trade finance, while not the panacea, can be part of the solution.

Trade finance attracts foreign currency

Take for example canned tuna and frozen fish, both of which are key export-driven businesses with significant growth potential. One company we spoke to in the port city of Lae sells about $100 million per year to overseas markets. But its growth is hampered because of lack of access to foreign currency and to trade finance.

Currently, when its products are exported, the firm must wait 2-3 months for goods to arrive in Europe before payment is received. This delays getting cash into its bank and it slows down access to much needed foreign currency that the company could use elsewhere in its business, for example to purchase cans from abroad.

Trade finance products can help plug these payment or receivable gaps. In PNG, ADB is working with a local bank to offer trade finance solutions that include financial assistance through hard currency loans to businesses for trade.

Such assistance speeds up the process of sourcing foreign currency for exporters, and raises foreign exchange liquidity. But more importantly it means that exporters get the financial support they need to grow their businesses, which in turn means more overall economic growth and employment, and more foreign currency in the system.

On the import side, letters of credit also need more take-up. Too many businesses currently pay for their goods in advance, which is risky, strains cash flow, and causes foreign currency to leave the system sooner than needed.

ADB training PNG businesses on documentary collections, letters of credit

ADB has been training local businesses on payment mechanisms, such as documentary collections and letters of credit, which allow importers to maintain control of goods until payment is made.

Letters of credit can also be used to delay foreign currency payments, which could create valuable breathing space for those times when foreign currency shortages peak. While this might not always be appropriate— since banks would need to carefully allocate foreign currency requirements in advance for maturing letters of credit—letters of credit can be used selectively, for example with big-ticket transactions.

PNG is a market with huge potential. The country’s growth rates averaged just below 6% from 2012 to 2016, although more recently growth has slowed to around 3%.

With the right kind of support from multilateral institutions, including support for trade finance, PNG can be propelled back toward much higher growth, as it seeks to graduate from frontier destination to emerging market.