Executive Summary

The Bank of Papua New Guinea (Bank) expects price stability to continue in 2007 and over the mediumterm.

This is based on its projections in 2007 of:
• Headline and underlying inflation to be 6.0 percent and 4.0 percent, respectively;
• Stable kina exchange rate;
• Prudent fiscal management by the Government;
• Private sector credit growth to continue; and
• Real Gross Domestic Product (GDP) growth of 4.5 percent.

The main risks to price stability are imprudent fiscal management by the Government and a loss in public
confidence associated with the 2007 National Elections.

The Bank supports the Government’s decision in the two supplementary budgets in 2006 to increase development expenditure.

A fast drawdown of these appropriations, which were deposited in trust accounts would exacerbate the already high liquidity levels in the banking system. The adverse impact this might have on the exchange rate and inflation would leave the Bank with a major task of diffusing the excess liquidity. Therefore, a closer co-ordination between the Bank and the Government is essential to ensure that macroeconomic stability is maintained and economic growth continues over the medium-term.

Although headline inflation is expected to be higher than in 2006, based on the projected underlying inflation the Bank will maintain a neutral monetary policy stance. The Bank will closely monitor the above risks and, if necessary, make changes to the monetary policy stance to counter any adverse
effects on the maintenance of price stability in the first six months of 2007.

The non-transmission of the official interest rate to market (deposit) rates is of concern to the Bank. In this
regard, the Bank is supportive of any initiatives by the Government to develop the secondary market for
Government securities.