July 21, 2022
SUVA, Fiji – Rising debt and declining income seem to add up to an austere future for Pacific Island nations. But belt-tightening may make things worse.
The whole Pacific region is in recession, according to a late-2021 International Monetary Fund report. Income is down and spending is up. Global demand for regional exports has declined, and COVID-19 shut down the vital tourism sector. Meanwhile, countries have had to meet the expense of managing both the pandemic and climate change. It has all pushed Pacific nations into greater risk of debt distress. But austerity measures are only likely to undermine the region’s economic recovery.
GDP declined by an average of 2.4 percent in 2021, on top of a 3.7 percent slide in 2020. The COVID-19 pandemic hit tourism-dependent economies such as Fiji, Palau, Samoa, Tonga and Vanuatu hard — they saw an average economic contraction of 6.5 percent in 2021. Declining global demand also adversely impacted commodity-exporting countries such as Papua New Guinea (PNG), Solomon Islands and Tuvalu.
With falling GDP and a rise in public spending to cushion the ravages of the pandemic, Pacific countries find themselves in a sovereign debt crisis. United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) country reports show that for Pacific countries, the debt-to-GDP ratio, a commonly used benchmark, has increased from an average of 32 percent in 2019 (before COVID) to 42.2 percent in 2021. Fiji and Palau have a debt-to-GDP ratio of over 80 percent and 70 percent, respectively.
The worrying debt levels and growing climate crisis are constraining governments’ ability to invest in public services. Remoteness from global markets and the geography of Pacific Island economies means high infrastructure costs. Remoteness also drives up import costs for capital equipment, mineral fuels and other intermediate goods. The island nations are now further witnessing an increase in prices, especially for essential commodities, due to pandemic-induced supply disruptions and the Russia–Ukraine war.
The Pacific’s vulnerability to natural disasters and climate-induced shocks adds to infrastructure costs because greater original investment is now needed to build climate-resilient infrastructure. Maintenance expenses are also higher because of recurrent damage. Increasing climate-related extreme events are making Pacific debt levels more precarious.
Pacific countries are now at greater risk of debt distress, according to a recent debt-sustainability analysis by the IMF and World Bank. Seven low-income Pacific Island countries — Kiribati, Marshall Islands, Micronesia, PNG, Samoa, Tonga and Tuvalu — are at high risk of debt distress.
Solomon Islands and Vanuatu are at moderate risk of debt distress, but they both have very limited capacity to absorb shocks. Timor-Leste, previously rated as low risk, is now rated by the IMF as at moderate risk of debt distress.
For middle-income countries like Fiji, Nauru and Palau, IMF assessment shows debt is sustainable, but in the case of Fiji, the debt situation has worsened and is subject to increased risk. The Asian Development Bank, while downgrading Fiji’s creditworthiness, noted sustained deterioration in Fiji’s debt sustainability, which has increased its risk of being unable to fulfil its financial obligations.
Most of the Pacific’s external debt is with multilateral agencies as opposed to bilateral creditors, according to World Bank data. The Asian Development Bank is the major creditor for countries such as Fiji, Samoa, Solomon Islands, Tonga and Vanuatu, holding about 38 percent of all external debt, followed by China (22 percent), the World Bank (13 percent), and Australia and Japan (6 percent). Chinese loans are less than half of the total in Fiji, PNG, Vanuatu and Samoa.
But Tonga, Samoa and Vanuatu are among the world’s most indebted countries to China. In 2020, these countries owed China the equivalent of US$1.6 billion. Tonga, with over 55 percent Chinese debt as a share of total external debt and in the high-risk category of debt distress, needs to be cautious in bilateral dealings.
A constant trade deficit and high debt levels may lead Pacific Island governments to adopt austerity measures in order to build fiscal capacity. This is likely to worsen poverty and inequality in the region and undermine economic recovery. Rapid fiscal consolidation can also have adverse implications for moving towards a climate-resilient Pacific and achieving the UN Sustainable Development Goals.
However, Pacific Island countries urgently need to improve their finances so they can invest in economic recovery and development and undertake climate adaptation and mitigation measures. To do this, they need substantial financial resources. Grants and access to concessional financing will be critical for the Pacific.
The existing international financial architecture and particularly the debt architecture do not adequately consider the vulnerabilities of the Pacific Island countries. Pacific Island countries need long-term financing. The World Bank estimates that Pacific Islands require more than 10 percent of their GDP annually and an additional 5 to 10 percent of GDP for climate and disaster resilience costs until 2040.
The gap between potential and actual revenue is significant in the Pacific, UNESCAP estimates show, and so Pacific Island countries could consider domestic economic activity to increase their revenue.
Pacific nations have substantial advantages in agriculture, manufacturing and other value-adding activities, but these sectors face challenges such as high operational costs due to capital and transport costs, consistent supply of materials, and the disconnect between the motivation to commercialise and the requisite political confidence, policies and resources. These issues need to be deliberately addressed.
If Pacific Island countries are to beat a path towards the sustainable expansion of financial and technical services, while balancing fundamental infrastructure development and institutional reforms, and managing national debt, they will need to work with development partners and multilateral agencies. Day-to-day management of public finance in the Pacific has improved, according to ADB’s Pacific Economic Monitor series, but it remains an area for further capacity building.
Experience from other developing economies highlights the need for developing a comprehensive approach, including strengthening investment priorities, public financial-management planning via short- to medium-term frameworks, and wider public-sector reforms to improve operational efficiencies.
Appropriate debt financing can play a crucial role in meeting long-term development needs in the Pacific. But strong transparency, accountability and effective debt monitoring are required to meet future debt obligation concerns and associated constraints on domestic resources.
Governments of the Pacific Islands must lead this process, having a firm commitment to prudent fiscal discipline through proactive policy approaches and investments in areas with sustainable and significant economic returns. It is crucial for the Pacific’s long-term fiscal sustainability and supporting the wellbeing of Pacific communities.
Keshmeer Makun is a Lecturer in economics at the School of Accounting, Finance and Economics at the University of the South Pacific in Suva, Fiji.