The Pacific has a growing debt problem – and here’s what governments can do about it

Rising debt and falling income appear to add up to a stark future for Pacific island nations. But belt-tightening can make things worse.

As nations converge in Fiji for the Pacific Islands Forum starting tomorrow, the whole region is in recession, according to a report by the International Monetary Fund in late 2021.

Revenues are down and expenses are up. Global demand for regional exports has declined and COVID-19 has crippled the vital tourism sector.

Meanwhile, countries have faced the expense of managing both the pandemic and climate change. All of this has pushed Pacific countries to a greater risk of debt distress. But austerity measures will only undermine the region’s economic recovery.

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GDP fell by an average of 2.4% in 2021, on top of a 3.7% drop in 2020. The COVID-19 pandemic has hit tourism dependent economies such as Fiji, Palau, Samoa, Tonga and Vanuatu. economic contraction of 6.5% in 2021. Lower global demand has also negatively impacted commodity exporting countries such as Papua New Guinea, Solomon Islands and Tuvalu.

With falling GDP and rising government spending to cushion the ravages of the pandemic, Pacific countries find themselves in a sovereign debt crisis.

Country reports from the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) show that for Pacific countries, the debt-to-GDP ratio, a commonly used benchmark, fell from an average of 32% in 2019 (pre-COVID) to 42.2% in 2021. Fiji and Palau have a debt-to-GDP ratio above 80% and 70% respectively.

Debt limits services

Worrying debt levels and the growing climate crisis are limiting the ability of governments to invest in public services. The remoteness from world markets and the geography of Pacific Island economies result in high infrastructure costs. Remoteness also raises the cost of importing capital goods, mineral fuels and other intermediate goods.

Island nations are now witnessing rising prices, especially for commodities, due to pandemic-induced supply disruptions and the Russian-Ukrainian war.

The Pacific’s vulnerability to natural disasters and climate-induced shocks increases infrastructure costs, as larger up-front investments are now required to build climate-resilient infrastructure. Maintenance expenses are also higher due to recurring damage. The increase in extreme climate-related events is making debt levels in the Pacific more precarious.

To whom does the Pacific owe?

Pacific countries are now more at 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 both have very limited capacity to absorb shocks. Timor-Leste, previously classified as low risk, is now classified by the IMF as having a moderate risk of debt distress.

For middle-income countries like Fiji, Nauru and Palau, the IMF assessment shows that the 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 a sustained deterioration in Fiji’s debt sustainability, which increased its risk of not being able to meet its financial obligations.

According to World Bank data, most of the Pacific’s external debt is with multilateral agencies, not bilateral creditors. The Asian Development Bank is the main creditor of countries such as Fiji, Samoa, Solomon Islands, Tonga and Vanuatu, holding around 38% of all external debt, followed by China (22%) , the World Bank (13 percent), and Australia and Japan (6 percent). Chinese loans represent less than half of the total in Fiji, PNG, Vanuatu and Samoa.

But Tonga, Samoa and Vanuatu are among the countries most indebted to China in the world. In 2020, these countries owed China the equivalent of US$1.6 billion ($2.3 billion). Tonga, with more than 55% Chinese debt as a percentage of total external debt and in the high-risk category of debt distress, needs to be careful in bilateral relations.

A continuing trade deficit and high debt levels could lead Pacific island governments to adopt austerity measures to strengthen their fiscal capacity. This risks deepening poverty and inequality in the region and undermining economic recovery. Rapid fiscal consolidation can also negatively impact the transition to a climate-resilient Pacific and the achievement of the United Nations Sustainable Development Goals.

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So how do we support the Pacific?

Pacific island countries urgently need to improve their finances so they can invest in economic recovery and development and take action on climate change adaptation and mitigation.

To do this, they need substantial financial resources. Grants and access to concessional finance will be essential for the Pacific. The existing international financial architecture, and in particular the debt architecture, does not sufficiently take into account the vulnerabilities of Pacific island countries.

Pacific island countries need long-term financing. The World Bank estimates that the Pacific Islands need more than 10% of their GDP per year and an additional 5-10% of GDP for climate and disaster resilience costs through 2040.

The gap between potential and actual incomes is large in the Pacific, according to ESCAP estimates, and therefore Pacific island countries could consider domestic economic activity to increase their incomes.

Pacific countries have substantial advantages in agriculture, manufacturing and other value-added activities, but these sectors face challenges such as high operating costs due to investment costs and transport, a constant supply of materials and the mismatch between the motivation to market and the political conditions required. trust, policies and resources. These issues need to be deliberately addressed.

If Pacific island countries are to chart a course for 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.

The day-to-day management of public finances in the Pacific has improved, according to the AfDB’s Pacific Economic Monitor series, but this remains an area in need of capacity building. Experience from other developing economies underscores the need to develop a comprehensive approach, including strengthening investment priorities, public financial management planning through short- and medium-term frameworks, and broader reforms public sector to improve operational efficiency.

Appropriate debt financing can play a crucial role in meeting long-term development needs in the Pacific. But transparency, accountability, and effective debt monitoring are needed to address future debt obligation issues and associated constraints on domestic resources.

Pacific island governments must lead this process, with a strong commitment to prudent fiscal discipline through proactive policy approaches and investments in areas that offer sustainable and meaningful economic returns. It is crucial for the long-term fiscal sustainability of the Pacific and for the well-being 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. This article was first published under Creative Commons by 360info.

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