With their far-flung territories and distance from global economic hubs, the Pacific islands face significant hurdles in delivering social and infrastructure services to their people. Adding to this challenge are these countries’ narrow economic bases, which limit their ability to collect domestic revenues; their reliance on mostly imported inputs; and their vulnerability to disasters and extreme climate change, the impacts of which can drive up public spending.
Pacific governments can borrow to augment their resources and stabilize public spending and services; but this debt is generally from external sources and comes at a relatively higher cost than it would be for more developed countries, which are considered less of a credit risk due to their more diversified economies. Nevertheless, borrowing is a viable enough option during economic “boom” years, when the government is earning enough to service its debt, but the burden can become excessive when “bust” years hit and revenue streams dry up.
Such was the experience of the Cook Islands in the mid-1990s. After years of borrowing to fund public investments and a growing government payroll, its economy went into a decline and the government was unable to keep up with its debt obligations. At its peak, external debt was equivalent to about 140% of gross domestic product (GDP), meaning that borrowings were worth 40% more than the value of the country’s entire economy.
The Manila Agreement of 1998, brokered by ADB between the Cook Islands and three creditor countries, restructured the Cook Islands’ debt, reducing this burden on the government. It also sought to promote discipline through something called fiscal responsibility ratios. These ratios are mutually-agreed indicators that track public spending and revenue collections as well as debt, and set targets that need to be met before taking on any new commercial loans.
Since then, the Cook Islands government has used fiscal responsibility ratios in managing debt and monitoring operating fund flows. Development partners, including ADB, have used compliance with these ratios as conditions for extending certain types of assistance that have, in turn, helped the Cook Islands to better manage its public finances. The Cook Islands government also reserves part of its funds to partially cover its borrowings, and regularly releases official, publicly available reports on the status of its debt profile and loan repayment reserves.
The continued commitment to fiscal responsibility and strengthening public financial systems has paid off: the government is keeping debt below its set target of 35% of GDP—well below what it was in the 1990s—and recent assessments have found the Cook Islands to be capable of meeting its financial obligations. That said, responsible government spending and borrowing remains key to maintaining this momentum. This should be complemented by mitigating the risk from disasters and adverse economic shocks. The Cook Islands is doing this through investments in energy and information and communications technology, establishment of an emergency trust fund, and disaster-contingent financing from the Pacific Catastrophe Risk Assessment and Financing Initiative and development partners.
Over the long term, strong public financial management will help the Cook Islands avoid a crippling debt burden that would divert the resources of future generations from funding crucial public services, particularly those for health and education. Complementary measures to broaden investments and safeguard against disaster risk will help diversify the country’s economic base, create new business opportunities, and ensuring resilience to disasters and external shocks.
This blog post relates to the 2019 ADB Annual Meeting institutional event Is Debt Sustainability a Cause for Concern? Follow the 2019 ADB Annual Meeting on Twitter @ADB_HQ and Facebook @AsianDevBank using the hashtag #ADBFiji.