6 Pacific island countries at risk of falling into debt traps
Collectively and individually, the economic performance of the Pacific island countries has been erratic for the most part, and in most cases quite pinched, hence their heavy reliance on external aid. Financial analyses indicate the volatility of their real GDP growth. The annual average rates for growth have been low.
International lenders have identified at least six Pacific island countries that are facing elevated risk of debt distress. The list includes Kiribati, Marshall Islands, Federated States of Micronesia, Samoa, Vanuatu, and Tuvalu. Narrow economic bases, vulnerability to economic shocks and exposure to climate change and natural disasters are among the factors that arrest the development of these economies, according to the Asian Development Bank’s Pacific Economic Monitor released in December 2018.
ADB’s analysis of the Pacific island countries’ books indicate a recurrent —and worsening— financial predicament that will extend for a long period of time and curtail their ability to pay their debt service.
“ADB and development partners are working with Pacific governments to strengthen debt management while also promoting long-term solutions to the challenge of expanding access to basic services,” said Carmela Locsin, director general of ADB’s Pacific Department. “While debt financing can play an important role in responding to substantial infrastructure needs in the Pacific, strong project due diligence, investment planning, and improved debt monitoring frameworks are needed to safeguard against future repayment concerns.”
Following are the highlights from ADB’s economic monitor report:
Marshall Islands: Despite significant progress in controlling its public debt, the latest debt sustainability analysis of the IMF and World Bank places the Marshall Islands at high risk of debt distress. Since 2012, the country has received sizable revenues from fishing license fees. This has been accompanied by large increases in recurrent spending, particularly on public sector wages, which accounted for 22.3 percent of total expenditure and increased by 8.3 percent in FY2017, and subsidies and transfers to state-owned enterprises, which increased 34.5 percent. On the revenue side, there is room to improve tax collections, with important reforms still pending.
Kiribati. Analysis for Kiribati baseline scenario shows that the present value of its external debt-to-GDP is projected to breach the indicative ceiling (30 percent of GDP) by 2023. Like most Pacific island countries, Kiribati faces many development challenges due to its geographical layout. Its high vulnerability to the adverse impacts of climate change, such as higher incidences of disasters, loss of groundwater, and rising sea levels, necessitates government spending on climate change adaptation efforts.
In the face of this vulnerability, Kiribati adopted a Joint Implementation Plan for Climate Change and Disaster Risk Management in 2014, which identifies key strategies that will cost $94.6 million or the equivalent of 52.2 percent of its GDP from 2014 to 2023, with the infrastructure strategy component accounting for $48.1 million. Faced with domestic resource constraints, Kiribati will be heavily dependent on the participation of development partners, if it is to successfully implement the plan.
Samoa. Sound policy reforms and prudent fiscal management allowed Samoa to reduce its debt burden from 121.7 percent of GDP in 1994 to 33.6 percent in 2008. However, damage and losses caused by a tsunami in 2009 and a cyclone in 2012 caused a decline in economic growth over the long term. The government responded with increased expenditure for rehabilitation and new public investments to stimulate growth, leading to high debt levels.
Fiscal deficit averaged 5.4 percent a year between FY2010 and FY2015 resulting in the breach of 50 percent debt target from FY2013. Samoa’s debt stock trends reflect large shocks faced by the economy as a result of global economic shock (2008–2009), natural disaster (2012), and public investment decisions.
Vanuatu. This is ranked as the world’s most vulnerable country for disasters in the United Nations World Risk Index in 2017. This has implications for debt sustainability. For example, Tropical Cyclone Pam, which struck Vanuatu in 2015, caused damage to infrastructure equivalent to around 60 percent of GDP. Vauatu’s public debt increased in the wake of Cyclone Pam from the equivalent of 24.1 percent of GDP in 2014 to 46.1 percent in 2016. Public debt is now at the higher end, compared with other Pacific island countries. Even before the cyclone hit, the government had a large infrastructure pipeline to be financed by grants and concessional lending. Yet, simple repairs required on some projects, including the airport rehabilitation, became major reconstruction activities due to cyclone damage.
Federated States of Micronesia The FSM’s Compact Trust Fund is seen to fall short of the target level required to generate replacement income for expiring U.S. Compact grants, based on current accumulation trends. Latest estimates from the IMF and Graduate School USA indicate that combined financial assets in the CTF and the FSM Trust Fund are likely to allow for sustainable withdrawals—that is, without eroding the real value of the funds for future generations—of about $35 million a year. This will be about $45 million short of expiring Compact grants (around $81 million) after 2023. A deficit of this magnitude would require substantial cuts in essential services such as education, infrastructure and health; increases in taxation; a considerable increase in debt; or some combination of these. In 2017, the IMF recommended a medium-term fiscal adjustment to boost fiscal surpluses of about $30 million in FY2015– FY2016 by another $15 million to cover the impending shortfall after 2023.
Cyclone Pam leaves a trail of destruction in Vanuatu in 2015. Photo courtesy of devpolicy.org
Tuvalu. In the 2017 World Risk Report, Tonga was ranked as the second highest country at risk of disasters due to its high exposure to weather disturbances and sea-level rise as well as weak disaster management. The impact of disasters in Tonga are severe both in the magnitude and cost of the damage. In the last two decades, there were four major cyclones that caused substantial damage in Tonga—three of which struck the country this decade. The latest and most destructive weather disturbance to hit Tonga was Tropical Cyclone Gita last February 2018. It cost the economy an estimated $164.3 million in losses which is equivalent to 37.9 percent of Tonga’s GDP.
When Cyclone Pam hit Tuvalu in 2015, around 45 percent of the population were affected as the country suffered from substantial losses amounting to $10.3 million, equivalent to 26.9 percent of its GDP. In these circumstances, there is a need to invest in infrastructure that can withstand future weather disturbances. Such investment and the costs of reconstruction are likely to impose a heavy burden on the government’s fiscal position. The debt level of Tuvalu would be greatly influenced by at least two possible shocks: disaster and fishing revenue. Under a disaster shock scenario, the impact of a cyclone similar to Cyclone Pam would result in a larger fiscal deficit equivalent to 10.0 percent of GDP in 2028. A fishing revenue shock assumes that changes in weather patterns would lead to a sharp decline in fishing license revenues between 2028 and 2032. This would result in a fiscal deficit equivalent to 15 percent of its GDP.