Pacific Islands ask for debt relief to help New Zealand hit Paris goals

New Zealand’s closest neighbours are worried about their Covid debts. The Pacific Island Forum reckons that as interest rates rise, debt servicing costs may become unsustainable. Ratings agencies are already swirling, warning Pacific countries need to cut back on spending or risk debt distress in the future.

But Pacific Island states have something up their sleeve: emissions reduction. The Forum has floated the idea of climate debt swap, which would allow debt from a Pacific country could be exchanged for helping a polluting country lower its net emissions. New Zealand is interested, Thomas Coughlan reports.

On March 24, Fiji published its revised economic and fiscal update. The document is something akin to New Zealand’s Half-Year Economic and Fiscal Update – a check-in on the state of the Fijian economy and Government finances.

A day later, ratings agency, Fitch published its budget analysis, warning that in the medium term, the Government’s focus would need to be on “deficit and debt reduction”, which would be “limiting” to the “government’s scope to increase spending”.

Tough luck for any Fijian politician wanting to increase public services. If Fiji wants to retain access to international debt markets, the focus has to be debt reduction.

Fitch reckoned Fiji’s budget deficit would peak at 13.2 per cent of GDP this year, and narrow to 7.7 per cent next year as tourism returned to the islands.

Thirteen per cent is a big deficit for a small country. In 2020 and 2021, New Zealand’s deficit was just 7.3 per cent and 4.6 per cent of GDP respectively. For Fiji, the cost of Covid has been very, very high indeed.

The issue hasn’t gone unnoticed in New Zealand. Leaf your way to the back of the Fiji’s EFU, and you’ll find New Zealand listed second in a list of donor nations who have offered up grants to the Fijian Government to prop up its spending.

New Zealand will offer up FJ$57m in the 2021-22 fiscal year, up from $61m in the 2020-21 year.

The sum of this aid is beaten only by Australia, which gave FJ$130m this year (and FJ$154m last year).

Other donors include the United Nations, the European Union, the World Bank, the Asia Development Bank, and the Governments of China and Japan.

This kind of aid is unusual, though not unprecedented.

More often than not, countries like New Zealand tend to favour aid attached to specific projects like improving water supplies, renovating schools, and markets. The mechanism is not unheard of – an Mfat spokesperson said “Budget support linked to economic reform is not a new development funding mechanism and has been used by Aotearoa New Zealand, and other development partners, for a number of years” – but it is relatively rare.

Grants are usually linked with requirement for economic reform. An Mfat spokesperson said New Zealand had been doing this in “Fiji, Kiribati, Nauru, Papua New Guinea, Samoa, Solomon Islands, Tonga, and Tuvalu” in association with “the Asian Development Bank, Australia, the European Union, and the World Bank”

Just handing over money to a foreign government to help ends meet nevertheless uncommon, particularly when countries in receipt of foreign aid are ruled by Governments with a few rough edges.

This is certainly the case in Fiji, with whom New Zealand has had a strained history of diplomatic relations. But during the pandemic, officials decided Fiji’s need was great enough to offer up grants in aid to offset the “economic and fiscal impacts” of the pandemic, with relatively few strings attached.

Last month, the Pacific Islands Forum (PIF) held a conference on the sustainability of Pacific nations’ debt.

Like most countries, including New Zealand, the Pacific islands loaded up on debt during the pandemic to support their domestic economies. With many island economies dependent on tourism, Covid-induced recessions were harder in the Pacific than they were elsewhere.

The Cook Islands experienced an estimated peak-to-trough fall in nominal GDP of close to 32 percent during the pandemic, despite the Government supporting the economy with a stimulus package of 20 per cent of GDP.

But those debts, and the cost of servicing them as interest rates rise, has the Pacific spooked. Cook Islands Prime Minister Mark Brown told PIF’s debt conference the pandemic had required $228m in borrowing, which had doubled net debt to 43.5 per cent of the Cooks’ GDP.

“The large increase in debt, and the servicing this requires for some of the loans with shorter terms, is a key challenge for us,” he told the conference.

“Our debt servicing costs are forecast to increase to $30 million by the end of this decade. That is approximately 16 percent of our total revenue. This is three times our current debt servicing costs,” he said.

This is substantially more than New Zealand’s financing costs, which have been lower than 2 per cent of GDP since the end of the 1990s, equating to about 6 per cent of total government spending.

Brown told the conference those costs were going to be a problem, as they would “severely impact our capacity to invest in,let alone maintain our infrastructure and will be a dampener to our attempts to fast track economic growth”.

“It will hamper our efforts to meet mounting social obligations as prosperity levels drop,” he said.

The Cooks were another country which received grants from New Zealand during the pandemic. New Zealand had no other choice. Realm countries like the Cook Islands don’t have access to international agencies like the World Bank or International Monetary Fund (IMF) if they get into distress.

Realm countries cannot join these organisations in their own right, leaving them dependent on New Zealand if they get into trouble. The Government had a choice between watching the Cook Islands go bust, or bailing out its Government.

In the wake of the Solomon Islands fiasco, New Zealand and Australia are keen to ensure Pacific Island debt does not create a back door for powers like China to establish a firm presence in the region. But doing so will be expensive.

PIF Director for Programs and Initiatives, Zarak Khan told the Herald the organisation had been watching the “Sri Lanka sovereign debt crisis closely” and it had vindicated the Pacific’s desire to strengthen its position around debt early, before crisis knocks at the door.

The forum has established the Pacific Resilience Facility (PRF), which, when fully funded with US$1.5 billion is meant to become a Pacific-owned self-financing fund to pay for damage from climate change and disaster risks. Former prime minister Helen Clark has signed up as the PRF’s global ambassador, to help it reach its funding target.

The debt conference also included more politically contentious outcomes. Khan said PIF would now be “looking towards New Zealand” to assist with lobbying internationally for “debt distress reduction strategies” to help Pacific Islands deal with their creditors.

One idea is for grants in aid like those given by New Zealand during the pandemic to become semi-permanent. This would mean Pacific Governments could run fiscal deficits without needing to borrow more debt.

“Fiscal deficits need to be funded sustainably,” Khan said.

“Instead of borrowing to fund their deficits, its more sustainable for countries to receive budget support in the interim period to bridge the fiscal gap, as it also won’t lead to debt creation”.

However Khan warned that long term this might not look “prudent” to other creditors, who wanted to see balanced budgets.

Another idea is something called a climate debt swap. Under-Secretary-General of the United Nations Armida Alisjahbana told the debt conference such a “swap” would allow creditor countries to allow states to reduce the amount of money repaid by a debtor country if that country invested an equivalent amount in climate action.

Developed countries like New Zealand are required, under the Paris Agreement, to help developing countries deal with climate change.

New Zealand has signed up to spend $1.3b over the next four years on such aid.

This particular type of swap will not work specifically for New Zealand because the Government does not itself hold any debt owed by Pacific countries.

However, the Government could use these funds to “swap” debts held by multilateral development banks, which could then be swapped for climate action.

Another, simpler, solution was floated by the Minister of Finance of Tuvalu, Seve Paeniu who told the Forum the Pacific should look at harvesting the value of the region’s fisheries and “pool future funds for development and savings like a credit union”.

The key to solutions like this is ensuring resource extraction rights do not lead to the same undermining of sovereignty that a forced debt default might.

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