There is a growing recognition that Australia will need to do a lot to help the Pacific get through the Covid-19 pandemic. Like everywhere, big sums of money are needed. The question is how to finance it.
Many advanced economies are rolling out budget packages of 10% of GDP or more. The Pacific might need something similar. If so, that could mean as much as A$5 billion.
For the aid dependent Pacific, funding at anywhere near this scale must come from outside. Though other development partners will need to contribute, Australia is by far the leading player in the region. So there is some expectation that Canberra will have to do a lot of the heavy lifting.
For nine Pacific countries, sizeable Covid loans combined with policy dialogue around how future government spending and development partner assistance might be adjusted seem a reasonable path forward.
Given Australia’s own budgetary pressures, consideration has naturally gravitated towards the idea that much of this may have to take the form of loans rather than grants. Yet, that sits awkwardly with the repeated warnings issued by many – including by the authors of this article, as well as the Australian government – about the mounting risk of debt overload in the Pacific.
Can a big round of Covid loans really be justified, especially at the scale that might be required?
Concerns about debt overload usually focus on the debt sustainability analysis (DSA) ratings produced by the International Monetary Fund (IMF) and World Bank. These DSAs generally point to very limited room for the Pacific to absorb significantly more debt, with many countries already judged to be at a high risk of debt distress (see the table below).
However, mechanically applying the existing DSA ratings is not the best guide to thinking about how to finance today's pandemic response. The DSAs are based on a host of assumptions that will now need substantial revisiting, most notably about the scale and nature of future government borrowing plans. Clearly, with the current situation facing the region – which also includes a major tropical cyclone which hit Vanuatu, Fiji, and Tonga – financing needs and priorities will be substantially reshaped. Like their rich country counterparts, Pacific governments will need to keep their economies (and societies) afloat today, even if this might come at the expense of spending plans for tomorrow.
Updated DSAs will be required. But policy decisions are moving fast. In a crisis, there is no other choice.
|Country||DSA rating *||Total public debt risk indicator||External public debt risk indicator|
|Kiribati||High risk||No breach||No breach|
|Marshall Islands||High risk||Breach||Breach|
|Micronesia||High risk||No breach||No breach|
|Papua New Guinea||Moderate||No breach||No breach|
|Samoa||High risk||Breach||No breach|
|Solomon Islands||Moderate||No breach||No breach|
|Tonga||High risk||No breach||Breach|
|Vanuatu||Moderate||No breach||No breach|
To provide some immediate guidance, we conducted a simple exercise to examine the implications of a large package of hypothetical Covid loans against two key debt sustainability warning indicators.
The first focuses on the size of public and publicly guaranteed debt as a share of GDP. The second is the same measure but focused only on that owed to external creditors. In both cases, we use “present value” measures that account for how concessional or expensive each country’s existing debt is on average. We then add 10% of GDP in Covid loans – adjusting for the fact that we expect these would be provided on at least a semi-concessional basis (broadly following the loan terms under Australia’s Pacific infrastructure financing facility). We then compare what would result from a one-off round of Covid loans for each country against the warning thresholds used by the IMF and World Bank in their DSAs. Note, we make no adjustment for reduced economic growth as this remains uncertain and in only a few cases would this likely be large enough to sway the picture presented here.
The chart below shows the result for the total public debt indicator, while the overall results are summarized in the table presented above, along with the existing DSA ratings.
While having its limitations, the exercise suggests that five of the nine Pacific countries for which data is available would not immediately breach either of the warning thresholds. For these countries, sizeable Covid loans combined with policy dialogue around how future government spending and development partner assistance might be adjusted seem a reasonable path forward.
Conversely, two microstates – Marshall Islands and Tuvalu – do not appear to have scope for large Covid loans. For these two, the Covid financing response will need to take the form of grants.
Finally, Papua New Guinea and Tonga present a mixed picture, with each breaching one of the two warning thresholds. The breaches are however small, implying either more concessional or smaller loans could still be feasible. A more careful approach will nonetheless be needed in these countries given their heightened risk as well as to account for the negative growth impact of the virus. In the case of PNG, for instance, a formal structural adjustment program already looks likely to be a key part of any Covid bail-out package.
Clearly, there are more sustainable ways to finance the pandemic response from a Pacific perspective – using more concessional financing and combining this with debt restructuring or even outright forgiveness. Hopefully these will also be part of the overall pandemic response. The multilateral development banks are for instance preparing concessional financing packages, while on Wednesday night, the G20 has agreed to an eight month standstill on debt repayments to bilateral creditors – an approach that could benefit some Pacific countries, on the condition they are currently on debt service to the International Monetary Fund or the World Bank.
Nonetheless, the perfect should not be the enemy of the good. The scale of the current crisis means large Covid loans may need to be part of the answer. Fortunately, there is at least some scope to do this sustainably.