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p. 43 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asia The Pacific Cook Islands Fiji Islands Kiribati Republic of the Marshall Islands Federated States of Micronesia Nauru Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia

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Cook Islands

Economic growth virtually stopped in FY2002, reflecting a decline in visitor arrivals following the September 11 events. Medium-term forecasts, however, suggest that economic activity should improve, if the expected expansions in tourism, pearl exports, and construction are realized.

Macroeconomic Assessment

Economic growth slowed to 0.3% in FY2002 (ended 30 June 2002), following 2 years of strong momentum. In the aftermath of the events of September 11, visitor arrivals fell by nearly 9% in FY2002 (Figure 2.24), with the largest decline occurring in the January-March quarter, leading to a 6.2% fall in visitor spending. International air services were curtailed for some airlines, though tourist growth resumed in the second half of 2002. Total merchandise exports fell from US$9.5 million in FY2001 to US$5.8 million in FY2002, largely due to an almost 50% drop in sales of pearls, which constitute around 90% of commodity exports. Due to bad weather condition, crops were reduced and many small farmers experienced difficulties with marketing their produce and remaining cost competitive. The tourism-related subsectors of hotels, restaurants, bars, transport, and communications experienced weaker sales. However, construction, trade, and community and personal services recorded modest to strong growth.

Consistent with the general slowdown, average inflation declined to 3.9% in FY2002 from 9.4% in the previous fiscal year. Price trends of various categories of goods and services showed different dynamics, with the index for the food group—with a 32% weight in the CPI—rising by 9.4% and that for gasoline falling by 18%. Inflation was low or negative in most other categories.

In FY2002, the budget was in surplus by NZ$0.53 million, equivalent to 0.3% of GDP, a steep drop from the surplus of NZ$2.7 million in FY2001. Total revenues and grants rose by 3.6%, due to a 4.9% increase in tax revenues and a 10.4% rise in grants; nontax revenues declined by 10.5%. On the expenditure side, the 6.6% increase in total expenditures was driven by a 9.2% rise in expenditures on goods and services, while capital expenditures fell by 9.0%. Net debt declined to 69.0% of GDP, with the Government maintaining a small reserve for future debt repayment. This compares with a debt stock of 76.0% of GDP in FY2000.

The steep fall in total merchandise exports stemmed largely from a 60% drop in pearl exports in the January-March quarter of the fiscal year. Also in FY2002, imports declined by 8.8% to US$46.3 million from the year earlier level, primarily because of decreases in imports of minerals and fuels, beverages and tobacco, and machinery and transport equipment. The trade deficit narrowed slightly from US$41.2 million in FY2001 to US$40.5 million in FY2002.

Net foreign assets in the banking system at end-June 2002 were down 7.0% compared with the level 12 months previously. Net domestic credit grew at a rate of 24.0%, reflecting higher claims on the private sector. Broad money supply at end-June 2002 was 3.2% higher than a year earlier. Nominal interest rates on deposits ranged from 1% to 3.25%, while nominal lending rates ranged between 9.75% and 16.50%. The Bank of the Cook Islands has been adopting a higher interest rate structure than Westpac and the Australia and New Zealand Banking Group, the two commercial banks present in the country.

Policy Developments

Following a period of political instability in the second half of 2001, a new Government came to power in early 2002. The new budget policy statement presented in March 2002 focused on achieving national goals in six areas: social cohesion, economic sustainability, good governance, infrastructure development, outer island development, and environmental management. These priorities are similar to those that were already in place with the exception of environmental management, which was a new concern. One notable policy direction was the decision to reverse the devolution of political and economic responsibilities to local governments. However, repeated changes of key political figures in the later part of the year and early 2003 may affect the direction and actual outcomes of government policy.

Although the FY2003 budget continues to target a small operating surplus of about 2.6% of GDP, an overall deficit of about 2.5% of GDP is likely, reflecting higher capital expenditures and a new superannuation scheme for members of parliament. Recent budgets have helped consolidate the fiscal position. However, fiscal sustainability is fragile since debt is still considerable, principal repayments will increase in the coming years, and the economy is small and heavily reliant on tourism. Any weakening of economic growth quickly impacts government revenues and the fiscal position.

Government debt reached unsustainable levels in the mid-1990s, culminating in a fiscal and economic crisis. A comprehensive economic reform program was initiated in 1996 with an emphasis on restoring fiscal discipline and transforming the economy to become more open and market friendly. External debt was restructured with the signing of the Manila Agreement in September 1998. Although the book value of external debt is still very high, much of it is at concessional rates and so servicing is currently manageable, provided that the fiscal stance remains prudent and economic growth continues. These, in turn, depend on ensuring that the public investments financed by the debt earn adequate economic returns and that the Government continues to pursue policies that support private sector development.

Current debt service commitments are close to the ceilings calculated when the debt restructuring agreement was put in place, so that there is currently little scope for increased borrowing. However, there will be some room to maneuver in the next few years to finance public infrastructure investments, of which the Government has identified several that it considers important in facilitating economic growth. These programs include lengthening the main airport runway on Rarotonga, sealing the runway on Aitutaki, and expanding port facilities to cater to the potential growth of offshore fishing. In relation to the last, there may be scope for negotiating arrangements with potential operators to have them pay for part of the capital costs upfront in return for usage rights.

Reform of the tax regime with the introduction of a VAT and reductions in company and income tax rates has been successful in improving economic efficiency and revenue generation. The FY2003 budget announced the raising of the income tax-free threshold from NZ$6,000 to NZ$10,000 for equity reasons, though there is still room to reduce import tariffs to be more consistent with economic efficiency. The Cook Islands has signed the Pacific Island Countries Trade Agreement (PICTA) and the Pacific Agreement on Closer Economic Relations between PICTA signatories and Australia and New Zealand. These agreements are expected to provide the impetus for further tariff reform.

With tourism the key driver of economic activity, environmental sustainability is an important issue. The expenditure allocation for environmental management was increased by 34% in the FY2003 budget. This will support environmental services on the outer islands. Options will also be developed for addressing environmental pressures on the Avaraua foreshore in Rarotonga.

The outer island communities are greatly disadvantaged. The new Government has identified social cohesion and outer islands development as priorities, and the latter received the largest single expenditure allocation in the FY2003 budget. However, the reversal of the devolution policy for agriculture, education, health, and justice has caused some confusion in terms of responsibilities and resource allocation. The outer islands were particularly hard hit by outward migration in the wake of the economic crisis of the mid-1990s and improving the delivery of economic and social services to them will continue to be an important challenge to the Government.

The Government is committed to facilitating the development of a longline tuna fisheries industry, constituting an important diversification as well as boosting growth over the longer term. There are no imminent developments but in the FY2003 budget the Government announced a loan to the Bank of the Cook Islands for NZ$2 million to support investors in commercial longline fishing.

Several major tourism projects to increase capacity are currently being considered by the Government. It is likely that these projects, as well as larger-scale fisheries industry development, will require significant foreign investment and management. A liberal approach to foreign investment was evident during the economic reform program under the authority of the Development Investment Board, but in its budget policy statement for FY2003 the Government noted that more emphasis is required both to protect business areas reserved for Cook Islanders and to ensure that major foreign investments have local partners.

A new draft investment code was in preparation in 2002 and early 2003. In developing and implementing the new code, it will be important to establish a transparent, consistent, and friendly foreign investment regulatory regime. Requirements that restrict the scope of foreign investment may result in less competition and a slower rate of economic development. The benefits of foreign investment to the local economy occur through employment, tax revenues, and skills transfer.

Outlook for 2003-2004

GDP is forecast to grow by 1.5% in FY2003 and by 3.2% the following fiscal year. These projections assume modest to strong growth in tourism and pearl exports as well as public and private construction activity, and are in line with the long-term performance of the economy. Inflation is forecast to stay in the 3-4 % range in FY2003. Pearl exports are expected to increase steadily to nearly NZ$9 million (or US$4 million) in 2005. However, total imports will continue to exceed exports, resulting in persistent trade deficits. The large surplus on the services trade account will help achieve a sustainable current account balance, with tourism receipts forming the bulk of services income.

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