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p. 52 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions 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 Republic of Palau Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia

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Cook Islands

Supported by rising tourism activity, a high level of building activity, and firm consumer demand, the economy continued to grow in 2004. The overall fiscal position is sound and the Government’s cash reserves increased further over the year. Medium-term outlook remains positive, with tourism expected to continue leading growth, and some rebuilding of other sectors in prospect.

Macroeconomic assessment of 2004

The economy achieved its sixth consecutive year of growth in 2004. Preliminary national accounts indicate that GDP grew by 3.4% in the 12 months to June 2004. It is expected to have remained firm in the quarters to September and December 2004 as tourist arrivals rose and building activity picked up.

Visitor arrivals in the quarters to March and June 2004 were only slightly above the same periods of 2003. Air New Zealand, the main international carrier, introduced cheaper airfares in June, and this led to a sharp rise in visitor arrivals over the second half of the year. Preliminary data suggest that total visitor numbers increased by 6% in 2004.

Like tourism, building activity appears to have leveled off in the first half of 2004. The value of building approvals fell over the first 2 quarters of the year, but approvals for commercial buildings recovered in the third. The total value of building approvals was 9% higher over the first 9 months of 2004 than in the same period of 2003.

Bank lending continued to grow. After rising by 41% in 2003, loans and advances increased by a further 13% by September 2004. Approximately half of the additional lending was provided in the personal services subsector, a reflection of firm consumer demand. Additional lending was also provided to the wholesale and retail trade and to hotels and motels.

Total merchandise export growth is expected to slow in 2004 relative to 2003. A contributing factor is a further contraction in the pearl industry. For the first 9 months of 2004, pearl exports were 28% below their value for the same period of 2003. On an annualized basis, pearl exports are now less than 15% of their peak value seen in 2000, a consequence of low international prices and the ongoing impact of disease that resulted from overcrowding in the main producing lagoon in 2000. In contrast, fish exports have surged in recent years and in 2003 replaced pearls as the main source of merchandise exports. However, adverse weather conditions and financial difficulties reduced their value by 72% in the first 9 months of 2004 compared with the same period in 2003.

Despite a large fall in imports of machines, transport, and equipment, total merchandise imports rose in the first 9 months of 2004 from the same prior-year period, in the process further widening the trade deficit. However, the surplus on the services account attributable to the vibrant tourism sector more than offset the trade deficit.

Inflation was low at 0.3% in 2004, a result of the overall sound fiscal position and the combination of low inflation in New Zealand, the main source of imports, and a nominal appreciation in the New Zealand dollar, the currency used by the Cook Islands. Broad money grew by 9.6% in FY2004 (ended 30 June 2004), slightly lower than the recorded 9.9% growth in FY2003.

The solid economic conditions helped further improve the fiscal position over the year. Revenues from the four main taxes (VAT, income tax, import duties, and company taxes) were 9% higher than in the previous year. Small increases in both the operating surplus and the level of net lending are projected.

Macroeconomic policy developments

By the mid-1990s, the Cook Islands had accumulated an unsustainable debt position and an excessive wage bill. A wide-ranging economic reform program was adopted to correct these economic imbalances, and the overall objectives of the reform program of economic growth and fiscal stability are now firmly in place. The challenge now facing policy makers is to address the consequences of continued expansion.

The final component of a 1998 debt restructuring was settled in 2004 through the acceptance of an offer of concessions from the French Government. The debt-to-GDP ratio has fallen steadily since the debt restructuring, aided in 2004 by the appreciation of the New Zealand dollar and the continuation of budget surpluses. The gross value of public debt is approximately 40% of GDP, much of which is held on concessional terms. Cash reserves, equal to 14% of GDP, have been built up to cover certain future debt obligations and to be a financial safeguard in the event of a natural disaster or economic downturn.

The overall improvement in the fiscal position was recognized in October 2004 by Standard & Poor’s, which raised the long-term rating to BB- from B+. This is the fourth upward revision to the rating since an initial B-/C rating was assigned in 1998. However, the Cook Islands was put on credit watch in early 2005 because of the threat to the economy from cyclone activity.

As part of the debt restructuring, targets were set for the ratio of the wage bill and other expenditures to GDP. There has been some slippage recently in the satisfaction of these targets, and a hoped-for shift in expenditures to capital and essential goods and services is yet to be achieved (Figure 2.25). At the same time, the burgeoning economy is placing greater demands on infrastructure. Roads, airports, water and sewerage systems, and the electricity network are candidates for higher capital and maintenance spending. A rebalancing of outlays toward infrastructure is increasingly important if the economy is to retain the capacity to grow in an ecologically sustainable and balanced manner.

Recent episodes of health problems arising from pollution in Rarotonga’s lagoon have provided an early warning of the potential consequences of sustained growth. Such episodes may increase in frequency if infrastructure is not upgraded and if land-use planning is not improved. The pressures being placed on the natural environment have the potential to both impair the quality of life of residents and undermine prospects for the tourism industry.

A further challenge facing policy makers is a sustained population decline. High levels of emigration and a rising foreign presence have raised community concerns of a weakening of the Cook Islands-Maori culture. The tourism industry is also concerned that any loss of the uniqueness of the Cook Islands experience sought by visitors will have repercussions for its prospects.

The country’s first National Development Plan is in preparation to help provide a national consensus on how to address these and other strategic issues. A national forum was held in late 2003 and sectoral working groups have been formed to prepare strategies for key sectors. Progress was slowed over 2004 by the national election held in September 2004 and a delay of some months in forming a government. But an economic summit is to be held in early 2005 to take stock of work on the National Development Plan and to assist in budget planning.

Outlook for 2005-2007 and medium-term trends

Visitor arrivals had reached a plateau of some 50,000 a year in the mid-1990s, but subsequent economic reforms and favorable external conditions saw annual tourist arrivals climb to 83,000 in 2004. Investment and consumption have strengthened, and unemployment has fallen to such an extent that low-skilled labor is now being drawn in from neighboring countries. This upward trend in activity is expected to continue. The latest official forecast is for average annual GDP growth of 3.1% over the medium term. GDP per capita is forecast to grow at a similar rate.

In December 2004, air services provided by Aloha Airlines to the US ceased. However, in the same month Air New Zealand expanded its services to the Cook Islands to provide connections to additional airports. In addition, another carrier, Pacific Blue, commenced flights to the Cook Islands in early 2005. These developments will push up capacity while helping maintain downward pressure on airfares. A 13% increase in arrivals is expected over the 12 months to June 2005, slowing thereafter to 4% a year. Although the trend is for additional arrivals to be from lower-spending segments of source markets, tourism is expected to continue generating economic growth over the forecast period.

Hotel capacity continues to expand in anticipation of a rising number of arrivals. Large hotel projects at Vaima’anga on the main island of Rarotonga and on the main outer island of Aitutaki are currently undergoing environmental impact assessment, while small, family-run businesses that have entered the industry to supply bungalow-style accommodation also have considerable potential for expansion. Activity is expected to remain concentrated on Rarotonga and Aitutaki, but increasingly tourism is spreading to other readily accessible outer islands.

Merchandise exports are expected to improve over the medium term. Pearl industry analysts suggest that the main producer of black pearls, French Polynesia, is operating at around break-even. Stabilization in global prices is expected with some prospect of an improvement as supply growth slows. The latest official forecast is for an average annual rise of 20% in the nominal value of pearl exports over the medium term. Fish exports are also expected to improve by 2006 as the predicted El Niño season in 2005 lifts the potential catch in the country’s waters.

An expansion of the Offshore Financial Centre is also in prospect over the medium term. This has stagnated in recent years as the Cook Islands remained one of the few Non-Cooperative Countries and Territories listed by the OECD Financial Action Task Force (FATF) on money laundering. Legislative and administrative changes had been made to comply with the requirements of the FATF, including the establishment of a financial supervision commission and new banking and financial transactions legislation. The country was removed from the list in February 2005 but will be subject to strict monitoring for at least 12 months.

Inflation is expected to stay low over the medium term. Local demand pressures have had little effect on the local inflation rate, and inflation in New Zealand and Australia remain the dominant influences. The Reserve Bank of New Zealand has an inflation target of 1-3% per annum, and a similar range is targeted by the Reserve Bank of Australia.

A potential risk is that liquidity constraints may push up interest rates over the forecast period. Deposits in the banking system have normally exceeded loans with the excess funds invested offshore. The very strong growth in loans and advances led to a reversal of this situation in December 2003. The commercial banking sector now needs to borrow offshore to help fund its domestic loan portfolios, and this is adding to the cost of funds and placing some upward pressure on interest rates.

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