Overview

• The Cook Islands' economy is recovering after two years of exogenous shocks. A strong rebound in tourism is leading the recovery, improving the government's fiscal outlook.
• A concentrated private sector limits the government's ability to raise revenues, highlighting dependence on external funding to plug fiscal gaps.
• On May 23, 2023, we affirmed our 'B+/B' sovereign credit ratings on Cook Islands.
• The stable outlook reflects our view that economic growth will support improvements in government finances and reduce net debt as a proportion of GDP over the next few years.

Rating Action

On May 23, 2023, S&P Global Ratings affirmed its 'B+/B' sovereign credit ratings on Cook Islands. The outlook is stable, and the transfer and convertibility (T&C) assessment is 'AAA'.

Outlook

The stable outlook on our long-term rating on Cook Islands reflects our expectation that, over the next 12 months or so, the economic recovery will narrow fiscal deficits, and reduce net debt relative to GDP.

Downside scenario

We could lower our ratings if Cook Islands' public finances were to materially underperform our forecasts. This could occur if fiscal deficits do not narrow and the resulting increase in debt increases the budgetary interest burden to above 5% of government revenues annually.

Upside scenario

We could raise our ratings if there is a sustained improvement in the government's fiscal outlook or economic wealth and diversity improve.

Rationale

We expect Cook Islands' fiscal outlook to improve as the reopening of borders spurs strong tourism flows. The important tourism sector has driven a meaningful improvement in the Cook Islands economy over the past 12-18 months.

Tourism nevertheless remains below pre-pandemic levels. We forecast the improvement in tourism numbers and consequently improvement in government revenues from tourism receipts will lower the ratio of net debt to GDP to about 30% over our forecast period. Fiscal deficits have meaningfully contracted; we expect these to improve to 4.3% of GDP in fiscal year 2023 (year ending June 30), from a high of 23.1% in fiscal 2021. A growing economy and smaller deficits have resulted in slower growth in debt. Cook Islands' debt burden remains modest compared with its peers', and the country owes most of its debt to official lenders.

Our ratings on Cook Islands also reflect the vulnerabilities associated with a weak institutional setting and capacity for making policies, lack of an independent monetary policy, and a narrow economic base. Partly offsetting these factors are the government's supportive relationship and high labor mobility with New Zealand (AA+/Stable/A-1+), financial and technical assistance from donor agencies, and the country's sound financial system.

Institutional and economic profile: Post-pandemic economic rebound under way as international tourists return

• We expect economic growth to average 4.7% over 2024-2026 after two years of rapid expansion. The economy contracted by 19% in fiscal 2021 when borders closed, shutting down the tourism industry.
• Weak policymaking culture and institutional settings constrain the ratings.

As we previously expected, Cook Islands is seeing a strong recovery in the tourism sector; the country is benefiting from its proximity to its largest tourism source market, New Zealand, and pent-up demand. We expect real GDP growth of 11.6% in 2023, spurred by tourism. Borders are now fully opened. In January 2022, Cook Islands reopened to tourists from New Zealand, who historically comprised about 65% of arrivals, and Australia in April 2022, which previously accounted for 15%-20% of arrivals. Tourism numbers had collapsed to zero when the government shut borders to stem the COVID-19 pandemic. Immediately prior to the pandemic Cook Islands enjoyed several years of strong tourism growth. The economy centers on tourism, which is the country's major revenue earner. In our view, this concentration makes the economy particularly vulnerable to tourist preferences, weather events, and downturns in major tourism markets.

The vulnerabilities associated with Cook Islands' relatively weak policymaking culture and institutional settings are a key ratings constraint. The outcome of the 2022 election continued the country's history of political uncertainty. Parliament was unable to sit for six months due to contentions around election polling. The fragmentation leaves Cook Islands vulnerable to policy shifts driven by populist sentiment, which has hampered previous development and much-needed reforms. Shortages of skilled labor continue to weigh on institutional capacity. The policymaking settings derive support from a vigorous free press, an outspoken business community, and efforts by major aid donors to promote sound financial and economic public policies and stronger administration.

In April, 2023, Cook Islands renegotiated terms regarding its developing nation status with the Asian Development Bank (ADB). This allows Cook Islands access to the ADB's concessional funding window. In contrast, Cook Islands no longer qualified to receive official development assistance through the Organization for Economic Co-operation and Development's (OECD) development assistance committee. On Jan. 1, 2020, Cook Islands acquired the status of a developed country from the OECD. Official technical assistance provides vital help to the islands. Additionally, we expect New Zealand--the country's largest aid donor--to maintain its historical support, reflecting long-standing political and social ties. Throughout the pandemic, the New Zealand government provided the nation with additional budget support in the form of grants to support the government's economic response plan and economic recovery plans.

Cook Islands is a self-governing country with a free association with New Zealand. Cook Islanders are citizens of New Zealand. The country achieved self-governance in 1965, but New Zealand controls its foreign policy, defense, and continues to provide budgetary support. The country benefits from a close and comprehensive political and economic relationship with New Zealand.

Flexibility and performance profile: Growing economy supports smaller deficits and slowing debt accumulation

• The growing economy is supporting the government's fiscal outlook and reducing net debt as a proportion of GDP.
• The lack of data on balance of payments and net international investment position continues to constrain our sovereign analysis.
• There is an absence of independent monetary policy since the Cook Islands uses the New Zealand Dollar.

The growing Cook Islands economy is helping to reduce the government's fiscal deficits. We expect fiscal deficits to improve to 4.3% of GDP in 2023 and continue to narrow thereafter. The government scrapped previous fiscal targets during the pandemic, replacing them with rules that outline fiscal prudence while supporting the economic recovery.

A fall in taxation revenues has caused the government to shift its expenditure planning over the next three years. It has paused new programs and focused on maintaining core community services.

We expect it will take a few years before this has a meaningful effect on public finances. The government has not announced any new revenue streams, and we do not anticipate substantive new taxes.

The pandemic interrupted three years of fiscal surpluses in Cook Islands. In fiscal 2021, the general government deficit blew out to 23% of GDP when borders closed.

The narrowing of fiscal deficits means net general government debt will peak at about 33% of GDP in 2023, before receding to about 30% of GDP in 2026. Net debt rose sharply during the pandemic as the government used its cash reserves to fund its large deficit. The concessional and long-term nature of current government borrowings, as well as the government's relatively low debt mean, that the ratio of the general government interest expenditure to revenues is low; we estimate it will average 4.5% of revenues in 2023 and 2025. Typically, borrowings are over 15 years in maturity. About 1% of general government debt is commercial. This is entirely borrowed through its airport authority.

Poor coverage and timeliness of statistical releases prevent a robust analysis of Cook Islands' economic and external accounts. We consider New Zealand to be the starting point, and we also recognize limitations to Cook Islands' external data gaps.

The country's monetary policy flexibility is limited because of the absence of a central bank and its use of the New Zealand dollar. This arrangement means it forfeits monetary independence, which is an important lever for promoting economic and financial stability. It can also make it difficult for the country to control inflation, even though the use of the New Zealand dollar previously enabled Cook Islands to benefit from lower inflation than its peers.

We equalize the local currency rating with the foreign currency rating, reflecting Cook Islands' absence of monetary policy flexibility, its use of the New Zealand dollar, and its lack of a domestic capital market

Key Statistics

Table 1

Rating Score Snapshot

Table 2

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings , Oct. 10, 2021
• Criteria | Governments | Sovereigns: Sovereign Rating Methodology , Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings , April 7, 2017
• General Criteria: Principles Of Credit Ratings , Feb. 16, 2011
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments , May 18, 2009

Related Research

• Cook Islands 'B+/B' Ratings Affirmed; Outlook Stable, Feb. 25, 2022
• Sovereign Ratings History, Feb. 7, 2022
• Sovereign Ratings List, Feb. 7, 2022
• Sovereign Risk Indicators, Dec. 13, 2021

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

Ratings List