One of the world’s smallest countries has declared itself debt-free and plans to spend the money saved from servicing borrowing on raising pensions and offering incentives to lure expatriates home.

The island of Niue, perched on a coral atoll in the south Pacific, is home to fewer than 2,000 people.

Although self-governing, the island is not fully independent and has a free association with New Zealand, which provides around $14m a year in aid and handles the bulk of the island’s foreign affairs, as well as providing its defence.

Premier Toke Talagi said Niue had managed to pay off up to US$4m of debt and had “no interest” in borrowing again, especially from big powers such as China that had offered the country “huge sums that other Pacific islands find too tempting to resist”.

“We are trying to live within our means using the island’s natural resources such as tourism, bananas and exporting water,” Talagi told the Guardian.

Toke Talagi, the premier of Niue, has declared his country’s ambition of never borrowing money again. Photograph: Torsten Blackwood/AFP/Getty Images

“It is better for us to be patient and invest in funding sources within our island that we will be able to depend on.”

On 1 December the pension for Niueans would rise from US$250 a fortnight to US$272, Talagi said – an increase of just under 9%.

The government was also aiming to increase public servants’ wages in the next three to five years, to reach 80% of New Zealand rates.

Talagi said government employees’ four-day work week would remain the same, as islanders had responded well to having an extra day to volunteer and participate in community activities.

In August, Niue announced that parents of new babies born on the island would be granted a one-off payment of US$1,437 – a move Talagi hoped would tempt young islanders to come home and start families.

The government’s approach is mostly motivated by a need to retain and grow its modest population. Over decades, thousands of people have emigrated to Australia and New Zealand for jobs and other opportunities.

The phenomenon left hundreds of empty houses dotted across Niue and remaining residents worried that there would be too few people left to keep the island running

The government also wants to move away from a heavy reliance on foreign aid – an ambition the New Zealand government has been keen to support.

“In the last few years we have seen a 10% rise in our population, mainly through young people returning from New Zealand, a sort of reverse migration. Things are tough in New Zealand with people sleeping in cars – it is ridiculous,” Talagi said.

“So we are seeing Niueans think twice about staying there, and we welcome them to come home.”

