UNTIL last year, the Republic of Narau spent millions in development aid on its national airline. With three planes and routes across the South Pacific, the minuscule island nation of 9,000 did battle with its historic nemesis - isolation.
But to Australia, the South Pacific's largest aid giver, Narau was throwing good money after bad. ''They were making very large losses,'' says an Australian official. ''It was in the neighborhood of tens of millions of dollars.''
Australia, long happy to play the Scandinavia of the South Pacific by doling out millions of dollars in no-strings-attached development aid, had had enough. Last month, the country enacted a federal budget that formalized a stringent and controversial new aid policy that called for massive economic reforms in the South Pacific.
The shift in policy has come under fire from some island nations in the South Pacific - a vast swath of ocean, archipelagoes, and poverty considered one of the most difficult parts of the world to develop.
''If you want to give us money, then give us money,'' says Johnson Honimae, an aide to Solomon Island Prime Minister Solomon Mamaloni. ''We know how best to spend it.''
Led by Papau New Guinea (PNG) and the Solomons, some South Pacific nations are attacking the reforms as paternalistic and colonial. Many gained independence from the United States, Britain, Australia, and New Zealand in the last 50 years. If aid is going to be given, they say, how it is used should be decided by each nation.
But Australian development experts disagree. ''A lot of countries are resisting,'' says Ila Temo, a development expert at the Australian National University in Canberra. ''But the feeling is that foreign aid in a lot of these island countries presents them with easy options. The hard decisions are not being made because of foreign aid.''
The shift reflects the spread of get-tough aid policies worldwide and Australia's struggle to better manage its own resources as it tries to compete with its booming Asian neighbors. In the new budget, the $3.3 million that would have been this year's inflationary increase was put in a new, experimental aid fund that will be given to governments carrying out the economic reforms Australia recommends. ''It's basically a mechanism to reward good performance,'' says an Australian diplomat. ''And obliquely to punish those who are less responsible.''
Australia has also begun the controversial process of phasing out all direct aid to the government of PNG, its former dependency, by the year 2000. Australian aid makes up between 20 and 25 percent of its national budget, but its economy and new currency are spiraling.
This Tuesday, protesters in Port Moresby, the PNG capital, decried an Australia-backed $487-million World Bank restructuring program that requires land privatization and other economic reforms. Papau New Guineans accuse Australia of still trying to dominate them 20 years after independence.
''For far too long [they] have viewed us in a condescending manner,'' ruling party member Ben Micah says. ''And now they want to use current economic hardship to justify taking over our country.''
But Australian government officials point to a series of islands they say are models of economic reform. Generalizing about nations with vastly different resources is difficult, but Fiji, the Federated States of Micronesia, Kiribati, and Tuvalu are seen as leaders in economic reform, according to experts here, while PNG and the Solomons have made little progress.
A new Australian study found that prices, tariffs, and the cost of doing business on Fiji have lowered following the implementation of a deregulation and privatization program. Foreign investment on the island, whose economy is based on sugar exports, has also increased.
Australian officials say that their government has little to show for the millions in aid it has pumped into the region since World War II. Australia will give $97.3 million to the South Pacific and $236.7 million in aid to PNG this fiscal year.
Most of PNG's and the South Pacific's 6 million population are poor and have inadequate education and health care. In many newly independent islands, dependence on aid from former colonial powers remains. Attempts to develop state-owned export industries on small islands separated by thousands of miles of oceans from large consumer markets have largely failed.
With the next annual meeting of South Pacific Forum leaders scheduled to be held in PNG in September, tensions are rising. Australian experts say nations with large forest or mining resources are depleting their resources too quickly.
But Solomon Island officials say they have no choice. ''Logs make up about 20 to 30 percent of our government revenue. Will Australia be able to inject that much if we stop?'' asks the Solomon's Mr. Honimae. ''I don't think Australia or [the World Bank] are capable of it.''