Journal Issue

Tonga: Staff Report for the 2016 Article IV Consultation

International Monetary Fund. Asia and Pacific Dept
Published Date:
June 2016
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1. Setting. Tonga is a small remote open economy in the South Pacific with a narrow production base and low connectivity, resulting in high transportation costs, limited economies of scale, and high fixed costs (Figure 1).1 As a result of the large number of workers abroad, Tonga is one of the highest-level recipients of remittances as a share of GDP among all developing countries. Tonga’s high dependence on remittances, foreign aid, tourism, and energy imports pose challenges to its development, which is also affected by a protracted period of slower growth in advanced and emerging market countries, particularly in Australia and New Zealand, as well as natural disasters2 and El Niño-related weather events. With limited resources, the government’s recent challenges have been to support reconstruction in the aftermath of Cyclone Ian in 2014, which caused damages estimated at 11 percent of GDP, and to secure sufficient funding for the South Pacific Games (SPG) planned for 2019.3

Figure 1.Tonga: Stylized Facts

2. Political developments. Prime Minister (PM) ‘Akilisi Pohiva4 has been in office since January 2015, following general elections in which his pro-democracy party “Democratic Party of the Friendly Islands” obtained nine out of 26 seats in the Legislative Assembly.5 Under his leadership, the government prepared the second Tonga Strategic Development Framework (TSDF II) for 2015–25 with the focus on governance, inclusion, and private sector development. The Minister of Finance and the Governor of the National Reserve Bank of Tonga (NRBT) have stayed in their posts. The head of state in Tonga, a constitutional monarchy, King Tupou VI, was crowned in July 2015 following his accession to the throne in 2012.

3. Traction. The authorities have made progress on key policy advice outlined in the last Article IV consultation. In the 2015 staff report, staff emphasized the importance of improving the primary fiscal balance over the medium term. The authorities have focused on raising revenues and improving PFM, and followed the policy of zero non-concessional borrowing. They also have been moving cautiously on the implementation of a levy on foreign exchange (FX) transactions and raising the departure fee. However, more needs to be done in the fiscal area to tame wage growth to ensure progress on fiscal consolidation. International reserves have been maintained at a comfortable level. The authorities are considering lowering the inflation reference rate and express their interest in further developing their monetary policy framework and macroprudential operational tools with technical assistance from the IMF. The authorities have made significant progress in structural reforms especially in the area of utilities and labor market, public enterprise reform, formalization of the informal sector, bankruptcy regime, an energy bill, and exports promotion via regional trade agreements.

Recent Developments, Outlook, and Risks

4. Recent developments. Tongan economy has been rebounding since a contraction in FY2013.6 Growth accelerated from 2.1 percent in FY2014 to 3.7 percent in FY2015, supported by construction, tourism, strong remittances, and strong private credit, and notwithstanding weather-related disruptions to agricultural production. Inflation declined from 0.2 percent (y/y) at end-June 2015 to -0.3 percent at end-February 2016, reflecting declining global food and fuel prices, well below the NRBT inflation reference range of 6 to 8 percent. The domestic component of inflation, however, edged up to reflect higher prices of locally produced food (Figure 2). External position remains strong, supported by strong remittances, donor aid, and low global fuel prices, with reserves at $142 million at end-February 2016, equivalent to more than 6 months of imports. From end-FY2014 to February 2016, the NEER for the Tongan Pa’anga, which is pegged to a basket of currencies,7 depreciated by 3.6 percent, while the REER depreciated by 6.1 percent.

Figure 2.Tonga: Recent Economic Developments

5. Outlook. The FY2016 real GDP growth is projected to remain relatively strong at 3.1 percent, driven by a recovery in agriculture and an increase in construction activity in preparation for the SPG. Domestic demand will be supported by lower fuel prices, remittances, and aid inflows, and inflation will remain low. In the medium-term, growth is projected to fluctuate between 2.3 and 3 percent, supported by construction, tourism, and trade in the run-up to the SPG, before converging to its historical average of about 1.8 percent by FY2021. Reflecting the stronger demand generated by the SPG, inflation is expected to increase to three percent in FY2019. The outlook for the external sector is positive with projected low global commodity prices, increasing remittances, and improving tourism receipts. Although the current account is expected to widen in the run up to the SPG, reserves will be maintained at a comfortable level and external debt will remain stable provided that expected donor financing for SPG is realized.

6. Risks. The overall balance of risk is tilted to the downside. Protracted period of slower growth in advanced and emerging market economies, particularly in Australia and New Zealand, could weigh on Tonga via aid, remittances, and tourism channels. On the domestic front, a resurgence of strong credit growth could threaten financial stability, even though the banking sector remains well capitalized and highly liquid. Large increases in current expenditure, particularly the wage bill, could lead to higher public debt, jeopardizing debt sustainability. Slippages in delivery of policy reforms could affect the level of development partners’ budget support, leading to lower aid. Cost overrun related to the SPG could make it necessary to mobilize additional resources, potentially resorting to non-concessional borrowing and raising the public debt. Natural disasters and weather-related events are also a high risk and could take a toll on the economy. On the upside, Tonga would continue to benefit as a net energy and food importer, if oil and food prices remain low (Appendix I).

Authorities Views

7. The authorities concurred with staff assessment of the economic outlook and risks for Tonga. They projected only marginally higher growth than the staff in the run up to the SPG, noting a strong impact on growth of construction projects undertaken by local churches and a major school anniversary celebration later in 2016. Regarding the risks, they viewed a delay in receipt of budget support, natural disasters, and an increase in public debt, including as a result of excessive wage growth, as the main risks.

Policy Discussions

The discussions focused on measures (i) to increase resilience of Tonga’s economy to shocks, including from climate change and natural disasters, (ii) to preserve macroeconomic and financial stability, and (iii) to improve Tonga’s long-term growth prospects.

A. Fiscal Policy

8. The fiscal deficit is projected to widen in FY2016 on the back of a high wage bill growth and lower grants. The overall balance reverted from a 1.7 percent surplus in FY2014 to a 1.1 percent deficit in FY2015, and staff projects a further increase in the deficit to 3.1 percent in FY2016. Revenues are projected to increase strongly on the back of administrative improvements in tax collection and increased excises and customs revenue. However, a decline in budget support grants, together with a shift towards a higher share of loan-financing by donors, and a strong increase in current spending led by wages, will result in a widening of the deficit.8 The projected deficit is higher than implied by FY2016 budget, reflecting a delay in the implementation of the FX levy and the departure fee, and notwithstanding under-implementation of projects constrained by capacity.9 The deficit will be financed by foreign loans, domestic bonds, and drawdown of government deposits. A larger share of loan-financing in overall donor funding will contribute to a higher deficit in FY2016. In the medium-term, spending pressures, arising from wages and preparations for the SPG, will continue. However, provided wages are held in check and grant-financing is secured to finance the SPG, the deficit is projected to decline.

Tonga: FY2016 Budget and Staff Projections
(In percent of GDP)
Total revenue and grants28.633.327.3
Total revenue21.424.523.7
Current revenue21.424.523.6
Tax revenue18.320.220.4
Nontax revenue3.14.43.2
Capital revenue0.00.00.1
Grants (in cash)
Project grants4.56.51.5
Budget support2.72.22.0
Total expenditure and net lending29.335.230.4
Current expenditure25.830.927.8
Capital expenditure2.43.41.7
Total lending minus repayments1.10.90.9
Overall balance (incl. grants)−0.6−2.0−3.1
External financing0.61.01.4
Domestic financing0.10.91.7
Primary balance (incl. grants)0.2−1.1−2.2
Primary balance (excl. grants)−5.9−9.8−5.8
Memorandum items:
Nominal GDP (in millions of pa’anga)846.1881.9881.9
Grants in-kind (in percent of GDP)
Total external public debt outstanding
(in percent of GDP)
Sources: Tongan authorities; and IMF staff estimates.
Sources: Tongan authorities; and IMF staff estimates.

9. Discussions were focused on the need to protect fiscal and debt sustainability. The current public debt of Tonga is around 49 percent of GDP. The authorities have been careful not to incur new non-concessional debt in line with the new debt management strategy. Debt sustainability analysis (DSA) conducted by staff suggests that public and external debt are sustainable under the baseline scenario, but there are significant risks emanating from (i) the high wage pressure, (ii) shortfalls in donor financing of the SPG and cost overruns, and (iii) natural disasters. Should these risks materialize, fiscal deficits would widen, potentially necessitating non-concessional borrowing and raising the debt level. Tonga’s overall risk of debt distress under the DSA is classified as moderate.10

10. Staff suggested measures to mitigate the risks. These include:

  • Restraining the wage growth to the level consistent with inflation in order to lower the share of wages in current spending and the GDP (14 percent in FY2016). A new formula for COLA, which is under development, could become a useful annual target starting from FY2017. A broader civil service reform informed by the results of the recent remuneration review should be undertaken in parallel to ensure that employment in government is rationalized and pay scales adequately reflect responsibilities, while the quality of public services is maintained.

  • Rationalize public spending on the SPG and seek donor grants for capital spending. Estimates of financing of capital spending on the SPG range from T$78 to T$93 million. The authorities are in the process of identifying donors for the SPG. Some donors expressed interest (for example China and PNG), but their commitments are yet to be confirmed. Given the risks to debt sustainability, staff supports the authorities’ intention to seek grant financing where possible.

  • Building fiscal buffers to mitigate the effects of natural disasters and to finance the operating costs of the SPG. Given the uncertainty regarding the potential revenue from the departure fee and the FX levy, contingency measures are needed to secure sufficient funding. In addition, maintaining fiscal reserves at three months of current spending is prudent for unexpected contingencies, such as natural disasters. Fiscal consolidation that would be needed to build buffers is estimated at about 1.1 percent of GDP per annum in the next three years. Savings derived from the rationalization of spending in the context of the ongoing expenditure review should be used for accumulating fiscal buffers.

11. Moreover, building resilience is contingent on broader structural reform efforts to increase the revenue and to raise the efficiency of public spending. The government is focused on collection of remaining tax arrears, reviewing tax exemptions, and broadening the tax base. Further improvements in tax administration will be contingent on continued efforts at risk-based supervision, stricter enforcement, improved efficiency as a result of a reorganization of tax administration along the functional lines, and implementation of Automated System for Customs Data (ASYCUDA) in customs with the assistance from PFTAC. In the area of PFM, efficiency gains could be derived from implementation of the reform program for the procurement system, better accounting and reporting (revising the chart of accounts to improve line ministry reporting), and improved commitment controls (enhancing the IFMIS) and budget reporting functions, all of which will support better governance.11 Staff welcomes the recent establishment of an Audit Oversight Committee of the Cabinet with the goal to improve timeliness and ensure a follow-up on audit recommendations as well as an on-going initiative to implement e-government. With the assistance of the ADB, the authorities are conducting a reform of public enterprises to improve their governance and financial results. Altogether, fiscal structural reforms will help create fiscal space for much needed growth enhancing investment in infrastructure and human capital.

Authorities Views

12. The authorities broadly agreed with staff assessment of fiscal outlook and risks. They saw excessive wage growth and spending on natural disasters as the main risks to fiscal outlook. They agreed with the need to rein in the wage bill, noting that they started reducing vacancies already this year. However, they were not ready to commit to a specific target for wage growth, indicating that this decision should await the completion of the organizational effectiveness review that is underway. The authorities reiterated their commitment to seek grant-financing for the SPG. They emphasized their efforts to lower debt burden by refinancing expensive debt to the Retirement Fund Board by using government bonds and negotiating debt relief with Bank of China. They agreed with the need to build fiscal buffers, noting existing provisions in place to respond to natural disasters (see below). In addition, they noted the need to secure resources to service large debt to China starting in FY2019, and the establishment of a sinking fund for this purpose.

B. External Stability

13. The staff emphasized the need to maintain adequate level of international reserves. The current reserve cover, at about 6 months of imports, is adequate according to staff analysis, which weighs economic costs of external shocks against the costs of holding reserves12 although it is above the NRBT’s target range of 3–4 months of import cover. Exchange rate is in line with fundamentals and there are no signs of deteriorating competitiveness (Box 1). However, should pressure on reserves emerge, the NRBT should be ready to depreciate the Pa’anga against the basket of currencies in order to safeguard external stability. More restrained fiscal policy could also be needed to alleviate potential external pressures.

Authorities Views

14. The authorities agreed with staff’s exchange rate assessment and on the need to maintain sufficient reserves, but questioned whether the current level of reserves is excessive. Given large developmental needs of Tonga, they thought that the opportunity cost of holding reserves could be higher than estimated by staff. They expected the reserves to come down in the coming years as investment projects scale up.

C. Monetary Policy

15. Monetary policy stance remained accommodative with growth of broad money and private credit accelerating, and no change in monetary policy is warranted at this time. Broad money (M2) growth increased to 18.2 percent (y/y) in February 2016, from 9 percent (y/y) in June 2015, reflecting accumulation of surplus liquidity in the banking sector and inflows from abroad; and private credit growth increased to 14.6 percent (y/y) in February 2016 from 8.6 percent in June 2015. The credit growth was supported mainly by the implementation of the government-managed loan-subsidy scheme, lower lending rates, a boom in construction, and an increase in commercial loans, and has not been a concern so far. The resumption of credit growth needs to be monitored closely to ensure that risks do not build up. The authorities expressed concerns about the excess reserves of banks, noting that monetary policy tools have not been effective in addressing them. In staff’s view, monetary tightening is not needed at this time, and strong credit growth is not yet a concern, since it started from a low level last year, and there are no signs of overheating. Monetary tightening, however, will be needed should signs of overheating emerge, particularly if inflation were to spike up. Raising the reserve requirement or selling government bonds could be used for this purpose.

16. In the medium-term, the authorities are looking for ways to improve the monetary policy framework. For this, the NRBT is considering introducing a short-term policy interest rate to guide lending and deposit rates. Staff encouraged the NRBT to follow best international practices by setting the neutral policy interest rate above the long run inflation rate and to seek TA from the IMF on the design and implementation of the framework.

17. Staff and the authorities agreed on the need to move away from the current reference range to a lower, more realistic reference rate of inflation. Ever since the reference range of 6-8 percent was introduced in 2011, inflation has fallen well below the range, undermining its usefulness as a guide for monetary policy. Pursuing an inflation range in the context of a fixed exchange rate regime, a weak monetary policy transmission mechanism, and sensitivity to external price shocks has been challenging. Staff advised to set a reference rate at four percent, to be more consistent with historic inflation and better aligned to the medium-term inflation outlook (while preserving a margin to accommodate future domestic and external price shocks). Any changes in reference rate should be publicly explained.

Authorities Views

18. The authorities concurred with staff assessment of monetary policy stance. At present they viewed raising reserve requirement as a first defense against overheating. In the medium-term they wished to expand their monetary policy toolkit to improve monetary policy flexibility and requested technical assistance from the IMF in this area. They have been receptive to the proposal to move to a new inflation reference rate, however, they were noncommittal to specific action deadlines.

D. Financial Stability and Macroprudential Policies

19. Financial sector is highly profitable and stable, but vigilance is needed. Tonga’s banks have strong capital positions and are highly liquid, although their level of NPLs remains elevated.13 Interest spreads have been declining, perhaps reflecting increasing competition in the banking sector and better access to credit information. Credit-to-GDP ratio is still under 30 percent, a low level by international comparisons, and credit growth is consistent with financial deepening. The authorities, however, monitor banks closely, and are willing to explore macro-prudential tools, including loan-to-deposit ratio, loan-to-value ratio, caps on credit to specific sectors, and caps on net interest margin, to prevent a buildup of systemic financial risks. Although the risks from the government subsidy scheme with Tonga Development Bank (TDB) are minimal at this stage, lax lending standards could potentially become a problem. The non-banking financial institutions (NBFIs) sector remains small and is currently effectively unsupervised (although it has been brought under the supervision of the NRBT recently), which could become a concern in the future.

20. The authorities are making effort to strengthen financial stability by upgrading the NRBT supervisory, regulatory, and legal framework. Efforts have focused on strengthening regulations including amending the NRBT Act, and the Banking Act (formerly Financial Institutions Act), and improving the legal framework for all types of financial institutions. Work is ongoing to finalize the Banking Act, as well as other financial sector legislation, which would allow the NRBT to start supervising NBFIs, strengthen the autonomy and accountability of the NRBT, reform its governance framework, provide the NRBT with the powers to issue binding regulations, and entrust the NRBT with clear enforcement actions. Adopting the Banking Act in the near future would improve banking resolution regime, which is currently based on the Company Act. The NRBT continues receiving TA on risk-based supervision for the banking sector from the PFTAC, which would further improve supervising and regulatory capacity of the NRBT.

21. De-risking of global banks has not yet become an issue for Tonga, but the situation needs to be monitored. While some money transfer operators have closed down their operations, World Bank data indicate that remittances inflows have been stable and the transaction costs decreased between 2014 and 2015. At the same time, all Tongan banks have been able to continue normal correspondence banking activities with banks abroad.

Authorities Views

22. The authorities concurred with staff assessment of financial sector risks. They are committed to further improving financial sector supervision and regulation, with TA from PFTAC, and extending supervision to nonbanks. They are concerned about the potential effect of de-risking on banking activity and foreign remittances, and are monitoring developments in the region in order to take actions, if necessary.

E. Financial Deepening, Structural Reforms, and Climate Change

23. The authorities are promoting access to finance to support inclusive growth. The NRBT is currently implementing SMEs finance project and conducting Demand Side Survey to study determinants of credit demand. Mandated credit reporting and extension of credit bureau coverage to non-bank credit providers, such as utilities, aim to reduce costs of due diligence and thereby support access to finance. Revision of the Land Act would help improve development of collateral for personal and business loans and reduce impediments for access to finance. Measures to promote collateral, credit information databases,14 and deposit insurance, are also expected to support financial stability.

24. Government on-lending scheme via TDB has been part of the effort to increase credit to private sector. The scheme involve lending of government funds to small enterprises in selected sectors, such as agriculture, fisheries, education, and microfinance for women at low interest rate, currently 1 to 4 percent per year, and a fixed fee. Although the evaluation of the scheme has yet to be undertaken, anecdotal evidence suggest that accessing funding via TDB has been difficult for small businesses with no credit history or collateral. Therefore, staff recommended to simplify this scheme for small businesses and to consider adopting a comprehensive microfinance approach for informal sector and unbanked population.

25. Raising Tonga’s growth potential remains an overarching goal and will require improving opportunities for private sector development and FDIs. The government has made significant progress in bringing structural reforms up to date, including in regulated utilities and labor market (recently becoming a member of the ILO), public enterprise reform, and is developing legislation to facilitate formalization of the informal sector, including revising the foreign investment act and work permit rules. The authorities continue efforts to adopt the receivership bill and develop bankruptcy policy and legislation based on this bill. They also work to develop a new National Energy Act, which would facilitate competition in the power generation sector, based on a revised Tonga Energy Road Map 2010-20 and continue promoting exports via regional trade agreements. Tonga is a member of the Pacific Island Countries Trade Agreement (PICTA), the South Pacific Regional Trade and Economic Cooperation Agreement (SPARTECA,) and the World Trade Organization (WTO). Still, more needs to be done, as the share of private sector in the economy is low, and FDIs in FY2015 is estimated at a low 2.7 percent of GDP. Staff also recommended to prepare a comprehensive private sector development strategy to guide reform implementation in the medium term.

26. Progress is being made in natural disaster preparedness. Tonga is ranked second on the risk of natural disaster based on the World Bank Risk Index. The authorities are undertaking several initiatives to enhance its resilience in the context of the TSDF II programs targeting (i) rural electrification, (ii) energy efficiency, (iii) Disaster Risk Management training and improving communication with districts and communities, and (iv) completion of specialized hazard maps and detailed analysis. More broadly, they have measures in place to improve ex post and ex ante resilience to shocks within a multi-pillar framework at the national level.15 They have funding arrangements in place to respond in case disaster struck, including ex ante cash emergency fund of T$5 million, with an additional T$1.5 million donor funded emergency financing for rapid response assistance. Ex post arrangements include flash appeal, bilateral and multilateral donor assistance for relief and reconstruction, and capital budget realignment. Additional measures that could be considered include funding through a contingency budget, as well as sovereign catastrophe risk and traditional disaster insurance. At the same time, comfortable gross international reserves supported by favorable external environment and moderate public debt should provide Tonga with some self-insurance in the medium term. A risk scenario in the DSA, integrating projected fiscal costs of future natural disasters into the macro-framework, demonstrates that external debt will remain sustainable, albeit at an elevated level.16

Natural Disaster Risks - World Risk Index, 2015, Top 16

(In percentage points)

Source: 2015 World Risk Report.

Note: Risk combines exposure to natural hazards, coping, and adaptive capacities, ranges 0 to 100 with higher number means higher risk.

Tonga: Strengthening Ex-Ante and Ex-Post Resilience
Risk ManagementMeasures Taken and On-going
Risk AssessmentAssess vulnerability Incorporate disaster costs into−Maintaining an emergency fund of minimum T$5 million for rapid response
national budget planning−Enhance PFM systems
Self InsureBuild buffers− Maintaining funding through contingency budget
− Maintaining adequate gross international reserves and moderate public debt
Risk ReductionEnhance preparedness− Rural electrification program
− Invest in smart infrastructure− Energy efficiency
− Enhance debt management capacity− Disaster risk management training and improving communication with districts and communities
− Completion of specialized hazard maps and detailed analysis
Risk TransferRegional poolingParticipate in sovereign catastrophe risk insurance and traditional disaster insurance
CopingEmergency response and reconstructionMaintaining financial tools and arrangements such as capital budget realignment, bilateral and multilateral donor assistance for relief and reconstruction, flash appeals

Authorities Views

27. The authorities agreed that improving business environment and financial inclusion are key to raising growth potential. In this context, they noted strong pressure from the government and legislature to facilitate more bank lending to the private sector, including by imposing caps on interest rates. Although banks’ interest rate spreads have been declining, average lending rate at 8 percent remains high. Staff warned against imposing interest controls as those could undermine banks’ financial position and lead to less, rather than more credit. Moreover, stimulating more credit growth risks undermining financial stability, at time when credit growth is already strong. Regarding preparedness for natural disasters, the authorities noted that existing arrangements with donors (primarily Australia and New Zealand) for emergency assistance and their support of reconstruction effort in the aftermath of the disasters have been crucial for Tonga’s economy.

Other Issues

28. Data issues. While broadly adequate for surveillance purposes, data quality and timeliness remain a concern, complicating monitoring of economic conditions and policy formulation (see the Statistical Issues in the Information Annex).17 Notwithstanding some progress—national accounts statistics by expenditure have been produced, the balance of payments (BOP) statistics is now in line with BPM6, and the central government budget migrated to GFSM 2001—improvements are needed in many areas, including labor market, household survey, population census, government finance statistics (GFS), compilation of financial soundness indicators (FSIs), and financial access survey (FAS). In this regard, weak capacity and understaffing at the statistics office is a concern, which the authorities are planning to address through technical assistance from the IMF and PFTAC.

Staff Appraisal

29. The performance of Tonga’s economy has improved and the economic outlook is favorable, but there are downside risks. In FY2015 growth strengthened, inflation declined, gross reserves remained at comfortable level, and private credit accelerated. Overall competitiveness of the economy has improved with tourist arrivals increasing and the REER depreciating. Positive growth outlook is expected to continue in FY2016 and the medium-term, with strong external inflows and low fuel prices supporting domestic demand. However, as noted above, there are serious external and domestic policy risks which could cloud the outlook.

30. Fiscal position is expected to improve in the medium-term, and fiscal policy should be aimed at addressing fiscal risks and building buffers. Staff welcomes the authorities’ commitments to rein in the wage bill, and recommends setting up a limit on annual wage growth in line with average inflation. A broader civil service reform is needed in the medium-term to ensure the efficiency of wage spending. Given the risk to debt sustainability, staff supports the authorities’ intension to seek grant financing to cover the costs of the SPG, although strict control over expenditure will be required to prevent cost overruns, and to lower the debt burden via debt relief and refinancing. In addition to fiscal buffers for unexpected contingencies, such as natural disasters, the authorities should build fiscal buffers to cover the operational costs of the SPG. Contingency measures may be needed, if revenue from new taxes to finance the SPG (FX levy and departure fee) falls below projections. Staff encourages the authorities to closely monitor the implementation of the FX levy to ensure its compliance with Tonga’s obligations under Article VIII.

31. Continued progress with fiscal structural reforms along with good debt management will be important to maintain fiscal sustainability and to secure fiscal space for growth-enhancing spending in the medium-term. In line with the new debt management strategy, the government should adhere to the policy of no non-concessional borrowing and seek opportunities to lighten the debt burden. Structural reforms should aim at broadening the tax base, and improving tax administration and PFM, leveraging technical assistance from development partners and the IMF (PFTAC). Fiscal space as a result of these reforms could be used for growth-enhancing investment in infrastructure and human capital.

32. The authorities should maintain gross reserve buffers at the current level to safeguard external stability. Staff estimates that reserves at around 6 months of imports are appropriate for Tonga given its vulnerability to external shocks and fiscal risks, and the exchange rate is broadly in line with fundamentals. The authorities, however, should stand ready to depreciate the Pa’anga against the basket of currencies in order to safeguard external stability should external pressures emerge. More restrained fiscal policy would also be needed to alleviate potential external pressures.

33. The current accommodative stance of monetary policy is appropriate in light of low inflation and strong external position, but vigilance is needed to guard against macro-financial risks. The recent acceleration in the growth of private credit is not a concern as it is coming from a low level and is consistent with financial deepening, given the low rate of banking penetration in Tonga. However the NRBT should stand ready to mop up excess liquidity in the banks should signs of overheating emerge. The banking sector remains stable and profitable. However, the NRBT should continue supervising banks closely and adopt macro-prudential tools as needed to avoid buildup of systemic risks. Global de-risking has not yet affected Tonga in a major way, but risks associated with it should be monitored. To support financial stability more broadly, staff encourages the authorities’ ongoing efforts at upgrading Tonga’s supervisory, regulatory, and legal frameworks. The IMF stands ready to continue providing TA to the NRBT in the area of financial sector legislation.

34. Staff supports the NRBT’s plan to strengthen its monetary policy framework. Staff welcomes the authorities’ intention to move away from the current inflation reference range, which lost its usefulness as a guide for monetary policy, to a new indicative reference rate of inflation, set to be consistent with inflation outlook in the medium-term. Staff also sees merit in introducing a policy interest rate to guide lending and deposit rates and strongly encourages the NRBT to follow best international practices in setting the policy interest rate and developing the monetary instruments. In this regard, staff welcomes the NRBT’s TA request to MCM on enhancing monetary policy framework, improving FX reserve management, and introducing macroprudential policies and instruments.

35. Raising Tonga’s growth potential, requires improving opportunities for private sector development. Staff commends the government’s initiative to improve financial access to support inclusive growth, however warns against excessive reliance on administrative methods of credit allocation. While supporting private sector via government lending schemes, such as in TDB, could be beneficial, caution is needed to ensure that public resources are applied effectively, and international experience should be studied in this regard. Staff notes progress on reforms to improve the business climate, including in the areas of regulation of utilities, labor market, and foreign investment and encourages the authorities to prepare a comprehensive private sector development strategy to guide reform implementation in the medium term. Such strategy should encompass the areas of governance, transparency, business climate, access to external markets, as well as investing in transport, communications, human capital (health and education), and tourism, building on the TSDF II. Additionally, to ensure sustainability of the growth, a comprehensive national strategy along the lines presented by staff is needed build Tonga’s resilience to climate change shocks. Such strategy should encompass measures, including ongoing under TSDF II, to mitigate the risks and to cope once a disaster strikes. Staff welcomes efforts that are already underway to address climate change shocks.

36. Improving economic data remains a high priority. Given the importance of data timeliness and quality for formulation of sound macroeconomic policies, staff encourages the authorities to strengthen capacity of the Tonga Department of Statistics, including through improving staffing, and seek technical assistance from the IMF’s Statistics Department and PFTAC on (i) the System of National Accounts, including developing quarterly GDP and moving compilation to SNA 2008, (ii), external sector statistics, (iii) GFS, and (iv) FSIs.

37. It is recommended that the next Article IV Consultation takes place on the standard 12-month cycle.

Box 1.Tonga: Exchange Rate and Competitiveness 1/

Tonga’s real effective exchange rate is broadly in line with medium-term fundamentals. Other indicators suggest that the economy remains competitive.

Exchange rate

  • Tonga’s real effective exchange rate (REER) is broadly in line with medium-term fundamentals. The current account approach suggests an overvaluation by around 2.2 percent and current account gap of -0.2 percent. REER and nominal effective exchange rate (NEER) have been depreciating since September 2011 suggesting an improvement in external competitiveness.

Other indicators

New Zealand Tourists to Selected Pacific Islands

(In thousands)

Source: Statistics New Zealand.

Exchange Rates and Consumer Prices, Jan.2011-Feb.2016

(Index, 2010=100)

Source: Athorities and IMF staff estimates.

  • Reserves. Gross international reserves remain adequate at about 6 months of the prospective imports in FY2016, which is marginally above the target of 5.6 months of imports calculated using the IMF reserve adequacy template.

  • Exports. Exports recovered quickly from a slump during the global financial crisis and have grown moderately in recent years. In the medium term, exports are projected to grow at about two/three percent, in line with the overall economic growth. Continued lower commodity prices are projected to negatively affect exports, but higher demand for agricultural products (squash and root crops) will compensate for this.

  • Number of tourists. The number of tourists has increased steadily as Tonga attempts to become an attractive tourist destination.

  • Costs of doing business. Tonga remains competitive compared with other PICs, according to the World Bank’s Doing Business 2016 report. Relative strengths include getting credit and electricity, dealing with construction permits, and starting a business. There is room for improvement in terms of registering property and resolving insolvency.

Source: World Bank Doing Business (2016 Doing Business Report).

1/ Higher rank indicates more costly. These indicators should be interpreted with caution due to a limited number of respondents, a limited geographical coverage, and standardized assumptions on business constraints and information availability. These indicators should be intereted with caution due to a limited number of repondents, a limited geographical coverage, and standardized assumptions on business constraints and information availability.

1/ Prepared by Agnes Isnawangsih and Anh Lee (both APD).

Figure 3.Tonga: External and Monetary Developments

Figure 4.Tonga: Financial Intermediation

Figure 5.Tonga: Financial Access

Table 1.Tonga: Selected Economic Indicators, FY2011–17 1/
Nominal GDP FY2015: US$435.4 million
Population (2014): 103.8 thousands
GDP per capita FY2015: US$4182
Major exports: root crops, vanilla, squash, fish
(Annual percent change)
Output and prices
Real GDP 2/2.70.9−
Consumer prices (period average)−0.2−0.4
Consumer prices (end of period)−0.90.1
GDP deflator5.
(In percent of GDP)
Central government finance
Total revenue and grants26.327.425.227.528.227.327.4
Total reveue19.518.019.620.021.423.724.1
Total expenditure and net lending33.730.226.525.729.330.429.1
Of which: Current expenditure22.723.524.925.025.827.826.4
Capital expenditure9.
Overall balance−7.4−2.8−1.31.7−1.1−3.1−1.6
External financing (net)
Domestic financing (net)−1.1−2.41.0−
(Annual percent change)
Money and credit
Total liquidity 3/
Of which: Broad money (M2)
Domestic credit−12.3−
Of which: Private sector credit−9.9−5.2−
Interest rates (end of period)
Average deposit rate2.52.41.982.092.35
Average lending rate12.710.09.448.668.23
(In millions of U.S. dollars)
Balance of payments
Exports, f.o.b.13.616.715.017.917.916.316.2
Imports, f.o.b.−203.4−203.4−187.4−187.6−216.5−217.2−238.1
Services (net)4.7−−2.00.7−5.3
Investment income (net)12.912.
Current transfers (net)96.0123.8140.3128.6144.7183.4191.0
Of which: Remittances68.377.2107.4102.7107.7125.1127.4
Current account balance−76.1−58.5−20.4−35.1−51.4−13.0−31.5
(In percent of GDP)−18.0−12.4−4.5−7.9−11.8−3.1−7.1
Overall balance34.623.12.411.2−
Terms of trade (annual percent change)−4.0−3.01.1−3.3−
Gross official foreign reserves
In millions of U.S. dollars122.1145.2147.6158.7142.5158.6162.0
(In months of next year’s goods and services imports)
Debt (in percent of GDP)
Public debt (external and domestic)43.648.751.445.849.048.748.2
External debt (public)36.041.845.342.
Debt service ratio28.
Exchange rates
Nominal effective exchange rate (2005=100)100.3106.5105.4103.3103.0
Real effective exchange rate (2005=100)101.9108.1105.5103.4101.7
Memorandum items:
Remittances (in percent of GDP)16.116.323.923.224.729.628.8
Tourism (in percent of GDP)
FDI (in percent of GDP)1.6−
Nominal GDP (millions of T$)774.8800.6779.3803.6846.1881.9910.7
Population (thousands)103.0103.3103.5103.9104.1104.4104.6
Sources: Tongan authorities; and IMF staff estimates and projections.

Fiscal year beginning July.

Including preliminary data.

From the Banking Survey which includes the Tonga Development Bank

Sources: Tongan authorities; and IMF staff estimates and projections.

Fiscal year beginning July.

Including preliminary data.

From the Banking Survey which includes the Tonga Development Bank

Table 2.Tonga: Summary of Government Operations, FY2011–FY2017
(In millions of pa’anga)
Total revenue and grants203.8219.4196.7220.9238.3293.4240.7249.6
Total revenue151.0144.4153.0160.9181.4216.4209.1219.0
Current revenue149.1144.2152.3160.9181.4216.4208.5218.4
Tax revenue133.0126.9132.7139.2154.9177.9180.1188.3
Of which: Taxes on income/profits38.325.330.328.834.736.834.936.1
Sales tax and consumption tax81.987.886.995.1103.5115.2123.3128.5
Nontax revenue16.117.419.621.726.538.528.430.1
Capital revenue2.
Grants (in cash)52.875.043.860.
Project grants30.737.932.032.734.057.713.514.4
Budget support23.637.111.827.322.919.218.116.2
Total expenditure and net lending261.1241.5206.7206.9247.6310.8268.0264.6
Total expenditure249.9232.4206.7208.2238.3303.3260.5257.1
Current expenditure175.6187.8194.1201.1218.0272.9245.1240.2
Wages and salaries91.883.684.592.4101.8115.0122.0125.1
Capital expenditure74.444.712.67.120.330.415.416.9
Total lending minus repayments11.29.00.0−
Current balance (excl. project grants)−5.2−9.5−41.8−40.2−36.6−56.5−7.3−21.7
Overall balance (incl. grants)−57.3−22.1−10.014.0−9.3−17.4−27.3−15.0
Primary balance (incl. grants)−50.8−15.6−2.921.1−2.1−9.7−19.6−7.2
Primary balance (excl. grants)−103.6−90.6−46.6−40.2−49.7−49.7−51.2−37.8
Total financing57.322.110.0−14.09.317.427.315.0
External financing65.541.
Domestic financing−8.2−19.18.0−
(In percent of GDP)
Total revenue and grants26.327.425.227.528.233.327.327.4
Total revenue19.518.019.620.021.424.523.724.1
Current revenue19.218.019.520.021.424.523.624.0
Tax revenue17.215.817.017.318.320.220.420.7
Of which: Taxes on income/profits4.
Sales tax and consumption tax10.611.011.211.812.
Nontax revenue2.
Capital revenue0.
Grants (in cash)
Project grants4.
Budget support3.
Total expenditure and net lending33.730.226.525.729.335.230.429.1
Current expenditure22.723.524.925.025.830.927.826.4
Wages and salaries11.810.410.811.512.013.013.813.7
Capital expenditure9.
Total lending minus repayments1.41.10.0−
Current balance (excl. project grants)−0.7−1.2−5.4−5.0−4.3−6.4−0.8−2.4
Overall balance (incl. grants)−7.4−2.8−1.31.7−1.1−2.0−3.1−1.6
Primary balance (excl. grants)−13.4−11.3−6.0−5.0−5.9−5.6−5.8−4.2
Total financing7.42.81.3−
External financing8.
Domestic financing−1.1−2.41.0−
Memorandum items:
Nominal GDP (in millions of pa’anga)774.8800.6779.3803.6846.1881.9881.9910.7
Grants in-kind (in percent of GDP)7.28.911.69.79.711.0
Total external public debt outstanding

(in percent of GDP)
Sources: Tongan authorities; and IMF staff estimates.

Recurrent expenditure excludes one-off expenditure.

Sources: Tongan authorities; and IMF staff estimates.

Recurrent expenditure excludes one-off expenditure.

Table 3.Tonga: Depository Corporations Survey, FY2011–17 1/
(In millions of pa’anga, end of period)
Net foreign assets195.9240.4252.6268.5283.2305.5308.0
Claims on nonresidents224.3267.9277.7299.8316.7345.0347.5
Other depository corporations18.313.89.115.816.816.416.4
Liabilities to Nonresidents−28.4−27.5−25.1−31.2−33.5−39.5−39.5
Other depository corporations−6.4−10.0−7.0−13.0−14.0−19.3−19.3
Net domestic assets109.686.691.3100.4120.1139.2174.8
Net domestic credit243.7209.1214.3231.1266.8302.0339.6
Net claims on government−31.4−58.9−44.4−54.4−50.0−35.1−31.8
Claims on public nonfin. corps.13.613.716.841.747.545.945.9
Claims on private sector261.5247.9229.3230.9250.7274.3308.5
Other items, net−134.1−122.5−123.0−130.8−146.7−162.8−164.8
Total liquidity305.4326.9343.8368.9403.3444.7482.8
Broad money (M2)293.7314.9334.1358.3390.4431.6469.4
Narrow money96.8119.4149.4167.7182.1185.2188.4
Quasi money196.9195.6184.7190.7208.3246.4281.0
Securities other than shares 2/11.811.99.710.512.913.113.4
(Annual percentage change)
Net foreign assets36.922.
Net domestic assets−28.5−
Net domestic credit−12.3−
Claims on private sector−9.9−5.2−
Total liquidity3.
Broad money (M2)
(In millions of U.S. dollars)
Net foreign assets116.1137.3138.8150.1134.6147.4150.7
Claims on nonresidents133.0153.1152.6167.5150.5166.5170.1
Liabilities to nonresidents−16.8−15.7−13.8−17.5−15.9−19.1−19.3
Memorandum items:
Velocity (GDP/average M2)
Loan to deposit ratio94.084.273.569.970
Pa’anga per U.S. dollar (end of period)
Sources: Tongan authorities; and IMF staff estimates.

Comprises the National Reserve Bank of Tonga (NRBT) and other depository corporations (ODCs), including the Tonga Development Bank (TDB).

Comprises bills and promissory notes issued by financial sector and held outside the sector.

Sources: Tongan authorities; and IMF staff estimates.

Comprises the National Reserve Bank of Tonga (NRBT) and other depository corporations (ODCs), including the Tonga Development Bank (TDB).

Comprises bills and promissory notes issued by financial sector and held outside the sector.

Table 4.Tonga: Balance of Payments Summary, FY2011–17(In millions of U.S. dollars, unless otherwise indicated)
Trade balance−189.7−186.6−172.4−169.7−198.6−200.9−221.9
Exports, f.o.b.13.616.715.017.917.916.316.2
Imports, f.o.b.−203.4−203.4−187.4−187.6−216.5−217.2−238.1
Services (net)4.7−−2.00.7−5.3
Investment income (net)12.912.
Current transfers (net)96.0123.8140.3128.6144.7183.4191.0
Official transfers (net) 1/20.735.328.317.621.138.643.7
Private transfers (net)75.388.5112.0111.0123.6144.8147.3
Current account balance−76.1−58.5−20.4−35.1−51.4−13.0−31.5
(In percent of GDP)−18.0−12.4−4.5−7.9−11.8−3.1−7.1
Capital account balance44.756.425.514.220.014.316.6
Financial account balance17.627.7−2.716.214.214.718.4
FDI (net)6.6−1.65.311.711.712.012.8
Other investment (net)11.029.3−
Overall balance2/34.623.12.411.2−
Memorandum items:
Gross official foreign reserves122.1145.2147.6158.7142.5158.6162.0
In months of next year’s goods and services5.
Exchange rate
Pa’anga per U.S. dollar (period average)
Pa’anga per U.S. dollar (end of period)
Nominal GDP (in millions of US$)422.9472.3449.5443.4435.4422.3442.5
Commodity price indexes (2005 = 100)
Sources: Tongan authorities; and IMF staff estimates.

Includes all official grants excluding project funds related to capital formation.

Change in gross official foreign reserves.

Sources: Tongan authorities; and IMF staff estimates.

Includes all official grants excluding project funds related to capital formation.

Change in gross official foreign reserves.

Table 5.Tonga: Medium-Term Scenario, FY2011–21 1/
(Annual percentage change)
Output and prices
Real GDP2.70.9−
Consumer prices (end of period)−
Consumer prices (period average)−0.2−
GDP deflator5.
(In percent of GDP)
Central government finance
Total revenue and grants26.327.425.227.528.227.327.428.628.829.729.6
Total revenue19.518.019.620.021.423.724.124.624.725.225.3
Of which: tax revenue17.215.817.017.318.320.420.721.021.121.621.7
Total expenditure and net lending33.730.226.525.729.330.429.129.529.629.829.7
Current expenditure22.723.524.925.025.827.826.426.126.025.925.9
Capital expenditure9.
Net lending1.41.10.0−
Overall balance (incl. grants)−7.4−2.8−1.31.7−1.1−3.1−1.6−0.8−0.7−0.2−0.1
External financing (net)
Domestic financing (net)−1.1−2.41.0−−1.2−0.1−0.6−0.2
Primary balance (incl. grants)−6.6−1.9−0.42.6−0.2−2.2−
Primary balance (excl. grants)−13.4−11.3−6.0−5.0−5.9−5.8−4.2−4.0−4.0−3.8−3.6
(In millions of U.S. dollars)
Balance of payments
Exports, f.o.b.13.616.715.017.917.916.316.216.617.117.518.0
(Annual percent change)39.922.9−10.619.50.0−8.9−
Imports, f.o.b.−203.4−203.4−187.4−187.6−216.5−217.2−238.1−266.2−275.3−276.1−280.0
(Annual percent change)16.90.0−
Services (net)4.7−−2.00.7−5.3−7.1−2.64.9−2.2
Investment income (net)12.912.
Transfers (net)96.0123.8140.3128.6144.7183.4191.0202.6205.3216.1221.7
Of which: Remittances68.377.2107.4102.7107.7125.1127.4132.4137.7143.8149.8
Current account balance−76.1−58.5−20.4−35.1−51.4−13.0−31.5−48.3−48.9−31.2−35.8
(In percent of GDP)−18.0−12.4−4.5−7.9−11.8−3.1−7.1−10.5−10.1−6.2−6.8
Capital account balance44.756.425.514.220.014.316.618.616.918.117.6
Financial account balance17.627.7−2.716.214.214.718.425.921.121.920.2
FDI (net)6.6−1.65.311.711.712.012.813.414.114.815.5
Other investment (net)11.029.3−
Overall balance34.623.12.411.2−−3.8−
Gross international reserves (end of period)
In millions of U.S. dollars122.1145.2147.6158.7142.5158.6162.0158.2147.4156.3158.2
In months of next year’s goods and services imports5.
External debt (in percent of GDP)
Public sector external debt36.041.845.342.
Debt service ratio28.
Memorandum items:
Private transfers (net, in millions of U.S. dollars)75.388.5112.0111.0123.6144.8147.3153.0159.1166.2173.1
(In percent of imports of goods and services)
Nominal GDP (millions of pa’anga)774.8800.6779.3803.6846.1881.9910.7948.41004.91053.21101.5
Sources: Tongan authorities; and IMF staff estimates and projections.

Fiscal year beginning July.

Sources: Tongan authorities; and IMF staff estimates and projections.

Fiscal year beginning July.

Table 6.Tonga: Financial Soundness Indicators, FY2009–15 1/
(In percent)
Financial sector
Total loans/GDP52.542.935.533.530.533.935.2
Net domestic credit(Year-on-year percent change)
Public non-financial corporations−1.1229.0−
Private sector−3.7−15.6−9.9−5.2−
(In percent)
Risk-weighted capital adequacy ratio22.118.923.930.535.939.839.0
Net interest income to average assets4.
Non-performing loans20.515.315.215.313.912.710.0
Loan loss reserves to gross loans13.314.815.011.611.07.8
Sources: National Reserve Bank of Tonga; and IMF, International Financial Statistics.

Data as of end of fiscal years.

Sources: National Reserve Bank of Tonga; and IMF, International Financial Statistics.

Data as of end of fiscal years.

Table 7.Tonga: Millennium Development Goals, 1990–2015 1/
BaseDegree of
Goal 1: Eradicate extreme poverty and hunger
Proportion of people living below National Poverty Line (%)22.5Below target
Income share held by lowest 20%6.6Below target
GDP per person employed (constant 1990 PPP $)Below target
Employment to population ratio, 15+, total (%)Below target
Prevalence of underweight, weight for age (% of children under 5)1.9On target
Prevalence of undernourishment (% of population)On target
Goal 2: Achieve universal primary education
Total enrollment, primary (% net)92.392.698.984.6On target
Persistence to last grade of primary, total (% of cohort)90.4On target
Literacy rate, adult total (% of people ages 15 and above)99.099.4On target
Goal 3: Promote gender equality and empower women
Ratio of female to male primary enrollment (%) target
Ratio of female to male secondary enrollment (%) target
Ratio of female to male enrollments in tertiary education (%)On target
Share of women employed in the nonagricultural sector (% of total nonagricultural employment)Below target
Proportion of seats held by women in national parliaments (%) target
Goal 4: Reduce child mortality
Mortality rate, under-5 (per 1,000)21.918.917.417.116.7On target
Mortality rate, infant (per 1,000 live births)18.716.215.014.714.4On target
Immunization, measles (% of children ages 12-23 months) target
Goal 5: Improve maternal health
Maternal mortality ratio (national estimate, per 100,000 live births)36.4On target
Births attended by skilled health staff (% of total)92.098.498.0On target
Contraceptive prevalence (% of women ages 15-49)31.534.1Below target
Adolescent fertility rate (births per 1,000 women ages 15-19)25.523.717.615.4Below target
Pregnant women receiving prenatal care (%)97.9Near target
Unmet need for contraception (% of married women ages 15-49)Below target
Goal 6: Combat HIV/AIDS, malaria, and other diseases
Prevalence of HIV, total (% of population ages 15-49)On target
Condom use at last high-risk sexNear target
Proportion of population aged 15-24 years with comprehensive knowledge of HIV/AIDSOff target
Incidence of tuberculosis (per 100,000 people) target
Tuberculosis case detection rate (%, all forms) target
Incidence and prevalence associated with obesityBelow target
Goal 7: Ensure environmental sustainability
Forest area (% of land area)12.512.512.512.5Near target
CO2 emissions (kg per PPP $ of GDP) target
CO2 emissions (metric tons per capita) target
Marine protected areas, (% of territorial water) target
Improved water source (% of population with access)98.698.699.299.699.6Near target
Improved sanitation facilities (% of population with access)94.493.791.691.091.0Near target
Goal 8: Develop a global partnership for development
Aid per capita (current US$)On target
Telephone lines (per 100 people)4.66.929.811.3Near target
Mobile cellular subscriptions (per 100 people)0.00.352.264.3Near target
Internet users (per 100 people) target
Sources: World Bank, World Development Indicators; and Tonga Millennium Development Goals Final Report.

Latest available data are reported for each time period.

Sources: World Bank, World Development Indicators; and Tonga Millennium Development Goals Final Report.

Latest available data are reported for each time period.

Appendix I. Risk Assessment Matrix1
SourceLikelihoodImpactPolicy Response to Minimize Impact
Structurally weak growth in key advanced economiesPreserve fiscal and external policy space to cope with adverse shocks in the short term. In the longer term, boost public investment, and pursue structural reforms to improve the investment climate and reduce dependence on aid and remittances.
An economic slowdown in key advanced countries (New Zealand, Australia, and the U.S.) hosting Tongan overseas workers could weaken remittance inflows. Tonga’s exports would be also significantly affected.High/MediumMedium/High
Significant China slowdown
Tonga would be affected indirectly through China’s trade links with New Zealand/Australia, and directly through a slowdown in Chinese official development assistanceLow/MediumMedium
Persistently lower energy prices
Tonga would on balance benefit from the lower energy prices. However, persistently lower oil prices would discourage certain investments, including in seabed mining and renewable energy.HighLow
Reduced financial services by global/regional banks (“de-risking”)
Stricter global regulatory requirements could further push MTO to close down, which could potentially increase the cost of inward remittances.MediumLow
Slippages in the execution of policy reform
Slippages in the reform process could derail critical reforms agreed with development partners. Such an outcome could affect grant flows for budget support, resulting in a significantly larger gross financing gap.LowHighTake early remedial actions, including stronger commitment to ensure fiscal prudence, renewed reform

efforts, and streamlining the Games, to redress impaired
Cost overrun relating to the 2019 South Pacific Games and wage pressure
Excessive wage growth and/or underestimating the true cost of construction works could make it necessary to mobilize additional resources and might necessitate corrective fiscal consolidation in the long run.Medium/HighHighconfidence and re-energize support by the donors.
Natural disasters (regional)Prepare for future disaster by: (i) building fiscal space and maintaining international reserve buffers, (ii) participating in catastrophic insurance schemes; and (iii) following disasters, using programs and funds available through global financial safety nets.
Natural disasters similar to the recent cyclone could take significant toll on Tonga, such as damages to infrastructure and production base.Low/mediumHigh
Appendix II. Frequency and Impact of Natural Disasters in Tonga1

Tonga faces a high risk to natural disasters. Tonga, a small island close to equator, is exposed to cyclones, floods, earthquake, droughts, and sea-level rise. In the past five years, Tonga was affected by natural disasters more frequently than previously, with average sustained winds of cyclones passing through Tonga increasing. In early 2016, cyclone Ula battered northern islands of Tonga with minimum damage. In February, tropical cyclone Winston double hit Tonga within a week, leaving some minor damage and power outage. The United Nation University’s World Risk Index ranked Tonga second of 171 countries in 2015, up one rank from 2014 on account of deteriorating adaptive capacities.

Natural Disasters in Tonga, 1961-2015
TypeDateTotal damageTotal affectedTotal deaths
(in thousands of US$)(persons)(persons)
Source: EM-DAT database.
Source: EM-DAT database.

Strong Tropical Cyclones in the South Pacific, 1985-2016

Source: Meteorological Service of New Zealand, Regional Specialized Meteorological Center in Nadi, Fiji

Average losses from disasters in Tonga have been substantial. Across the Pacific, which is the most vulnerable region in per capita terms, Tonga is among the most affected by disasters over the past 20 years. According to data on the costs of recent disasters (for example, storms, floods, earthquakes, volcanic activity, etc.) from the EM-DAT database (see also table above), Tonga suffered damages and losses to property, crops, and livestock equivalent to about 1.9 percent of annual GDP over the period from 1996 to 2015. This is second only to Vanuatu, which experienced massive losses in 2014 after Cyclone Pam.

In addition to human cost and damages, natural disasters also lower long term growth, weaken fiscal position and the current account. For damage and losses equivalent to 1 percent of GDP, growth drop by 0.7 percentage point in the year of the disaster, according the IMF recent research.2 Actual damages and losses during 1980-2014 reduced trend growth by 0.7 percent. Additionally, post-cyclone incomes do not recover for 20 years, effectively pushing the GDP trajectory downwards, and that a 90th percentile event (i.e. wind speeds of up to 19.5 meters per second) can effectively undo 3.7 years of average development.3 Recent cyclone Ian in January 2014 is estimated to cost 45.4 million US$ or 11 percent of GDP.4 Staff estimates a weakening of current account by 2.5 percent of GDP in FY2014 and 9.1 percent in FY2015 and an increase in total expenditure by 2.5 percent of GDP in FY2015.

Estimated Impact of Cyclone Ian(In percent of GDP)
FY 2014FY 2015
Total expenditure and net lending26.325.7−0.626.829.32.5
Current account (in percent of GDP)−5.4−7.9−2.5−2.7−11.8−9.1
Sources: Tongan authorities; and IMF staff estimates.
Sources: Tongan authorities; and IMF staff estimates.

The population has remained broadly constant at around 100,000, despite a high birthrate, reflecting large-scale emigration to Australia, New Zealand, and the United States, as well as a low life expectancy of estimated 72.6 years in 2014. (World Bank, World Development Indicators).

Severe cyclones occurred in 1982, 1991, and 2014.

Capital costs of the SPG are currently estimated at T$93 million, or 9 percent of estimated GDP in FY2019. The government seeks donor support to cover capital costs of the SPG.

He is the first commoner to become a PM in Tonga.

Of the Legislative Assembly’s 26 members, 17 members are elected by popular vote, and nine are chosen by 33 nobles.

Fiscal year in Tonga runs from July 1 to June 30.

The value of local currency is determined by a weighted basket of currencies comprised of the US, Australian, and New Zealand dollars, and the Japanese yen with the US dollar as the intervention currency, and the monthly maximum adjustment limit set at 5 percent.

The decline in project grants is linked to under-implementation of projects, and thus, is deficit-neutral. Following a change in risk rating under Joint Debt Sustainability Analysis by the IMF and the WB in 2014 from high to moderate, the WB and the ADB changed their financial support to Tonga from 100-percent grants to 50:50 ratio of grants to loans.

The FX levy was slated to be imposed in FY2016 on financial institutions by taxing financial institutions on the spread on the purchase and sale of foreign exchange. However, a delay in the implementation of FX levy occurred amid lack of clarity about its modalities and concerns about possible Fund jurisdictional implications of the FX Levy, which has resulted in Tonga’s parliament passing amendments to the underlying law. In the end, the levy was implemented at a rate of ½ seniti per Pa’anga on the Pa’anga value of the spread, where “spread” is the difference between the actual transaction rate and the midpoint rate quoted by the NRBT, beginning June 1, 2016. Fund staff will monitor whether the operation of FX levy gives rise to jurisdictional concerns. For departure fee, the plan was to raise it from T$65 by T$100, but concerns about its impact on tourist arrivals have led to a delay in its implementation. Together the two measures were expected to raise T$7.5 million per year.

See Staff report for the 2016 Article IV Consultation—Debt Sustainability Analysis—Update.

Progress is being made in these areas with the assistance of PFTAC, the WB and the ADB.

See Box 2 of the Staff Report for the 2015 Article IV Consultation. The analysis by the staff remains valid to date.

There are five banks operating in Tonga. However, the NRBT prohibited one bank from deposit-taking after its capital position and liquidity weakened last year.

Currently, the credit bureau is located in Fiji for a number of the Pacific islands (, though it would be more effective to move it to Tonga.

See the multi-pillar framework on strengthening ex ante and ex post resilience in Caberon, Hunter, Tumbarello, Washimi, and Wu, “Enhancing Macroeconomic Resilience to Natural Disasters and Climate Change in the Small States of the Pacific,” IMF Working Paper, WP/15/125.

See “Staff Report of the 2016 Article IV Consultation—Debt Sustainability Analysis Update”, IMF.

Tonga has been participating in the Enhanced General Data Dissemination System (e-GDDS) since May 30, 2006.

The Risk Assessment Matrix (RAM) shows events that could materially after the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Prepared by Agnes Isnawangsih (IMF) and Johannes Wolf (AsDB).

IMF Working Paper 15/125.

S.M. Hsiang and A.S. Jina. 2014. The Causal Effect of Environmental Catastrophe on Long Run Economic Growth: Evidence from 6,700 Cyclones. NBER Working Paper. No. 20352. Cambridge, MA.

IMF 2014 Staff Report.

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