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Statement by Marzunisham Omar, Executive Director for of Tonga, and Mardini Eddy, Senior Advisor to the Executive Director of Tonga, June 13, 2016

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
June 2016
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Mr. Omar and Mr. Eddie submitted the following statement:

On behalf of the Tongan authorities, we would like to express our sincere appreciation to the IMF mission team for the constructive and candid discussions during the 2016 Article IV Consultation. The discussions mainly centered on policies to further strengthen the resilience of Tonga’s economy, preserve macroeconomic and financial stability, and improve long term growth prospects. The authorities broadly agree with the thrust of the staff assessment of the macroeconomic performance, the risks to the economic outlook, as well as the proposed reforms and policy recommendations to enhance Tonga’s long-term growth prospects.

Recent Economic Developments and Outlook

Tonga’s economic recovery from the devastating effects of Cyclone Ian in January 2014 continues to gather momentum. The National Reserve Bank of Tonga (NRBT) estimates economic growth of 3.3 percent for FY2016 (July 2015 to June 2016), from an estimated 3.7 percent in FY2015 and 2.1 percent in FY2014. The average growth rates over the past three years have been driven by reconstruction efforts following the cyclone’s aftermath, as well as increased activity associated with the Coronation in July 2015 and the upcoming 150th Anniversary for Tupou College in June 2016. Growth is forecast to moderate to 1.9 percent in FY2017. Remittances remain a reliable source of income while the agriculture sector is expected to record higher export volumes with the production of new crops and emergence of new export markets.

Inflation picked up 1.4 percent (year-on-year) in March 2016, following seven consecutive months of deflation. However, the authorities expect that inflationary pressure will be moderate in the remaining months of FY2016 to record an annual deflation of 0.84 percent by June 2016. On the external front, foreign reserves have grown to record high of TOP323 million at end-April 2016, equivalent to 9 months of imports, significantly higher than the standard requirement of 3-4 months of import coverage, reflecting strong remittances and foreign aid. The narrowing of the current account deficit in FY2015 is attributable to the lower oil and import prices, however, moving forward the trade deficit is expected to widen further due to the projected increase in imports in preparation for the 2019 Pacific Games.

The authorities agree with staff’s assessments of a positive outlook of the economy in the medium term. The hosting of the 2019 Pacific Games will be a boon to the services and tourism industry, as well as the construction sector, where a number of projects have been earmarked including the airport refurbishment, hotel renovation, construction of new resorts, as well as the resumption of projects delayed in 2014/2015. Tonga will also likely to benefit from the promising potential of the seabed mining industry in the next five years where exploration is under way for oil, and industrial metals such as gold, silver and copper. In terms of inflation, the authorities expect inflation to gradually pick up in FY2017, although inflation risks may rise in the near-term if the upturn in oil prices persists.

The authorities are in agreement with staff that the overall balance of risks to the economy is tilted to the downside. Tonga is vulnerable to a multitude of risks due to its small geographical size and location. On the external front, weak global growth especially for its main trading partners, may affect foreign aid, remittances and trade volumes while an upturn in global oil and food prices could lead to inflationary pressures. In addition, a major risk is natural disasters and volatile weather conditions, as evidenced by the hurricane and drought already experienced in 2016.

Fiscal Policy

The authorities remain committed to fiscal discipline, lowering the fiscal deficit and building fiscal buffers. The 2015/2016 budget theme was “Improved Government Delivery and Accountability”, to support the Tonga Strategic Development Framework 2015-2025 (TSDF II), through promoting enhanced good governance at all levels of the society. The authorities are guided by four key principles in their fiscal strategy, namely (i) delivering good governance; (ii) building inclusive and sustainable growth; (iii) alleviating poverty; and (iv) providing safe and better public infrastructure.

In the pursuit of fiscal prudence, the authorities recognize the need to improve the productivity and quality of the civil service, with a review of the productivity, efficiency and effectiveness of line ministries currently underway. The authorities are steadfast in their commitment to reform the civil service and contain the public sector wage bill, including cost of living adjustments (COLA). Steps have already been taken to eliminate half of the unfilled vacancies in the first three months of 2016, and the outstanding vacancies will be gradually abolished. A Remuneration Authority has been established to advise the government on the suitable level of COLA, and the authorities are also reviewing the Employment Relations Bill to review the civil and private sector employees’ wages.

The authorities concur with staff on the need for improvements in public financial management and the collection of government revenues. Measures have been adopted by the relevant departments to improve the collection of taxes and arrears, and corporate planning and budgeting, where the tax administration, working closely with PFTAC, is currently undergoing a structural review of its procedures.

The authorities are implementing a prudent fiscal and borrowing strategy of not incurring new concessional debt and will work closely with its development partners for budget support. With Tonga’s expected moderate risk level of debt distress rating over the medium term and the present level of external debt, the authorities are committed to maintain external debt at a sustainable level and explore ways to mitigate the costs and risks in the debt portfolio. The authorities acknowledge staff’s views for Tonga to safeguard its fiscal and debt sustainability and accumulate fiscal buffers, and gradually reduce its reliance on budget support. The Ministry of Finance and National Planning (MoFNP) recently produced its inaugural Medium Term Debt Strategy (MTDS), outlining alternative borrowing strategies which could help meet its debt objectives and achieve a more desired balanced composition of public debt. The authorities will, over the coming years, execute the various identified strategies.

Tonga will host the Pacific Games for the first time in 2019, and in preparation for the events, investment in sporting and related infrastructure will be implemented over the next few years. The authorities are confident in meeting the funding requirements for the Games and are presently working with its development partners to secure grant financing. Additionally, the Foreign Exchange Levy (Amendment) Act 2016 was passed on April 28, 2016 and will be effective from June 1, 2016, the revenue of which will help contribute to finance the Games’ operational costs. A fee for airport departures is also likely to be levied beginning July 2016, for the same purpose.

Monetary and Financial Stability

The authorities share staff assessment that the current accommodative monetary policy stance is appropriate, and stand ready to take appropriate measures if there are signs of overheating. The current inflation reference range of 6-8 percent range is consistent with the previous experience of high inflation, given Tonga’s exposure to volatilities in global commodity and food prices, as it imports most of its goods. Nonetheless, the authorities are keen to explore other monetary policy instruments to enhance its monetary policy framework, including macroprudential tools and liquidity management, and would welcome technical assistance from the Fund in these areas.

While staff assess that the current reserves cover of 6 months of imports is adequate, the authorities view the level as high, given the opportunity cost of maintaining the reserves in comparison to the various investment needs of the country. Nevertheless, the authorities acknowledge the need to maintain the current level of reserves given the country’s ability to generate foreign currency receipts is not so robust, as it currently relies heavily on government donor funds and remittances while structural reforms required to boost the export and tourism sectors will take time to materialize. The outlook on payments, on the other hand, includes higher imports for the Games and the payment of principal loan amounts starting in 2019.

On financial stability, banks remain liquid, profitable and well-capitalized with risk-weighted capital ratio (RWCR) at 37 percent, well above the statutory minimum requirement of 15 percent. NPLs are currently around 10 percent, significantly lower than the 20 percent level in FY2009, and the authorities will continue work on lowering NPLs further. Credit growth is strong but as rightly pointed out by staff, this is based on a lower base and consistent with financial deepening. The authorities expect construction work and private lending in preparation for the Pacific Games to support credit growth in the next few years. Banks weighted lending rate stood at 7.94 percent in March 2016 compared to deposit rates of 2.23 percent, and interest spreads are gradually narrowing, although the authorities view the annual percentage rates as still being quite high. The authorities acknowledge the rising credit growth trend and excess liquidity in the banking system. As the loans to deposit ratio for the banking system of around 76 percent is below the benchmark of 80 percent, there is potentially still room for growth in prudent lending. Nonetheless, the authorities will continue to be vigilant and diligent in their surveillance and supervision, and will stand ready to address potential risks to preserve financial stability.

NRBT is making great advances in strengthening its supervisory, regulatory and legal framework. The authorities are presently working on the laws for the licensing and supervision of non-bank financial institutions, including the microfinance institutions, money lenders, credit unions, as well as amendments to the Foreign Exchange Control Act and the Financial Institutions Act, which will be renamed as the Banking Act. Initiatives are also underway to improve financial access and financial inclusion, where Tonga is committed to the Maputo Accord 2015 under the Alliance for Financial Inclusion (AFI), which include developing and improving access to finance of the small to medium enterprises (SMEs), women and youth, and developing policies and regulations for SME finance, consumer protection and financial literacy. The authorities are also keen to highlight that the global de-risking situation has had some noticeable impact on the local financial players, and will closely monitor developments in correspondent banking relationships for the local banking and money transfer operators.

Structural Reforms

Tonga is moving progressively to achieve the goals of the TSDF II and to achieve a long-term vision of “A more progressive Tonga supporting a higher quality of life for all”. The authorities concur with staff assessment on the calls to create a conducive and dynamic business environment to stimulate private enterprises and attract further foreign direct investment. A host of existing and new legislations are either under review or being considered, a number of which will facilitate the development of the private sector. The authorities are also cognizant of the need to review the Land Act to address existing gaps in the legislation and improve the usability of lands, for improving access to credit for example. Separately, the first National Agriculture Sector Plan was also endorsed by the Cabinet in December 2015. This five-year plan identifies measures to boost and modernize the agriculture industry across the board, where TOP36 million of government and Public Private Partnership (PPP) funds will be invested, and will also involve collaborations with the World Bank, International Fund for Agricultural Development (IFAD) and United Nations Development Programme (UNDP).

The decline in fuel prices over the past two years have benefitted the economy greatly. But being an oil importer, Tonga is vulnerable to volatilities in global commodity prices. To address the nation’s long-term energy requirements, the authorities launched the Energy Roadmap in 2010, establishing an objective of achieving 50 percent renewable energy (RE) source by 2020. The vision involves the participation of seven ministries as well as the private sector. Several important steps have been undertaken, including developing legislations to enable RE projects and PPP schemes to move forward, restructuring the petroleum sector to be more efficient, and working with development partners. There is a good potential for greater use of renewable energy in Tonga including wind, ocean and solar energy, where 5.5 mW of solar energy is required to achieve the 50 percent RE target.

As noted by the World Bank Risk Index, Tonga is one of the world’s most exposed to natural disaster country. Apart from the provision for an emergency fund allocated in the annual budget, additional efforts are required to mitigate the risks of natural disasters including climate proofing of infrastructures and monitoring ocean and weather patterns. The authorities are very much aware of the need to increase climate resiliency, and to that end, the Cabinet recently approved a climate change policy which will look at data management, research and information, as well as capacity building in this area. The authorities also wish to note that the existing arrangements with its close partners for emergency assistance is a crucial element to address these challenges and is working with various parties including the European Union and the World Bank on climate resilience projects.

The authorities agree with staff assessment on the need to increase capacity in its data provision, and the importance of data quality and timeliness. In this respect, the authorities would like to express their appreciation for the technical assistance received from the Fund and PFTAC, and look forward to further technical assistance, especially on national accounts, external sectors and banking legislations.

Final Remarks

The Tongan authorities remain resolute in their commitment to implement broad-based structural reforms, and build buffers to meet potential headwinds with a view to achieve their long-term economic goals. The authorities will focus on the successful implementation of the policy recommendations, while maintaining adherence to the principle of good governance.

The authorities wish to acknowledge the support and assistance provided by the Fund including PFTAC, World Bank, Asian Development Bank, and other development partners, and look forward to continuing their long-standing cooperation and partnership with the Fund.

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